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Self Managed Super Fund (SMSF) Article
Pension strategies amongst dwindling value

By Tony Negline.

This article may be out of date.

15th April 2009

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Retirees receiving super pensions have had a tough time lately.

They have had to watch as the value of their retirement assets have vanished because of market failure and the need to regularly pay themselves an income from the pension.

Many people have been asking what they can do to cope with the associated problems.

Those receiving a part age pension from Centrelink, or the Department of Veterans' Affairs have been cushioned somewhat from negative market returns.  This has occurred in one of two ways.

Firstly people with relatively high asset levels who were previously ineligible for the age pension may have become entitled to it as the value of their assets fell below the relevant maximum thresholds.  Becoming eligible for the government pension will have cushioned the decline in income that they have otherwise suffered and also provided to them all non-income benefits that become payable such as reduced electricity and gas bills with the age pension.

Secondly those who have always been eligible for a part age pension will have seen their government pension increase as their assets have declined in value and the income they receive from their investments have also gone down.  These people will have received the benefit of an increased income payment from Centrelink or the DVA.

The last 18 months has once again shown what a great system the part age pension is.  When used properly the age pension can be used as a very effective buffer for people who have unexpectedly seen their asset values or investment income decline.

The age pension is not the only strategy that will help a retiree.  The Costello Better Super tax changes contain at least three strategies which might be helpful to retirees who are not yet 60.

Our first example involves increasing the tax-free portion of a pension.  With these cases lets assume that a person started a pension on 1 July 2008 with $800,000.  Assume that at that time it was $500,000 (62.5%) Tax-free Component and $300,000 (37.5%) Taxable Component.

Now assume that the current account balance is $480,000.  This represents a 40% decline which will not be unusual in this current environment.  The dollar value of the pension's account balance is now less than the initial Tax-free Component.

One strategy is to commute (or stop) the pension and move the assets back to the accumulation phase.

When this is done the Tax-free and Taxable Components are restruck.  The tax laws say that any reduction in a pension account balance impacts the Taxable Component.  The rules do not provide any adjustment to the Tax-free Component once the assets are used to pay a pension.

This is a very different approach to the pre-Better Super superannuation tax era.  Under these obsolete rules the tax-free portion of account balances reduced with each account balance.

The net impact of these new rules is that because the current account balance is less than this initial Tax-free Component upon rollover the whole account balance becomes Tax-free Component.

Our second example assumes that the above pension has declined to $600,000 or a 25% reduction.

If this pension is commuted back to the accumulation part of a fund then the Tax-free Component will remain at $500,000 and the Taxable Component will become $100,000.

Our last example assume the same initial details but lets assume that the pension account balance is now only $400,000 (a 50% fall in the value of underlying assets).

Before commuting the pension the investor makes a $100,000 concessional contribution.  That is a contribution which are claimed as a tax deduction.  After the 15% tax on contributions the net amount of this benefit is $85,000.  Ordinarily these contributions form part of the Taxable Component.

Next the investor commutes their pension.  At this point the new contributions and the pension account balance are merged.  The Tax-free Component of the pension was initially $500,000.

The account balance of the merged interests is now $485,000.  Therefore the whole amount – including the concessional contribution – becomes Tax-free Component.

It appears that we would get the same result if the pension is commuted first and the concessional contribution is then made.

Obviously this last example is only relevant if you have some additional capital which you are prepared to commit to the superannuation environment.  It also assumes that you are allowed, or someone on your behalf is allowed, to make super contributions and that those contributions can be claimed as a tax deduction or are taxed by the fund in the year they are made.

Just a reminder with this last example, it is impossible to add additional capital to a pension once it has commenced.  The only way to increase a pension's account balance is via paying less out in income payments than you are receiving as income or asset price growth.

These strategies are also helpful to retirees older than 60 but only in a minor way.  These strategies will reduce the amount of tax payable for lump sum death benefits paid to non-dependants.

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