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Self Managed Super Fund (SMSF) Article
Pensions and lump sum withdrawals from super funds
By Tony Negline.
This article may be out of date.
7th April 2010
For the last twenty years most pensions provided by small super funds and retail super funds have not been set and forget. They require active management from at least three perspectives – asset allocation, income management and liquidity management.
Liquidity management is the process used to ensure there is always sufficient cash to pay the pension income payments.
Of particular importance is the range of specific administrative and legal issues which have to be considered when cashing out, rolling back, rolling over, refreshing, merger and establishing or resetting any reversionary beneficiaries.
Here we'll discuss what cashing out means and the issues that have to be considered when completing these transactions. In future articles we'll look at all the other types of transactions that can occur.
Cashing out a pension occurs when a lump sum is withdrawn from the pension. This lump sum might be for some or all of the pension's account balance. Pension payments will continue to be paid from any remaining account balance after the lump sum has been paid.
The purpose of this transaction is to release of money from the pension. In some cases a lump sum of money cannot be paid. For example, for Transition to Retirement pensions can only have a lump sum paid from them if the pensioner is officially retired.
Before the lump sum is paid, the pro-rata minimum pension must have been paid. The lump sum cannot be used to satisfy this minimum pension payment requirement. (There is some conjecture on this point in superannuation circles. Some argue that the words used in the super laws provide that the lump sum can be used to meet the pro-rata minimum pension payment. Others respond that this is making too much of the words used in the super laws and would not have been the intention of the government who drafted these rules.)
Once the lump sum has been paid, some people recalculate the annual required minimum pension payment. Ordinarily this minimum pension amount is worked out each 1 July. The rules don't allow the minimum pension to be recalculated. To be explicit, the minimum pension payment is not recalculated because of a lump sum commutation.
The lump sum paid is split between the Tax-free and Taxable percentages which were worked out when the pension commenced. (Special rules can apply to some pensions which commenced before 1 July 2007.) These percentages are used to work out the Taxable and Tax-free Components. If the pensioner is under 60 when the lump sum is paid and it contains some Taxable Component then tax may have to be deducted by the super fund.
How are these benefits taxed? If the person doesn't specifically nominate that they want to receive a lump sum then they will be deemed to be receiving a pension payment. For those aged at least 55 but under 60 the pension payment will be taxed at their marginal rates less a 15% rebate. For those over 60 these pension payments will be tax-free.
If tax does need to be deducted then the super fund will have to be registered for Pay As You Go Withholding purposes. The process to apply for this PAYG Withholding is relatively simple but can take a bit of time to finalise. This can be a pressure point if the lump sum is needed urgently.
Once the lump sum payment has been made there is no adjustment to the Tax-free and Taxable Proportions in the pension.
From the financial services law point of view the lump sum is deemed to be similar to the purchase of a financial product. This means that if a licensed financial adviser has recommended the lump sum payment then they should issue a Statement of Advice and detail why taking the lump sum is an appropriate course of action as well as all the costs involved in the transaction.
However in most cases the lump sum payment does not involve issuing a financial product and as a result the super fund trustee does not need to issue a Product Disclosure Statement.
How are these transactions typically completed? It's generally a ten step process:
- Member requests payment or notifies that they have the right under the terms of the superannuation product
- The trustee confirms entitlement to cash out a lump sum
- The trustee issues a Pre-payment Statement – a specific ATO issued document
- The pre-payment statement is completed and signed by the super fund member & returned
- The trustee acknowledges that the member wants the payment to be treated as a lump sum or pension payment
- If required the trustee applies to be a PAYG Withholder
- If required the trustee works out what the pro-rata minimum pension payment should be just before the lump sum is paid
- The trustee sells/transfers assets to make the lump sum payment
- The trustee adjusts the pension account balance
- Finally the trustee pays the lump sum and if required withholds PAYG 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.