The impact of tax to influence whether to take a lump sum or pension from your SMSF is something that requires appropriately planning and consideration of one’s overall tax position. Whilst the drawing benefit as either lump sums or pensions over 60 are tax-free (non-assessable income), there are some important considerations for those aged 55-59 who may be seeking access to their retirement savings.
To demonstrate some of these important considerations, let’s consider the following case study.
Bob (57) has $1,000,000 in accumulation phase and has just retired from employment. All of the benefits include taxable component. Bob’s intention is not to seek further employment and as a result he can advise the trustees that he has met a ‘condition of release’ (and move his benefits from preserved to unrestricted non-preserved).
Bob wishes to commence an account based pension and draw the minimum pension of $40,000 or 4%.
Subject to Bob’s personal marginal tax rate, the tax payable on the minimum pension withdrawn would be:
|Tax Rate||Tax Payable|
|Minimum pension payment of $40,000||16.5%||$600|
By way of comparison, what if Bob wishes to take this amount (or series of amounts) as a lump sum? Bob can withdraw up to $150,000 of taxable component from his low rate threshold (cap) tax-free as his benefits are unrestricted. If Bob has already used his low rate threshold, then any taxable amounts withdrawn above this amount have the tax rate capped at 16.5% (inc. Medicare).
Note: It is important to remember that any amount that is withdrawn from taxable component must be taken in proportion with any tax-free component.
An important additional consideration in deciding to take a lump sum versus an income stream is the taxation rate inside the SMSF. Whilst taking lump sums may provide a personal tax saving to Bob, the fund will remain in accumulation phase and the income be taxed at 15%. Alternatively, where Bob draws an income stream, this pension will be taxable in his own hands but the income within the fund is tax exempt (0%).
If we assume the fund generates 5% income on the portfolio, the SMSF will have earned $50,000 of taxable income.
A comparison of the two options is:
|Fund Tax Rate||Tax Payable on $50,000 income|
|$40,000 taken as a lump sum||15%||$7,500|
|$40,000 drawn an income stream||0%||$0|
Therefore, as you can see from an overall tax position, unless Bob’s taxable income was in the 38% tax bracket or above (+ Medicare), he is then better to take the $40,000 as an income stream.
Note: the 38% tax bracket takes effect from $80,000 of taxable income as above.
But wouldn’t it be great if Bob could have the best of both worlds?
Well… he can have his cake and eat it too!!
When looking at the application of both the SIS Regulations (SISR) and the Income Tax Assessment Act (ITAA 1997), an Account Based Pension amount, whilst a “superannuation income stream benefit” can elect to have the amount treated as a lump sum if the member specifically elects beforehand to do so. Furthermore, where the member makes this decision (and hence the payment is taxed as a superannuation lump sum), there is nothing in SISR 1.06(9A)(a) which would stop it being counted towards the minimum pension requirements set out in Schedule 7.
Please refer to the heading “technical analysis” below for further details.
So, what this effectively allows Bob to achieve is to:
- take the $40,000 as a pension (which exempts the fund’s income), but Bob can elect to have these amount to be treated as a lump sum against his tax-free low rate cap; and
- can have the payments (regardless of being lump sum) meet his minimum pension (4%)
This achieves a highly effective outcome for Bob, who through partial commutation lump sums can not only take out his $40,000 minimum pension tax-free but also have all the income generated by the fund exempt from income tax.
It is important to note a few points:
- This strategy is not available with a transition to retirement income streams (TRIS), as these benefits are preserved. If a client has unrestricted benefits available, consideration should be given to running multiple income streams.
- The election must occur before the payment is made; and
- The election is only effective while the pension is still operative. If the pension is terminated (fully commuted and paid out in cash or paid out as a death benefit on the death of the pensioner), the election cannot be made and the payment will not count towards meeting the minimum pension requirements.
SIS requires at least a minimum amount to be paid from a pension each financial year. However, in the case of an Account Based Pension, SIS Regulation 1.06(9A)(a) simply requires that “the total of payments in any year (including under a payment split but excluding amounts rolled over) is at least the amount calculated under clause 1 of Schedule 7”.
Distinct from the old rules for allocated pensions, the “payments” do not exclude commutations paid in cash. When it comes to taxing “payments” from a pension, the ITAA 1997 is concerned with totally different issues – that Act uses quite different terminology in describing the tax treatment of “pensions”. For example, the term “pension” is not used at all, but rather two types of payments known as:
- Superannuation lump sums – taxed using the low rate cap; and
- Superannuation income stream benefits – taxed at normal marginal rates less the 15% tax offset (between 55 – 59 years).
So when is a payment a “superannuation income stream benefit” or a “superannuation lump sum”?
The default position is that any payment from a superannuation income stream (a pension) is a superannuation income stream benefit. This is established in the definition of “superannuation income stream benefit” set out in Regulation 995-1.01 of the Income Tax Assessment Regulations 1997 (ITAR 1997).
However, Regulation 995-1.03 ITAR 1997 provides that a payment from a superannuation income stream is not a superannuation income stream benefit if it comes from an income stream which allows flexible payment amounts (such as an account-based pension) and:
“The person to whom the payment is made elects, before a particular payment is made, that the payment is not to be treated as a superannuation income stream benefit” (Regulation 995-1.03(b))
Therefore, any payment that is not a superannuation income stream benefit (whether from a pension or not) is a superannuation lump sum (Section 307-65, ITAA 1997).
 Medicare levy payable only as tax offset on exceeded tax payable on income stream
 Details contained within technical analysis provided by Meg Heffron paper, SPAA Conference 2010