This is it, the moment you have been waiting for and the reason for starting your own self-managed super fund (SMSF) in the first place. Once you reach age 55 you can start withdrawing money from your fund. For most people, retiring on a super pension means never having to pay tax again.
You can start a super pension once you satisfy a condition of release such as retirement, temporary or permanent incapacity or financial hardship. You can also start a pension in the years leading up to retirement once you reach preservation age, currently 55.
Many SMSFs have members in pension phase and other members in accumulation (pre-retirement) phase at the same time. But it is also possible for individual members to have both types of account.
Once your individual balance is in pension phase no further contributions can be made to this account but many SMSF members have an accumulation account they contribute to and a pension account to withdraw from at the same time. This makes it simple to identify which income is tax free.
Types of pension
If you are over 65 or aged between 55 and 65 and retired the only type of pension you can start is an account-based pension. If you are aged between 55 and 65 and not yet retired you can still switch on an income stream with a transition to retirement pension (TTR).
- Account-based pension: This is the most popular form of super pension. Although there are restrictions on the minimum amount you can withdraw each year (see below), there is no upper limit on how much you can access or when. You can also withdraw lump sum amounts whenever you want.
- Transition to retirement pension (TTR): If you are aged between 55 and 65 and wish to continue working full or part-time you can withdraw up to 10% of your super balance each year. Like an account-based pension, there is a minimum annual withdrawal of 4% from July 1, 2013 and no restrictions on the timing of payments.
Once you reach 65 it is a simple process to convert a TTR to an account-based pension. Even better, from age 60 onwards all withdrawals from your fund, including lump sums, are tax free. Not only that, but there is no tax to pay on any income or capital gains from assets supporting the pension. This opens up the potential to supplement your wages with tax-free pension income while boosting your super balance at the same time. You can maximise the tax benefits of such a strategy by salary sacrificing super contributions from your pre-tax salary.
But it gets even better. If your fund is in pension phase and holds fully franked shares then the Australian Taxation Office (ATO) will send you a refund cheque each year.
Minimum pension payment
You can nominate the amount you wish to take as an account-based pension each year. While there is no upper limit on the amount you can withdraw (unless you have a transition to retirement pension where the maximum is 10%), there is a minimum annual draw-down depending on your age at July 1 each year.
In response to the downturn in global financial markets the pension draw-down was reduced from 2008 to June 30, 2013 but it returns to normal in the 2013-14 financial year.
The good news is that all withdrawals are tax-free once you reach age 60. The bad news is that SMSF trustees who fail to withdraw their age-based minimum pension could be penalised by the ATO.
While a small inadvertent breach may be excused, the ATO has the power to stop non-complying account-based pensions. This means that all income and capital gains within the fund will be taxed at pre-retirement rates of tax.
Tax changes ahead
If you think that a tax-free retirement sounds too good to be true, there is one fly in the ointment. The government has announced it intends to introduce a new tax on super pension earnings above $100,000 from July 1, 2014. If the assets supporting a pension generate income of more than $100,000 a year, earnings above this threshold will be taxed at 15%.
Say, for example, your fund earns an annual return of 5%; you will start paying tax when your pension assets rise above $2 million. If your fund earns 7% a year the new tax will kick in for balances above $1.43 million.
The threshold will apply to each individual member but pension withdrawals will remain tax free.
There is no need to change your fund’s investments when you start a pension, but in practice most people adjust their asset allocation in the lead-up to retirement and beyond.
Once you stop working and depend on investment income to fund your lifestyle it is harder to recover from major market downturns. It is also important to have enough cash and liquid investments to cover your short to medium term living expenses.
For this reason, most retirees reduce their exposure to growth assets such as shares and direct property and increase the amount of money allocated to short-term cash and fixed interest investments.
Even so, it is important to retain some exposure to growth to ensure that your money doesn’t run out before you do. Life is a marathon, not a sprint, with the finish line at death, not retirement.