How to start your DIY pension

It’s not quite as simple as flicking on the ‘pension’ switch in your SMSF: there are certain steps. Here’s how.

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.

Trustee meeting/s

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?

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.

Centrelink/DVA

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.

  • Two different studies are suggesting that DIY super growth may be hitting a ceiling. Russell Investments and the SMSF Professionals Association (SPAA) research, based on figures from CoreData, found that trustees would have contributed another $12.4 billion to their funds in 2010-11 had the contribution caps not changed. Meanwhile, Tria Investment Partners used tax office information to find that contributions fell from $22 billion in 2008 to $15 billion in 2010, employer payments fell from $10-11 billion to $7 billion in the same years, and outflows have doubled since 2006 to $22 billion in 2010. SPAA chief Andrea Slattery says the halving of contribution caps is the root cause but Tria managing partner Andrew Baker says a supporting factor could also be that SMSF numbers grew so quickly they’ve now hit a peak.
  • Draft regulations on SMSF borrowing, released on Monday, will allow funds to access indemnity insurance, but restrict those who can advise on them. DBA Lawyers say limited recourse borrowing arrangements (LRBAs) would become financial products requiring a PDS and statement of advice, and bring them under the financial consumer protection framework. “The key implication for advisers is that only those with an Australian Financial Services Licence covering derivatives or securities will be able to recommend LRBAs,” the firm said. It added that the proposed limited advice licence for SMSF accountants probably won’t cover LRBAs.
  • SMSF lobbyists outraged by a proposal from Greens leader Bob Brown, for higher tax on the super of higher income earners, is being backed by analyses from consultancy Mercer and the Association of Superannuation Funds of Australia (ASFA). Mercer senior partner David Knox says his report found the level of government support across all retirement incomes is “remarkably level” and the three tiers of compulsory and voluntary contributions and the age pension make the system very fair. ASFA found that middle income earners receive the most benefit from government tax concessions on super, and that the costs of these are far lower than estimated.
  • Accountants are bowing to the inevitable on SMSF licensing, says AMP-owned licensing business SMSF Advice. National development manager Kath Bowler says she’s seen a change in attitudes, from frustration about the removal of the SMSF exemption for accountants, to the view that it could be an opportunity. Bowler says of AMP’s three levels of licences, the second tier category, which allows accountants to give detailed strategic SMSF advice and make non-product specific investment advice, is the most popular, although she expects the basic category to become more popular once the exemption is lifted.
  • SMSF consultant Craig Gerard Dangar faced a Sydney court on Tuesday and accused of obtaining about $250,000 from trustees by deception. He is charged with one count of making a fake or misleading statement and two counts of obtaining money by deception, while employed by accounting practice SMSF Consultants in southern Sydney between 2004 and 2007. ASIC is claiming Dangar falsely claimed that he was a director of an SMSF in order to get a loan to buy shares in Morris Finance, which he then recommended as an investment to clients at a misrepresentative price.

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.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.