The recently released NTLG superannuation technical sub-group committee minutes from the September 2009 meeting looked at what I think may be a common problem within the SMSF industry around paying the minimum pension. A question that was raised was whether an SMSF (or other super fund) can accrue a pension payment to meet the minimum pension requirements under SISR1.06(9A) where the physical payment of pension hasn’t been met before 30 June?
I would suggest that accruing pension payment shortfalls within SMSF administration is somewhat common practice to deal with the problem. However, do people really understand the implications imposed by tax and superannuation law that took effect from 1 July 2007. The introduction of the account based pension requirements in conjunction with sections 295-385 and 295-390 effectively deny the fund the right to claim an amount for exempt pension income. Recent ATO grumblings around reviewing tax agent practices in SMSF administration and compliance may actually find a few people out in this regard… I noted from reading that exempt pension income calculations is one of the key concerns the ATO has with accountants and administrators preparing SMSF returns.
The law is quite clear here; the member is required to be paid at least annually an amount at least equal to the minimum pension. The ATO appears also to be quite definitive in their view that the fund must meet its requirements to pay the pension. You cannot simply say that the pension will be paid in accordance with section 1.06 and then actually not pay the minimum amount within the prescribed time frame.
It is important to remember at this time that pension payments must also be made in the form of cash and not as an in-specie payment (refer APRA Super Circular I.C.2).
A pension that does not meet the imposed super law requirements cannot actually be defined as a superannuation income stream and therefore is ineligible to the income tax exemption for the SMSF. Furthermore, superannuation law does not allow (quite logically) for the requirements to be met where a payment would be made in the following year. Could you imagine how this would operate?
So, how do you practically deal with a situation where the minimum pension has not been taken but want to ensure that the fund is entitled to a level of exempt pension income? Consider the following scenarios:
- Arrange to roll-back the income stream at an effective date that would ensure that the minimum pension has been met
Example - John is 62 years of age and has $1m account balance at 30 June. His following year revised minimum account based pension level is $40,000 (4%) (ignoring any current 50% reduced minimum pension concessions). John realises at 30 June the following year he has only drawn $30,000. The application of the law will state his pension is not a complying income stream and deny any exempt pension income tax deduction. But, what if (retrospectively) the member decided to rollback their existing income stream to an accumulation interest at 31 March 2009? On this basis, John will have met the minimum pension requirement and whilst not receiving a full year’s tax exemption on fund income, 75% of the year is better than none. At 1 July the following year, John could simply recommence a new income stream. Whilst I’m not an advocate for retrospective paperwork, the reality is that many areas within SMSFs operate this way, in particular with income streams as they are dependent on financial statements which typically are prepared several months after the close of the financial year. So, in my opinion, I see this as a far better method to pursue than accruing pension amounts that will (or should) get caught out under audit.
- In a falling market, whilst the fund might be denied an exempt pension income tax deduction if the minimum pension payments aren’t met, there may be some merit in treating all these payments as lump sums and remain in accumulation for the financial year. Subject to the level of tax-free and taxable components, a falling market in accumulation can only benefit a future income stream commencement tax-free proportion as any reduced balance in accumulation phase effects the taxable component. This is opposed to components of a pension being paid where the tax-free (TFC) and taxable (TC) components are determined at commencement and remain for the life of the pension. Therefore, using the example above, if during that financial year, John’s balance dropped to $700,000 in which there was $500,000 of TFC, upon recommencement at the lower account balance, John has effectively increase the TF proportion of his pension from 50% to 71% (50% being $500k/$1m & 71% being $500k/$700k). Long term growth with this higher TF proportion would provide significant estate planning benefits to his family. Under age 60, John would also benefit in with increase tax efficiency of the pension.
It does raise a serious issue though about the requirements of a transition to retirement income stream (TRIS) recipient who falls short of their minimum pension requirements. Why? because, a TRIS pensioner whilst having met a condition of release has not met a cashing restriction requirement to unpreserve (or gain access to) their benefits. So, you can get into a situation where the individual has taken what were meant to be pension payments, but by virtue of not meeting the SISR1.06 requirements, these pension amounts actually become lump sums and the fund is denied any tax exemption. However, the member is not allowed to draw lump sums (access) from their benefit as the money is preserved. Do we then have an illegal early access issue?
Whilst you would hope some level of common sense would prevail here, it just goes to show – know you minimum pension, and make sure you take it!!