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Self Managed Super Fund (SMSF) Article
A question on TtR pensions
By Tony Negline.
This article may be out of date.
19th August 2009
Roger, a regular DIY Super reader wrote about a current problem he has with his Self Managed Super Fund: "I am over 60 and run a Transition to Retirement pension. Each year I'm also making super contributions. At the end of every year I want to combine my existing pension and the new super contributions into one pension but, frankly, I don't know how to do it."
Transition to Retirement (TtR) pensions can be paid to people who are aged at least 55 but under 65 but are yet to retire. Lump sums cannot be paid until either permanent retirement or age 65.
To combine an existing pension and new contributions Roger will need to fully commute the pension, combine its assets with the contributions and then begin a new one. Unfortunately the super and tax rules are not crystal clear that this can be done repeatedly over several year but the large funds seem to allow it. This overall strategy uses many different parts of the super system and some care is needed to successfully implement it. Of critical importance will be his fund's trust deed and the ability it gives the trustee to actually carry out these transactions.
The advantage of the super pension is that the income payments from it are paid tax-free each year because he is over 60.
If Roger is claiming any personal super contributions as a tax deduction then it will reduce the amount of income tax paid on any other income he has to declare for income tax purposes. However there have been some important changes to the income test for this deduction especially for super investors who are employed and care needs to be taken.
Also the maximum deduction for all super contributions has been halved from 1 July 2009 and for those over 50 now stands at only $50,000. It's often worth remembering that because of the way the whole tax system works, it may not be the most tax effective strategy to claim this maximum deduction.
Contributions above this threshold are taxed at 46.5%. Some additional eligibility rules, which we will not look into here, must be satisfied before this deduction can be claimed.
A TtR pension must pay an income of between 2 per cent and 10 per cent of the market value of assets. The market value of assets is worked out on every 1 July for the whole financial year. A special rule is used in the first financial year of the pension.
The two percent minimum is half the normal amount and applies for 2008/09 and 2009/10 only and was put in place to help super pensioners cope with plunging financial markets.
The 4 per cent minimum income applies for all super pensioners aged under 65. The minimum income increases from that age onward.
Once the super investor satisfies the super retirement definitions or reaches age 65 the 10% income limitation disappears and all the pension assets could be paid as a lump sum. The only requirement is that income payments must meet the minimum required.
Our reader has mentioned that with the proceeds from the contributions made he would like to take the new contributions and combine them with the existing TtR pension.
Ideally he doesn't want to have new pensions for all the contributions made over the years before retirement. That is at the start of year 2 there would be two pensions, in year three he would have a third pension and so on.
A very important principle of superannuation law is that once a pension commences no new capital can be added to it. So we cannot simply take contributions and add them to his existing pension.
The income and capital gains earned on the assets supporting a pension are not subject to income tax in the super fund. The income and capital gains from assets not used to support a pension at taxed at 15%.
The only way to combine the pension and the contributions is to fully commute the pension and move all of its assets from the 0% tax part of a fund and place them back into the 15% part of the fund. When we commute the pension we will need to make sure that at least the required minimum pension has been paid.
Do we have a problem if we begin a pension and not long after stop it again? This is a difficult question to answer and each case will have to be assessed on its merits.
One interpretation on the continual use of this process might be to assume that a super fund has not been paying a pension. If this interpretation is adopted by the ATO then a fund will probably have underpaid its income tax liabilities and paid benefits out of a fund before the law allows them to be paid. Various penalties might flow from this.
Anecdotal evidence suggests that most large funds permit these transactions on a regular basis. Let's assume that this strategy works. In most cases these transactions will be simple book entries. Upon pension commutation money will be debited out of the "pension account" and credited into the member's "accumulation account". As this occurs the old pension money and the new contributions will be combined into one amount. The taxable and tax-free components will be adjusted but be careful as this can be a complicated calculation.
Some super funds elect to physically use a separate bank account for their pension assets. If they do this then they will need to move the money from this bank account to their non-pension bank account.
Once this work has been completed and a new pension can commence and appropriate book entries will take place. At this point some trustees will want to give to the pensioner a Product Disclosure Statement detailing the benefits available from the pension and also a Pension Agreement document. PAYG tax withholding calculations and procedures will be required for those under 60.
This type of administrative work is not complicated but can be quite fiddly. It's common for simple mistakes to be made. Allocating net investment earnings between the 15% tax and 0% tax parts of the fund can be painful. Anyone contemplating these transactions should expect to pay more for administration and possibly for annual audit.
Within the accounts of the fund there will need to be separate accounts for each pension showing the outstanding account balance.
The super fund trustees have a choice if they wish to use the 'segregated' asset system or the 'unsegregated' asset system.Unsegregated means that no particular fund asset belongs to a particular member or pension. Segregated means that particular assets are deemed to be 'owned' by a member. The unsegregated system is much simpler to administer which probably explains why most pension paying SMSFs elect to use it. A fund which implements this strategy will need an actuary to sign a certificate. Without this certificate the pension assets will not be exempt from tax.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.