Commencing a Pension in your SMSF
When you reach Preservation Age you have the option of commencing a Pension Income Stream from your SMSF. A Pension simply means that periodically (e.g. each month or other period you nominate) cash is transferred from your SMSF Bank Account to your personal Bank Account to fund your living expenses.
Generally, you must reach preservation age before you can access your super. Use the following table to work out your preservation age.
|Date of birth
|Before 1 July 1960
|1 July 1960 – 30 June 1961
|1 July 1961 – 30 June 1962
|1 July 1962 – 30 June 1963
|1 July 1963 – 30 June 1964
|From 01 July 1964
The two types of Pensions that you can commence in a SMSF are as follows:
Simple Account Based Pension:
A Simple Account Based Pension is an income stream that you receive from your SMSF when you reach age 65 or alternatively when you are aged between Preservation Age and 64 and "Retired".
Transition to Retirement Pension (TRAP):
A Transition to Retirement Pension (TRAP) is an income stream that you receive from your SMSF when you are aged between Preservation Age and 64 and NOT "Retired".
Which Pension should you commence?
This issue typically confuses clients. In reality there is really no choice. If you are over 65 or you are aged between Preservation Age and 64 and are "Retired" you can only commence a Simple Account Based Pension. If you are aged between Preservation Age and 64 and are NOT "Retired" then you can only commence a Transition to Retirement Pension (TRAP). Therefore in order to determine which Pension to commence the definition of "Retirement" is important and the definition will vary depending on when you cease work.
If you cease employment after age 60, "Retirement" means you simply cease your employment. In this case the intention to return to the workforce is irrelevant. This means that you can essentially return to work soon after ceasing your employment after age 60, but you will still deemed to be retired and able to commence a Pension. The definition of retirement in this case is less stringent than for those under 60. A "Retirement" Declaration must be signed if you cease employment after age 60 and can be found here.
If you cease employment between Preservation Age and 59, "Retirement" means that at the time you ceased employment you never intended to work again either on a full-time or part-time basis (defined as more than 10 hours per week). This declaration must be made to your SMSF and is made at the time you cease employment. It is noted that whilst a person who ceases employment when aged between Preservation Age and 59 never intends to work again, they may ultimately do so. This will not alter the person's status of being retired enabling them to have access to their Super Benefit notwithstanding they have returned to work. A "Retirement" Declaration that must be signed if you cease employment between Preservation Age and 59 can be found here.
Benefits of commencing a Pension
There are several benefits in commencing a Pension from your SMSF. The obvious benefit is that you are able to commence accessing your Super Benefit after Preservation Age even if still working. This will help with living expenses as and when they arise. However this is not the main benefit of commencing a Pension from your SMSF. The main benefit of commencing a Pension is that the SMSF tax rate effectively reduces to NIL for all income and realised capital gains made by the SMSF when you commence a Pension. This means that all income and realised capital gains on your share of the SMSF after the Pension has commenced will be tax free. Consider the benefits when you commence a Pension from your SMSF:
You never pay tax on your investment earnings in the SMSF (e.g. interest and dividends).
You never pay tax on your investment's realised capital gains made by your SMSF.
You receive a cheque from the ATO each year equal to any franking credits received by your SMSF.
You can access any level of income from your SMSF subject to an aged based minimum amount.
The Pension income you access is tax free if you are aged above 60.
The Pension income you access is concessionally taxed if you are aged between Preservation Age and 59.
You do not have to change your SMSF Investments when you start a Pension.
Taxation of Income and Realised Capital Gains in the SMSF
As detailed above the SMSF tax rate reduces to NIL on all income and realised capital gains on your share of your SMSF, when you commence a Pension. This means that all income and realised capital gains on your share of the SMSF after the Pension has commenced will be tax free. Importantly any accumulated capital gains up to the time of commencing the Pension will also never attract tax if sold after the SMSF converts to a Pension. For example, assume you bought shares in the year 2015 for your SMSF and they increased in value by $100,000 by July 2015 when you commenced a Pension. As long as you sell the shares after July 2015 when you commenced the Pension you will never pay tax on that capital gain. For more details click here.
