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Self Managed Super Fund (SMSF) Article
Defined benefit pension changes

By Tony Negline.

This article may be out of date.

19th October 2005

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Superannuation investors with big account balances have some hard decisions to make before 1 January 2006.

In late September the government announced that small super funds – both Self Managed Super Funds and Small APRA Funds – would not be allowed to start a new lifetime pension after 31 December this year. 

This means that investors with very large super fund account balances must decide whether they are going to try and access the concessions that might be available via lifetime pensions before the opportunity is closed forever.  These concessions are potentially substantial and should not be ignored.

What sort of people are we potentially talking about?  The potential number of investors is not very large but they are all very wealthy.

Compared to an allocated pension, a lifetime pension is very inflexible.  Once the level of income is determined (by an actuary before the pension commences) then it may only be changed by clearly defined indexation which can be a flat amount each year, for example 3% per annum, or the amount of increase can vary by CPI movements in the preceding year.

Investors with total super assets greater than their pension RBL may have to be prepared to lock money away in a complying lifetime pension so that they can access their pension RBL.  Effectively this means that the only way to access the capital invested in these types of pensions is via actual income payments.

Some investors might be able to purchase a lifetime commutable pension.  This type of pension is still payable for life but the super laws do allow some access to capital.

To be able to use these lifetime pensions, the investor must have been a member of the small super fund that will be paying the lifetime pension on 11 May 2004.

Additionally when the pension commences, the investor must be aged at least 65 or, if under 65, they must satisfy a particular definition of retirement.

There are two parts to this retirement definition.  Firstly if you stop work before you turn 60 and you want access to your super after turning age 55 but before 65, then you must be able to satisfy your super fund’s trustee that you stopped gainful employment (that is, employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment) and you never again intend to be gainfully employed for more than 10 hours each week.

Does making such a strong declaration preclude you from ever working again?  Strictly no.  But your arrangement must be bona-fide and look reasonable.  Obviously you cannot make this declaration whilst having a strong preference of either never stopping or returning to work.  Some people will be able to stop one job and will also be able to reduce the hours they work in their other professions below 10 hours each week.  Others will be happy to stop work altogether and spend their spare time actively managing their super fund investments.

The retirement rule changes once a person turns 60 (but is under 65) and is still working.  Super fund members must be able to demonstrate that an “arrangement under which the member was gainfully employed has come to an end”.  If a person who is older than 60 has more than one job they simply need to stop one of those jobs to access their super assets.  As a result some people get a small part-time job which is terminated after a short period of time thereby unlocking their super assets.  Whether such arrangements are legitimate is always a difficult issue.  Documentary proof is often needed to show that a job has been terminated.

In some situations the super funds' governing rules (trust deeds and other documentation such as trustee minutes) will need to be amended to allow a defined benefit lifetime pension to be paid. 

A pension payment must be made within 12 months of its commencement.

Before a fund begins paying a lifetime pension a trustee will need to appoint an actuary who will do some very complex calculations that will tell the trustee what initial level of income can be paid by taking into account the fund's asset allocation, the age of the pensioner and any reversionary, the type of pension being paid, the level of indexation for income payments.

Each year an actuary has to review these pensions to confirm that there is a 'high probability' that the pension will continue to be paid.  If the actuary can't make this declaration then the pension will need to be restructured.

However the ATO believe that this restructuring is the same as starting a new defined benefit pension after December 2005 and is not allowed.  For example it may not be possible to replace a nominated reversionary pensioner if they die before the primary pensioner because this would constitute an amendment to the rules governing the pension.

The investor and the super fund trustees must therefore carefully ensure that the pension is carefully structured before it commences so that this problem can be avoided.

Under the Corporations Act, a SMSF trustee is offering a lifetime pension should issue a Product Disclosure Statement because they are offering the investor a new product.  There are guidelines which trustees must follow to complete this type of document correctly.

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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.

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