Multiple funds the answer to taking pension while working

It’s an area many SMSF trustees don’t understand well – even those who might have been operating SMSFs for a long time. Trustees understand that their SMSF is there to eventually pay a pension. Therefore, at some stage, it must convert from being an accumulation fund to a pension fund. But what happens if they’re still working? Can you still make contributions?

Yes, you can.

Simply, if you turn on a pension in your super fund, you move a number of assets/cash from your accumulation fund to a new pension fund. But you’re free to continue contributing. What cannot occur by law is for further contributions to be made to your pension account. Once a pension fund is started, it cannot be added to with outside monies (only earnings). So any further contributions are made to a separate accumulation account for you. And it’s this accounting aspect that trustees often struggle to get their heads around, so let’s go deeper into that.

Accounts in SMSFs

The confusion often comes from a base misunderstanding that, in a SMSF there is only one account for the members of the fund. That’s somewhat understandable, given that all assets of the fund are held in the name of the trustees, usually jointly. That’s either, for example, “Michael Smith and Michelle Smith as trustees for the Smith Family Super Fund”, or “Smith Super Pty Ltd as trustee for the Smith Family Super Fund”.

Many trustees believe that even when there’s two members involved in the same SMSF, that there’s only one account. And that the money in there is joint. Incorrect. The only time that a SMSF would have just one account would be if the fund was a one-member fund and the member could not yet, or had not yet, started a pension. If there is more than one member of a SMSF, each member must have their own account (even if that account has a nil balance).

If a husband and wife set up a fund, with the rollover from a former corporate defined benefit fund of $1 million, then that $1 million goes into an account for the former employee. It is not, now, an account of $1 million owned 50-50 by the two members. Member one has a balance of $1 million. Member two has a balance of $0 (until they add to their balance). (For the majority that get an accountant to prepare their returns, you’ll generally find the individual account balances near the back of the SMSF annual tax return documents.) If it’s a two-member fund, with both members in accumulation phase, there are actually two accumulation accounts, even if the money is sloshing around together in the same physical bank accounts or share trading accounts in the name of two (or more) trustees (that is, the monies are unsegregated).

If you have two 67-year-old retired members in your fund, both of whom are taking a pension, then you still have two accounts.

Accumulation and pension – concurrently

What happens if you wish to turn on a pension from age 55, but continue working?

Simply, you have two accounts. The assets from your accumulation fund (some or all) are transferred into a new pension account for you. And you continue contributing to your accumulation account.

Note: You cannot make contributions to a pension account. Once a pension account is set up, it cannot be added to.

Again, those two accounts (accumulation and pension), or possibly four accounts (accumulation and pension accounts for two members), are all separate accounts, with their own account balance and account earnings.

Let’s take the Smiths (from above), both 60, who are still working and intend to continue doing so until age 65.

They have $1 million in their SMSF, split $700,000 for the husband and $300,000 for the wife.

To get their tax-free pension income, they both turn on pensions in the SMSF. As they are still working and this is a transition to retirement pension, they must take between 4% and 10% of their balances. That’s $28,000 to $70,000 for him and $12,000 to $30,000 for her.

But they’re still working, so they can still contribute to super. As they’re both over 59 on 1 July, 2013, they are able to contribute up to $35,000 each, which they do. They also take their full pensions.

On 30 June next year, the SMSF looks like this.

• Michael’s pension fund: $630,000 ($700,000 minus $70,000 pension).
• Michelle’s pension fund: $270,000 ($300,000 minus $30,000 pension).
• Michael’s accumulation fund: $35,000.
• Michelle’s accumulation fund: $35,000.

Of course, all these figures will be impacted by earnings on each of the individual accounts. (Hopefully they are positive.)

Just the four?

But are you limited to one accumulation and one pension account each? No. In many situations, it might make sense to have one or more accumulation accounts and one or more pension accounts.

Take this example in which multiple pension funds might be required for estate planning. A member has $1 million pension fund, built up over years in the workforce and through extra concessional contributions. But they also want to make a non-concessional contribution of $450,000. For personal reasons, they wish to leave the $1 million to their partner, but they specifically wish to leave the $450,000 to an adult child. The existing $1 million pension fund, if left to the existing partner, would be tax free, because it is being left to a dependent.

Non-concessional contributions can be left tax-free to those who are not financially dependent. So, in this case, it might make sense for a second pension to be set up that is designed to take just the $450,000 NCCs, with a death benefit nomination that the pension of NCCs be left to the adult child. If the funds that make up the two pensions were combined into one (a topic for another day), then only a portion of the death benefit paid to the adult child would be tax free. In this case, keeping two separate pensions, plus potentially one accumulation account, would make considerable tax sense.

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 strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au

• The SMSF Professionals' Association of Australia (SPAA) has welcomed the changes to the tax treatment of non-reversionary payments when a pensioner dies. "The changes to the super law to allow the tax exemption to continue on the income from investments after the death of a non-reversionary pensioner until a lump sum has been paid or a new pension begins is a positive outcome for trustees," said SPAA technical and professional standards director, Graeme Colley. Colley also said the change meant it was now possible to sell investments supporting a non-reversionary pension tax free after the pensioner's death and before it was paid to beneficiaries as a lump sum or before a new pension begins.
• In a report released this month, Business analysis firm IBISWorld said superannuation funds were at the top of the list of growth industries for the coming year, with an expected rise of 40.5% in total industry revenue, to $324.5 billion. IBISWorld general manager for Australia, Karen Dobie, said the increase would be driven by growth in the sharemarket, low unemployment and the increase in compulsory contributions.
• Self-managed superannuation fund (SMSF) investors are being urged to consider separately managed accounts (SMAs) and managed discretionary accounts (MDAs) as a means of delegating investment decisions while retaining an element of control and transparency. SMSF solution provider Xpress Super recently confirmed it has added Macquarie's SMA to its platform because it provides SMSFs with direct ownership of shares alongside professional investment management. Separately, Crystal Wealth executive director John McIlroy said MDAs provide SMSF trustees who want more transparency in their investments with an alternative to managed funds. "Trustees can see exactly what is in their equities' basket every day in an MDA," McIlroy said.