PORTFOLIO POINT: It’s not quite as simple as “insert pension, press play”. So how do you “flick on” a pension in your SMSF?
Pensions are, literally, what super is all about. The provision of retirement benefits is numero uno on the definition of superannuation’s sole-purpose test.
It’s the end game. But it’s an end game that can last decades. Depending on your genes (my 65-year-old father is aiming to live to 120), the pension phase of your super fund can run longer than the accumulation portion. That would give Dad 60-plus years on a pension, versus about 40 in accumulation.
But for many there will be an overlap. For one column on the benefits of a transition to retirement (TTR) and salary sacrifice (Sal Sac) strategy, see Retire your tax bill. That is, there are strategies, such as TTR and Sal Sac that are about both pensions and accumulation and how you can improve both at the same time.
As an investment tool, your SMSF is about building up a wad of cash and assets that will then support you when the time has come to slow down, or stop, with the working thing.
I’ve often written about “flicking on” the pension in your super fund. However, that’s considerably understating what’s involved. So, today I’ll take you through the steps that, as an SMSF trustee, you need to take to get your pension started.
First, it’s often overlooked or forgotten, but you need to understand that you have two separate roles in your super fund. You are, equally, a member and a trustee. As a result, many of the formal requirements seem to be simply asking and giving permission of or to yourself. That doesn’t mean they can be skipped or ignored.
Check your trust deed
A really, really basic question needs to be asked first: Can your trust deed pay pensions? It might seem like a silly question, but the trust deed is where you must start.
You need to read the trust deed to find out whether you can pay yourself a pension and what sort of pension you can pay yourself.
For example, SMSFs with older trust deeds might have been drafted before transition to retirement pensions were allowed in 2005. Other trust deeds might only allow certain types of pensions to be paid. And if you want, for estate planning purposes, to have an automatic reversionary pension (see Step lively on super pensions), does your SMSF’s trust deed allow it?
There are two main governing documents for super. There are the SIS regulations and there is your trust deed. The SIS Act applies to everyone. Your SMSF’s trust deed, and any changes that have been made to it, applies to your fund only, but you still have to follow the rules of your trust deed.
If your fund won’t allow you to do what you want to do, you might need to update or amend the trust deed itself.
Request a pension
The request from the member to the trustee needs to be in writing, it must specify how much the pension is to be, when it is to commence and the type of pension that it is (particularly if it’s an account-based pension). Signed and dated, of course.
The trustees need to meet to agree to pay a pension to the member on the terms requested by the member, assuming the request is appropriate.
If the member wants a pension of 6% of their super, then that is the request that needs to be implemented. If the member decides, through the year, that they need more than that 6%, then there will need to be a second request from the member and a second trustee meeting to approve it.
It might not seem important, but you can’t just go and grab money from your SMSF’s bank account when you’re on a pension. The penalties for the requests and agreement not being in writing can be that the tax office considers the member to have taken capital, instead of a pension.
For TTR pension members, accessing capital instead of a pension could be running the risk of losing their complying fund status. (At worst, that could have disastrous consequences for the fund.)
TFN and banking details
The trustees will also need to request (or check to make sure it’s already on file) the member’s tax file number and also the banking details will need to be requested and recorded for payment.
Segregation is a potentially powerful, but drastically underused, tax weapon for SMSF pension funds. For a column on its benefits, see Super and the value of segregation.
If you’re starting a pension and intend to use the segregation method in order to maximise the SMSF’s tax position, the assets need to be segregated before the pension begins.
Valuing the fund
If an account-based pension is being paid, then the fund will need to be valued to make sure that the minimums (and maximums) can be set.
For an ongoing pension, the valuation will normally be done as at June 30 on the year before the pension is paid. But for those starting a pension mid-way through a year, the fund will still need to be valued to determine the pension payments that can be made.
PAYG for TTR and the under-60s
This applies for pensions that are started for those less than 60 years old (including transition to retirement pensions).
The fund will need to register for PAYG with the tax office, as they will have to deduct tax from the pension payments prior to payment.
If the pensioner has a chance to be able to pick up even one dollar of the government age pension, the trustees should complete a “details of income stream” report for those agencies to aid the pensioner in applying for government payments.
Depending on what help you’ve hired for your SMSF (accountant, financial adviser, etc), you might find that many of these documents are prepared for you, the checking is done and the boxes are ticked.
But you certainly can’t assume that that is happening. You’re the trustee. It’s your responsibility. If something goes wrong, the tax office could be coming after half (well, 46.5%) of the assets in your fund. It won’t be your accountant that’s handing over the money, it will be you.
So, no matter how much help you’re getting, remember to check any documents that come in for you to sign to make sure they’re accurate and reflect your intentions and wishes.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.