Choosing between Pension and Lump Sum Withdrawals

When you are aged over 60 all withdrawals, whether they are Pension or Lump Sum withdrawals are tax free.  However when aged between 55 and 59 Pension and Lump Sum withdrawals may be subject to tax and the tax will differ depending on the which withdrawal type you make. 

Given the difference in the taxation treatment of accessing monies from your SMSF as a Pension or Lump Sum when you are aged between 55 and 59, it is sometimes preferable to treat withdrawals as a combination of both a Pension and Lump Sum, rather than solely as a Pension once you commence a Simple Account Based Pension between the age of 55 and 59.  It is important to understand that if you have commenced a Simple Account Based Pension it means you are "Retired" and this is a precondition to being able to take Lump Sum withdrawals.  You cannot make Lump Sum withdrawals when you commence a TRAP and Pension payments are capped at 10% of your Super Benefit.

Remember your Super Benefit is made up of two components, namely a Tax Free Component and a Taxable Component.  The Tax Free Component typically comes from after tax personal Non Concessional Contributions made by you over time.   The Taxable Component typically comes from Concessional Contributions made by you over time which include Employer Contributions and Salary Sacrifice Contributions. 

Any withdrawals must be paid in the same proportion as the Tax Free and Taxable Components of the Member's interest in the SMSF.  This requirement is known as the "Proportioning Rule".  Under the "Proportioning Rule" and where the Member is aged between age 55 and 59, the "Tax Free" Component of the withdrawal is tax free.  The "Taxable" Component of the withdrawal is taxed differently depending on whether it is a Lump Sum or a Pension.  That is the "Taxable" Component of the Pension withdrawal is taxed at the Members marginal tax rate less a 15% "Pension Rebate".  Alternatively the first $165,000 of a Lump Sum withdrawal is tax free and the balance is taxed at 16.50%.

Example 

Barney is 58 and has a Super Benefit of $1,000,000 made up as follows:

	$
Taxable Component:	$800,000
Tax Free Component:	$200,000
Total Super Benefit:	$1,000,000

In the above example this means that 80% ($800,000 / $1,000,000) of Barney's Super Benefit is taxable and $20% ($200,000 / $1,000,000) is tax free.  Barney commences a Simple Account Based Pension on 1 July and must access 4% of his Super Benefit as a Pension (ie $40,000).  

Assume Barney decides to access $150,000 from his SMSF.  If the entire amount was treated as a Pension withdrawal, Barney would pay a whopping $16,150 in tax.  That is he would be taxed on 80% of the Pension Income of $150,000 (ie $120,000).  Tax on $120,000 is $34,150.  After applying a 15% "Pension Rebate" of $18,000 ($120,000 x 15%) the net tax payable is $16,150.  If Barney alternatively had chosen to take the Minimum Pension of $40,000 only and treat the additional withdrawal of $110,000 as a Lump Sum Withdrawal, the tax result would be completely different.

That is on the $40,000 Pension withdrawal, Barney would be taxed on 80% of the Pension Income (ie $32,000).  Tax on $32,000 is $2,960.  After applying a 15% "Pension Rebate" of $4,800 ($32,000 x 15%) the net tax payable is $0.  It is noted that if the Pension Rebate creates a refund the refund is lost.

On the remaining $110,000 Lump Sum withdrawal, Barney would be taxed on 80% of the Lump Sum Withdrawal (ie $88,000).  Given that Barney can access the first $165,000 in Lump Sum withdrawals tax free, the entire $110,000 would be tax free.

This means that Barney's withdrawal of $150,000 is now completely tax free (ie a Pension Withdrawal of $40,000 that is tax free plus a Lump Sum Withdrawal of $110,000 that is tax free).  This simple strategy has saved Barney $16,150. 

Now the good news 

Trying to determine the optimal way to treat withdrawals can be difficult.  This is why ESUPERFUND does it for you as part of the annual compliance process.  Even better we will prepare all supporting paperwork absolutely FREE of charge.  Most accountants would charge $1,000 or more for the same service.