Refund of Franking Credits
Given that there is no tax payable on your share of the SMSF income including dividends, when you commence a Pension you are entitled to receive any franking credits on Australian Share dividends in cash from the ATO. Franking Credits simply represent tax paid by Australian companies on dividends your SMSF is receiving. Given that the company has paid 30% tax and your SMSF tax rate on dividends is Nil when you commence a Pension, the entire 30% tax paid is refundable to your SMSF. Example: For every $10,000 received in fully franked dividend income, your SMSF receives $4,285 as a cash refund from the ATO each and every year the dividends are paid, after you commence a Pension!
Investments do not change
Nothing changes when you commence a Pension. That is your investments stay as they are. All that happens is that you execute documentation declaring that you wish to commence accessing your Super Benefit as an income stream. Even better the documentation is prepared for you by ESUPERFUND when you are ready to commence your Pension. For example if your SMSF owns cash and shares, then when you commence a Pension these assets stay as they are. You do not need to sell the shares or transfer the cash to another account in the above example. The only difference you will notice before and after commencing the Pension is that your SMSF will no longer pay tax on earnings and realised capital gains!
Minimum Pension Income
Irrespective of whether you commence a Simple Account Based Pension or a Transition to Retirement Pension, you must take a Minimum Pension amount annually. The Minimum Pension amount is calculated as a percentage of your Super Balance based on your age as follows:
||Minimum Pension Factor
|65 - 74
|75 - 79
|80 - 84
|85 - 89
|90 - 94
|95 or more
In the Pension Commencement Year the percentage to be taken is applied to the Commencement Value of the Pension in that year (prorated if commenced part way during the year). Importantly each Financial Year the Pension Balance is recalculated on 1 July and the percentage is applied to the new balance on that date to determine the minimum amount that must be drawn in the relevant year.
For example, assume your SMSF has total assets of $1,000,000. The SMSF has 2 Members, you and your Spouse. Your proportional ownership of the SMSF is 60% so your Super Benefit in the SMSF is $600,000. You decide to commence a Pension with your Super Benefit but your Spouse who has a balance in the SMSF of $400,000 does not commence a Pension as they are only aged 50.
Accordingly you apply to commence a Pension using the ESUPERFUND online Pension Application. You nominate a commencement date of 1 January 2015 and are 60 years of age at the date of the Pension commencement. In this case the minimum Pension you must take per annum is 4% or $24,000. However given that the Pension is being commenced halfway during the year then only half of the minimum pension payment must be accessed before 30 June 2015, that is $12,000.
On 1 July 2015, assume that the SMSF assets have increased to $1,100,000. Your 60% proportional interest in the SMSF will in turn increase to $660,000. In this case the minimum pension amount will be recalculated for the following year ending 30 June 2016 to 4% of $660,000 or $26,400. This amount must be accessed before 30 June 2016. The recalculation will continue to occur 1 July each year.
Maximum Pension Income
With a Simple Account Based Pension, there is no maximum amount you need to take when you commence a Simple Account Based Pension. This means that you can take all your Super Benefit as and when desired.
With a Transition to Retirement Pension (TRAP), the maximum annual pension drawdown for a TRAP is 10%. This amount is not prorated if the Pension is commenced part way through the financial year.
Pension payments must be made to your personal Bank Account. You will need to arrange to transfer monies from your SMSF Bank Account to your personal Bank Account to evidence the Minimum Annual Pension Payment required. The transfer of monies can occur at any time and for any amount during the Financial Year as long as it exceeds the Minimum Pension Payment required. That is the nominated Pension payment can be paid either monthly, quarterly, half-yearly on an annual basis or other timeframe you elect, but must be paid at least annually.
