Starting and stopping a pension in SMSF
Stopping and then restarting a pension to restructure your superannuation benefits in a more tax-effective fashion is common practice, particularly among self-managed superannuation funds. In August 2011, the Australian Taxation Office (ATO) issued a ruling explaining how to calculate the minimum pensions to be paid from a superannuation fund if you decide to stop (commute) the pension you are receiving and start another one.
Australian superannuation funds that are paying pensions enjoy important tax concessions. The income generated by the assets supporting the pension is tax-free. However, a minimum amount must be paid to you each year from the fund. If you do not withdraw the minimum pension, your fund is deemed to be in breach of the rules and could lose its tax-free status for the entire year.
The calculation of the minimum pension relates to how old you are and the balance in your account in the fund, either when the pension starts or at the beginning of the year. The calculations are much more complicated in some situations, for example, if you have a pension account that is for a specific term or that is based on your life expectancy.
So why would you want to commute your pension? One reason could be that you want to add more capital to your pension account. Another could be that your circumstances have changed and you no longer want to take a pension.
If you are receiving a transition to retirement pension, you may have retired and you may want to stop that pension and convert it to an account-based pension. The main reason for doing this is to have greater flexibility in the maximum you can take from the fund. You are limited to 10% of your account balance in a transition to retirement pension, but in an account-based pension, you may take all the money in your account as a pension if you wish.
Be aware that when you commute a pension and use that capital to start a new type of pension, there will be a change to the proportion of your benefit that will go to your dependants tax-free when you die. More importantly, after they receive the benefit, the amount taxed at 16.5% will also change.
Because of this ruling, you should take some precautions before you stop a pension and start a new one, and you should always consult your advisers before you take any action.
If you do commute your pension, make sure that you can start a similar one in the fund. If you have a life-expectancy pension, for example, you may not be able to start a new one in a self-managed superannuation fund and you may have to roll your benefits over to a life-office type fund. If this is the case, you need to sell the assets and convert them to cash before you commute the pension. This conversion to cash before commutation will reduce the amount of tax you may have to pay on capital gains in the fund.
It is important that you recalculate the tax-free and taxable portions of your account balance – especially if you are adding more money to the fund. If you decide to proceed, make sure that the trust deed of your fund, your legal will and any death benefit nominations reflect your wishes. Sometimes it may be better to simply start a new pension with any extra capital, rather than commute and add to your account balance. Do your sums first.
Finally, make sure you have taken the minimum amount required for the year before you commute your pension. The new ATO ruling gives very clear guidance on how to calculate this. The ATO has also issued a draft ruling about the impact of death on stopping a pension and we look at that in detail in the next article. Both rulings should be read together.
The important thing is not to rush into a decision to commute a pension. Make sure you have looked at all the ramifications before taking this step.
Sources:
www.ato.gov.au “Stopping and starting a superannuation income stream”