Picking a pension winner

It doesn’t always make sense to start a pension in your SMSF, especially if you’re eligible for the age pension.

PORTFOLIO POINT: Some SMSFs may find it advantageous to halt (or not commence) a pension, in order to allow a Centrelink age pension to be claimed.

Super pension income is tax-effective income. We all know that – it’s just a case of whether it’s tax-free, or tax-advantaged income.

If you’re over age 60, the income comes to you tax-free. If you’re under age 60, then a super pension is going to be at least 15 percentage points better than earning the same extra amount in the workforce (unless it pushes you into a new tax bracket, but salary sacrifice can usually help with that).

Plus, the super fund itself stops paying tax on earnings (income and gains) when in pension phase.

Are there any reasons you wouldn’t turn it on as soon as you’re eligible? And would you ever stop an SMSF pension once turned on?

The answer is yes. There are many potential reasons to stop it, or not turn it on.

It could be that you don’t need the income, even if it is tax-effective. You might not want to draw down on your super – and if you have a pension running, you must draw certain minimums from it. Or, even though you are salary sacrificing the maximum you can, it could potentially leave you in a worse position (which is rare).

While all of those reasons can be valid and may make sense under individual circumstances, there’s another reason to halt or delay a pension: qualifying for the government age pension.

Even getting $1 of a Centrelink pension may have flow-on benefits (such as pharmaceutical benefits), meaning it can be a crucially important strategy for many.

Centrelink pension – the basics

First of all, you need to be of a certain vintage to qualify (see this link). Most of you will be perfectly aware of your own circumstances as it relates to age pension age.

Then there are two tests – the income and assets tests (we’ll deal with couples from here on).

If your combined income is less than $2542 a fortnight and your assets are worth less than $1,024,500 (for a homeowner), then you might qualify for a part (even full) Centrelink pension.

(The calculations are overly complex and we won’t go into detail here. For more information, go to the Centrelink website.)

Super pensions and the income and assets tests

The value of the home is exempt from calculations for the pension (the government only cares if you own a house; it doesn’t care about the property’s value).

Outside of the home, a person’s biggest asset is generally their super.

Once you hit age pension age, your own super counts as an asset for the purposes of the Centrelink assets test, but not necessarily your partner’s super.

When does super count as an asset?

Super counts as an asset for a Centrelink pension under two main conditions.

Firstly, if you are old enough to qualify for a Centrelink age pension, then your super is going to count as an asset, because you could be drawing from that pension.

Secondly, the super balance of your partner will count as an asset if they are of age pension age, or if a pension is being drawn from super, even if the partner is not of age pension age.

However, if the younger partner is not drawing a pension from their super fund, and is not of age pension age, then the asset does not count.

How would that happen?

Here’s a fairly common example: A husband has just turned 65 and his wife is 58. The husband has decided to finish work for good, after spending five years winding down his hours, through a transition to retirement (TTR) pension from his super fund and part-time work. He has $400,000 in his super fund.

The wife, more recently, started taking a TTR pension (also from a $400,000 fund) from age 55 because, after seeing an adviser, it made sense.

They own their own home. But outside of super, their assets are relatively modest and limited to some home contents, average motor vehicles and some modest investments (cash and shares).

The husband has applied for a Centrelink age pension. His super will count under the assets test for the age pension, and so will the couple’s other assets. But there is one asset over which the couple has some flexibility in terms of its classification by Centrelink: the wife’s super.

If the wife’s super is in pension phase – that is, she’s drawing an income stream from it – then it counts towards the income and assets tests.

However, if the wife’s super is sitting in accumulation mode, and she is under age pension age, then the asset does not count as an assessable asset.

But it’s already drawing a pension ...

That doesn’t matter – pensions can be rolled back to accumulation phase at any time. If you’re 95 years old and you no longer want to take a pension from your super, then you can turn it back to accumulation mode.

Why would the government allow that? Because the government gets to tax the fund again. A super fund in accumulation mode is taxed at 15% for income and 10% for long-term capital gains.

By switching the wife’s pension back to superannuation, the couple’s “assessable assets” have just dropped by $400,000.

That doesn’t necessarily mean they will get a huge increase to the potential Centrelink pension. Switching could lift the pension significantly, but it will depend on other issues, including the couple’s other income.

So what if the wife’s super fund had everything?