Not accessing the Minimum Pension Payment
A SMSF must adhere to the minimum Pension payment rules. If a Member does not take their minimum Pension payment for a particular financial year, then the tax free status of the Member's share of the SMSF earnings and realised capital gains may be at risk as the Member may not be considered to be in Pension Phase. In addition one of the objectives of the SMSF Investment Strategy is to have sufficient liquidity to meet all SMSF outgoings including Pension payments. Accordingly to ensure that you do not breach the SMSF Investment Strategy and Pension Regulations, you must ensure there is always sufficient liquidity to meet all the Pension payment requirements of the SMSF.
How long does it take to establish a Pension?
When you submit a Pension application online with ESUPERFUND you are required to nominate a Pension Commencement Date between 1 July of the current financial year and today's date. The date nominated will be the Pension Commencement Date.
If your SMSF is required to lodge a Tax Return for the prior financial year and has not done so, then the Pension documentation will be unable to be processed until the prior years' tax return has been prepared and lodged. If the prior years' tax return has been lodged or is not required to be lodged, you can expect to receive the Pension documentation for signing within 5 working days of making the Pension application.
Irrespective of when you receive the Pension documentation, the Pension will be deemed to have commenced on the date nominated in the original application. This means that the tax benefits begin to accrue from that date notwithstanding that the documentation may not be signed until a later date. It is also important to note that the Pension documentation does not need to be lodged with the ATO and is held on file. It will only need to be provided to the ATO if requested. The ATO is notified of the Pension Commencement when the SMSF lodges its next Tax Return.
When to commence accessing the Pension
You can commence accessing your Pension at any time after the Pension commencement date nominated in the online Pension application made on the ESUPERFUND website. It does not matter if the Pension documentation has not been signed or returned to our office.
Additional Contributions and Rollovers are allowable after commencing a Pension
You can continue to contribute to your SMSF and rollover monies to your SMSF from another Superfund, after you commence a Pension. For contributions you are still subject to the contribution rules which can be found on our website here. You should bear in mind that Concessional Contributions (which include Employer and Salary Sacrificed Contributions) continue to be subject to tax at 15% even after you commence a Pension.
Allocating Contributions and Rollovers after commencing a Pension
Before you commence a Pension your SMSF Benefit is recorded in your "Accumulation Account". When you commence a Pension your SMSF Benefit is transferred and recorded in your "Pension Account". These are simply "Accounting Entries" in your SMSF and do not require separate Bank Accounts for each Account Type.
Unlike Retail Funds, a SMSF can accept contributions (subject to the normal contributions rules) and rollovers after the Pension has commenced. These contributions and rollovers continue to be made to the Transaction Bank Account setup for your SMSF. When you make additional contributions and rollovers to your SMSF after you commence a Pension, they are allocated to your "Accumulation Account".
This will mean that you will have two "Accounting Accounts" at the same time in this case, namely a "Pension Account" paying your Pension and an "Accumulation Account" which represents the additional contributions and rollovers made to your SMSF after commencing the Pension. The difference between each Account is the "Pension Account" does not pay tax on earnings and realised capital gains but the "Accumulation Account" does pay tax on earnings and realised capital gains at up to15%.
Commencing Multiple Pensions
If you make significant rollovers or contributions to your SMSF after commencing a Pension these amounts will sit outside the "Pension Account" in the "Accumulation Account" as detailed above. This will mean that earnings on this part of your Super Benefit will continue to be subject to tax. In this case it may be appropriate to commence a second Pension with your "Accumulation Account" balance to ensure your entire Super Benefit continues to be completely tax free.
We caution however that additional Pensions should only be commenced when there is a significant balance in the Members "Accumulation Account" (e.g. $50,000 or more). Where you are making smaller contributions (e.g. from your monthly employer super contributions) you should not commence a separate Pension with each of these amounts as this becomes administratively burdensome. You should note that ESUPERFUND still provides you with a solution for these contributions, to ensure even these smaller amounts are consolidated into your Pension via our annual "merging" service detailed next.
