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Self Managed Super Fund (SMSF) Article
Clearing obstacles for funds paying pensions
By Tony Negline.
This article may be out of date.
12th November 2008
The prohibition on redeeming some unlisted managed funds is creating a large dilemma for many super funds particularly those paying a pension.
Under the law a pension can be viewed as an obligation to pay the pensioner an amount of income at least once per year.
What should be done if a super fund trustee can't access the super fund's investments in order to actually make these pension payments?
In many respects the actions a trustee might consider revolve around the agreement the trustee has to make the income payments.
Most pensions paid out of small super funds are called "account based pensions". Effectively these are designed to pay the member an income stream until the account balance of the pension is exhausted. Other names for these types of pensions are Allocated Pensions or Term Allocated Pensions or Cashback Pensions.
The terms of these pensions may be drafted in such a way as to oblige a trustee to make pension payments whilst the pension's account balance is greater than zero. The only way to know what obligation exists is to check the documents which govern the payment of a pension.
A small number of Self Managed Super Funds will be paying a guaranteed or defined benefit pension. By the very nature of these pensions a trustee has entered into an agreement make pension payments. Before these pensions commence it will have been decided to either pay income for a defined term or for the life of the pensioner or their spouse.
Whatever the pension type the trustee has agreed to provide, or effectively contracted, to make income payments weekly, fortnightly, monthly, quarterly or yearly.
When a trustee can't redeem fund assets to physically make pension payments a trustee and their advisers have a number of legal obligations.
If the inability to pay pension payments is prolonged a small super fund trustee should consider if they need to inform the Tax Office in writing if the fund has suffered a "significant adverse event" on the financial position of the fund.
These events are deemed to occur if, before the next annual report to members, the fund may not or will not be able to "make payments to beneficiaries as and when the obligation to make those payments arises". The super law provides for civil or criminal penalties if a fund trustee doesn't satisfy this rule. The fund's annual report to members would be deemed to take place when the next member statement is prepared.
The super laws also provide that the ATO must be told by a small super fund's auditor or actuary if the fund's financial position is, or is about to become, unsatisfactory. Again the law provides for penalties if this provision is not satisfied.
A super fund's financial provisioning might be unsatisfactory if it is providing a guaranteed or defined benefit pension and the fund's actuary believes that a super fund's assets are "inadequate to cover the aggregate benefit accounts of members of the fund" or "the value of the assets of the fund is inadequate to cover the value of the liabilities of the fund" owed to fund members.
Super funds paying guaranteed pensions might be deemed to be insolvent if "the net realisable value of the assets of the fund being less than the minimum guaranteed benefits of members of the fund". For practical purposes it is best to think of the minimum guaranteed benefits as a member's entitlements to future income payments.
So what can be done to fix the redemption problem? It would probably be unlikely that the managers of an unlisted managed fund would be able to convert the managed fund into bank deposits and make it eligible for the Commonwealth Government's bank deposit guarantee.
For small funds a valid option might be for the member to revert their pension back to the pre-retiree phase which is sometimes called the "accumulation phase". Assuming a super fund's trust deed allows a fund member to make this request then this would remove any obligation to make pension payments.
Super fund trustees thinking about this option should examine their trust deed carefully to make sure that they can allow a retired member to keep pre-retiree assets in the fund indefinitely. This is allowed by the super laws but this does not mean that those laws have been correctly reflected in the fund's trust deed.
Once the assets supporting a pension are moved into the pre-retirement phase the assets will be taxed at 15% in the super fund as opposed to 0% when they were paying the pension.
Some pensions, such as guaranteed pensions, can receive generous Centrelink aged pension asset test concessions. Those concessions can be lost, retrospectively and prospectively, if these pensions are stopped for any reason. Centrelink has administrative processes in place to ease the potential benefit repayment burden.
Another option maybe for the fund member and the super fund trustee to agree that pension payments should be temporarily suspended. Hopefully the freezing of redemptions from unlisted managed funds will be temporary and access to capital will be available before 30 June.
If this occurs catch up income payments could be made before 30 June so the annual income payment obligation are met.
The risk is that capital is not available before the financial year end.
Finally making income payments by transferring the physical assets is not an option. The ATO don't believe the super laws allow it.
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