That sort of strategy is possible, but be careful, as it is complex. In essence, to further reduce their assets for the purposes of Centrelink, the couple could consider shifting further assets into the wife’s super fund.

Keeping in mind the non-concessional contribution (NCC) limits of $150,000 a year and $450,000 pull-forward for three years, the couple could, potentially, get much of the rest of their investment assets into the wife’s super fund, where they would be protected from being counted as an asset until the wife turned age pension age.

To take this to the extreme, the wife could have an accumulation super fund worth $10 million. If she’s not of age pension age, the asset doesn’t count until such time as she is. (However, a fund of that size will likely be paying considerable tax on income and CGT earned in the fund, which would probably negate the benefit of the Centrelink pension, depending on the income and capital gains earned in the fund.)

In our example above, a recontribution strategy (from the husband’s account to the wife’s) could also potentially further reduce the husband’s $400,000 super pension. Recontribution strategies can be complex, and you should seek advice.

It can’t be all positive ...

The main cost of the above example is that the wife’s super fund is going to start paying tax again if it’s shifted back to accumulation mode. If a $400,000 fund is earning 5% income and then paying 15% income tax on that, it will be paying $3000 a year in income tax.

That could be substantially outweighed by the fund if the husband gets the full Centrelink age pension, which is around $13,600 a year.

What should you do?

The calculations for a Centrelink pension are very technical. Many people who qualify under the assets test will fail to qualify because of the income test.

Certainly, unless you have a great amount of time to research the options, see a knowledgeable adviser about how best to plan for Centrelink age pensions. It can be complex work, but getting it right can potentially add thousands of dollars to your income stream for many years.

  • Time is running out to take advantage of in-specie asset transfers into your SMSF, warns Chris Morcom, director and adviser at Hewison Private Wealth. As the end of the financial year approaches, the window of time before the rules regarding in-specie transfers, which can reduce exposure to market risk, change on July 1. “Investors should take advantage of weaker investment markets'¦if you’re a high income earner, it makes sense to transfer your assets into your super fund to shield yourself and your assets from market risk, and it can be a very tax-efficient way to build a retirement base,” Mr Morcom said. From July 1, investors will have to sell their asset on the market first, contribute cash to their SMSF, and then re-buy.
  • Changes to contributions caps and tax legislation are gradually being clarified by the Tax Office, and there are several emerging remedies for concessional and non-concessional cap breaches. SMSF Academy head Aaron Dunn says clarity has been provided in ATOID 2012/16 on the strategy of parking June contributions in a holding account within SMSFs. The decision states that the contribution is assessable in the year it is paid into the fund for income tax purposes, but for contribution cap purposes it counts in the year in which it is allocated. On another change, the 'De-minimus’ test, Mr Dunn says there has not been guidance to date on what constitutes “small amounts” of excess contributions. The test is designed to effectively refund individuals accruing a disproportionate ECT liability from a small breach.
  • In spite of negative press, derivatives can be a useful hedging tool within SMSFs, says a CFD trader. Capital CFDs head sales trader Ashley Jessen says since SMSFs were allowed access to the products in 2007, they can be a cost-effective hedging solution compared with options. “If an SMSF holds 2,500 ANZ shares then an options hedging strategy would require 25 separate options contracts to be written,” he says, as options are written in 100-share contracts. “Whereas, a single CFD trade could protect the ANZ shares on the downside, which is essential during market downturns such as recently when ANZ fell just over 12.5% in 13 days.” However, he warns only experienced investors should look at this kind of risk protection.
  • SMSF trustees must be careful not to fall into traps when renovating their fund’s real estate, and should seek specialist advice to avoid serious legislative pitfalls, warns Cavendish head of education David Busoli. He writes that care must be taken to ensure the market value of the work performed is considered, either in reference to possibly breaching contribution caps or how it is charged to the fund. “Work charged on a labour and materials basis may cause the fund to breach the prohibition of the acquisition of an asset from a related party rule,” Busoli says. Where goods or services are of insignificant value this is not a problem, but for major works the trustee must be registered builder, or hold the necessary licenses. “A solution could be for the Trustee to appoint another, under an enduring power of attorney, to act in their capacity as trustee for the duration of the project,” he says.

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, as some of the strategies used in these columns are highly complex and require high-level technical compliance.

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