Merging the Accumulation and Pension Accounts
As part of the annual compliance preparation process ESUPERFUND will review each Member's "Accumulation" and "Pension" Account balances. Where the Member has a balance in their "Accumulation Account" ESUPERFUND will automatically merge the balance in the "Accumulation" Account with the Member's "Pension" Account. Merging the "Accumulation" and "Pension" Accounts means that the Pension commenced must be "commuted" (i.e. stopped), and both the "Accumulation" and "Pension" Accounts merged. A new Pension with the Member's total Super Benefit is then commenced. This process is administratively burdensome so it is usually recommended that this "merging process" occurs only once per annum on 1 July. The great news is that ESUPERFUND will automatically merge these accounts to ensure your Super Benefit retains its tax free status. This service is absolutely FREE! This is unprecedented in today's market.
What if a second SMSF Member has not commenced a Pension?
If there are two or more Members in the SMSF and one or more Members remains in Accumulation Phase (i.e. they have not commenced a Pension) then those Member's share of the SMSF still attract tax at up to 15%. Of course those Members can also commence a Pension when eligible, reducing the tax rate on their share of the SMSF income and realised capital gains to 0% also. When ESUPERFUND attends to the annual compliance work for the SMSF, the assets will be prorated between the assets that are in "Pension Phase" and the assets that are in "Accumulation Phase".
Assume your SMSF has $1,000,000 in assets and the Member in "Accumulation Phase" has a benefit of $400,000 and the Member in "Pension Phase" has a benefit of $600,000. In this case 60% of the SMSF's assets are considered to be in "Pension Phase" and 40% in "Accumulation Phase". This is important as the earnings and realised capital gains from the assets still in "Accumulation Phase" continue to be subject to 15% tax, whilst the earnings and realised capital gains from assets in "Pension Phase" are tax free.
To determine the earnings and realised capital gains in "Accumulation Phase" and "Pension Phase" the total earnings and realised capital gains made by the SMSF are prorated. In the above example, 60% of the SMSF earnings and realised capital gains would be considered to be in "Pension Phase" and tax free and 40% of the SMSF earnings and realised capital gains would be considered to be in "Accumulation Phase" and subject to tax at 15%.
If you commence a Pension and are aged below 60, the Pension Income you access must be declared in your personal Income Tax Return. To do this the SMSF must provide to each Member aged below 60 PAYG documentation with the amounts that must be declared in your Tax Return and any rebates that may apply. The PAYG documentation including the calculation of the relevant amounts to include in your Tax Return is prepared by ESUPERFUND absolutely FREE of charge! This is unprecedented in today's market. It should be noted that no PAYG documentation is required for Pension withdrawals made after age 60 given that these withdrawals are tax free and do not need to be declared in your personal tax return.
Tax Savings when you commence a Pension
To see the potential Tax Savings associated with commencing a Pension view our Case Study here. To demonstrate the Tax Savings of commencing a Pension using your own personal circumstances click here to participate in our Interactive Pension Analysis and see how much tax you can save.
FREE Pension Setup
It is FREE to establish a Pension with ESUPERFUND.
FREE Ongoing Pension Administration
When you commence a Pension in your SMSF there are a range of additional compliance requirements necessary each year. These additional compliance requirements are all attended to by ESUPERFUND ensuring your SMSF continues to receive Tax Free Income and Realised capital gains. Importantly the additional compliance requirements are attended to by ESUPERFUND absolutely FREE! This is unprecedented in today's market.
When you are ready to commence a Pension, ESUPERFUND will attend to all aspects of the setup process for you. You do nothing. To establish a Pension simply determine which Pension applies to you and click below to apply:
If you are aged over 65 or you are aged between Preservation Age and 64 and are "Retired", you have the option to commence a Simple Account Based Pension. To apply click here.
If you are aged between Preservation Age and 64 and are NOT "Retired" you have the option to commence a Transition to Retirement Pension (TRAP). To apply click here.