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.
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Subject to Bob’s personal marginal tax rate, the tax payable on the minimum pension withdrawn would be: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[1] |
| 31.5% | $6,600 | |
| 39.5% | $9,800 | |
| 46.5% | $12,600 |
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 If Bob has already used his low rate threshold, then any taxable amounts withdrawn above this amount have the tax rate capped at 16.5% (inc.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Note: It is important to remember that any amount that is withdrawn from taxable component must be taken in proportion with any tax-free component.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.
Technical Analysis[2]
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).
[1] Medicare levy payable only as tax offset on exceeded tax payable on income stream
[2] Details contained within technical analysis provided by Meg Heffron paper, SPAA Conference 2010
Aaron
I am sorry that I do not agree with you (and with Meg Heffron) on this issue.
I agree that any payment from a super fund can be elected to be paid as a lump sum instead of being treated as an income stream as per ITAA Regulation 995-1.03(b), however just to take the lump sum enough to meet the requirement of minimum withdrawal as per Schedule 7 is too far reaching and extending the intention of SIS Regulation 1.06(9A)(a).
If you were correct then imagine the following
A 55 year commences a simple pension (no TRIP) with say $1M – the minimum about is $30k for 2011/12 and then $40K and by the time he reaches 60 the limit of $165K low rate threshold will increase – this will mean that none of the pension will be included in his income tax return as long as he withdraws the minimum amount and all the withdrawals will be treated as lump sums and since all the withdrawals are below the low rate threshold – no tax is payable and according to you (and Meg) the minimum withdrawal amounts have been met.
I am sorry, but the above is NOT acceptable to me as a SMSF Specialist Auditor – i can take this issue with our discussion group, but according to me, the withdrawal has not met the pension conditions and the fund according to me will not be able to claim Exempt Pension Income. I will prefer to see a private ruling from the ATO or something more concreate then an “opinon” of one advisors (well respected even by me) of the interpretation of SISR 1.06
Manoj Abichandani
Hi Manoj,
Thanks for your response. I can understand a conservative position that you may take in respect to this issue, but as you would be aware once these views are expressed by the ATO within a tax ruling, they are legally and administratively binding. Until this guidance was provided by the ATO, simply relying on a view expressed by the ATO in an NTLG Super Technical Meeting does carry risk as it is not binding in any way (it is simply a view).
I do not think that in practice that a person drawing a monthly income stream could effectively run this strategy as it would be administratively costly to arrange for multiple partial commutations. Questions would be asked about the “tax motives” as well, however, for an individual wanting to draw down a single pension payment within a financial year, it is very effective. In addition, with views expressed that these payments can done “in-specie”, this can allow somebody to arrange for a simple transfer of shares or units.
I’d be more than appreciative of further comments from auditors within the SPAA discussion group. I think you will find a ‘mixed bag’ of responses, in particular subject to the amount of times that the strategy is utilised by a fund member within a financial year.
Regards,
Aaron
I ueasrntdnd re the buckets.I guess what I was trying to get at, is if you want to go with cash and index funds, then is it that hard to do a SMSF? while these options are available in superfunds, you may be able to do it youself just as easily and possibly with lower fees (ie Ubank and vanguard)… I ueasrntdnd that there are SMSF support structures out there that can audit etc a SMSF for around $700 per year… So depending on your funds, that doesn’t necessarily equate to significant costs (ie to warrant someone needing a $1,000,000 before setting up a SMSF).I agree with you, re superfunds offering a fast variety of products and can manage for very low fees and probably mean that a SMSF isn’t necessary. But I think that SMSF isn’t necessarily that hard or expensive…. It is an interesting and complicated debate and I guess depends on what people want to achieve.
Aaron, you mentioned in your reply to Manoj that payments could be made ‘in specie’, would capital gains tax within the superfund occur at this point on the effectvie disposal of those assets?
Yes, the disposal is a CGT event, but if the fund is running an unsegregated investment strategy, the tax exemption should be 100% (i.e. sold tax-free).
Regards,
Aaron
Aaron, I note that the recent ATO draft taxation ruling supports your view on this. You mentioned that “this strategy is not available with a transition to retirement income stream (TRIS), as these benefits are preserved. If a client has unrestricted benefits available, consideration should be given to running multiple income streams.”
The ATO website states that “If a transition to retirement income stream is commuted, the resulting lump sum benefit cannot be taken in cash unless the member satisfies a condition of release with a ‘nil’ cashing restriction (for example, retirement) or the purpose of the commutation is to cash an unrestricted non-preserved benefit”.
This seems to indicate that a TRIS with an unrestricted non-preserved component can be partially commuted. Could you please clarify?
Regards,
Andrew
Hi Andrew,
Thanks for you question. I believe that if the TRIS has an unrestricted non-preserved component, it can be partially commuted and the unrestricted component can be paid as a lump sum. Ordinarily I would recommend separating any unrestricted benefits into a separate pension, rather than combining into a TRIS, as this component is required to be taken first. By setting up a second pension with the UnRNP, this can be an Account Based Pension and enjoy the benefits of net earnings being applied against UnRNP benefits rather than preserved where combined into the TRIS.
Regards,
Aaron
By way of update, I draw attention to TR2011/D3 and particularly paragraph 108, which I interpret as validating the lump sum strategy proposed by here (and by Meg Heffron). I’m hoping my SMSF auditor doesn’t take the contrary view taken by Manoj Abichandani prior to the ruling.
Hi Graeme,
Two points I make:
1. You note Manoj’s views were expressed pre-ruling; have these changed since the release of TR 2011/D3? and
2. As a prudent step, why wouldn’t you have the discussion with the fund auditor now and provide them with the technical references and industry commentary to provide comfort before sending to audit?
Regards,
Aaron