Cecile Apolinario explains the key issues and steps trustees need to address when starting a pension for a SMSF member.
What types of pensions can be started?
It is now generally only possible to start two types of pensions in an SMSF.
These are a ‘regular’ account-based pension if the member meets a full condition of release, and a ‘transition to retirement’ (TTR) account-based pension if the member has reached their preservation age.
A range of pension standards must be met with both options, such as minimum pension payments. TTR pensions also have a maximum annual payment of 10 per cent and commutations can only be made in limited circumstances.
Ten steps to starting a pension
1. Consult the deed
Before paying a pension, the trustees should arrange for a suitably qualified person to check and review the fund’s trust deed to make sure it allows the payment of a pension, as some funds don’t.
Many deed provisions will also influence when a pension can be paid, who can receive a pension and how the pension is to be operated and administered.
2. Put request in writing
The member must request, in writing, that the trustee commence paying a pension. The request must indicate the pension’s intended start date, the level of income required and the frequency of pension payments.
The member must provide the trustees with a tax file number declaration and details for the bank account for pension payments.
The member should also decide if the pension is to revert to a death benefit dependant (usually a spouse). Alternatively, the member may want to complete a binding death benefit nomination.
3. Validate and record request
The trustees need to validate the request by ensuring the member is eligible to start the pension. They then need to record in minutes that the request is valid and a resolution has been made to pay the pension.
4. Issue a PDS
The trustees must consider whether they need to provide a Product Disclosure Statement (PDS) if they have not already done so.
The Australian Securities and Investments Commission provides some guidance on this issue in Regulatory Guide 168. Some legal firms have created a generic PDS which can be amended as required.
5. Register for PAYG
The trustees must register for ‘pay as you go’ (PAYG) withholding if required to withhold tax from the pension payments.
This must be done before the first amount is withheld. The trustees may need to withhold tax from the taxable component of a payment that is made to a member less than 60 years old. The withholding rates are detailed in Schedule 34 – Tax table for superannuation income streams (NAT 70982).
Trustees don’t need to withhold tax when paying a pension if the member is 60 years old or over at the time of the payment, or they are under age 60 and all the payments comprise the tax-free component.
The trustees must complete a PAYG payment summary – superannuation income stream (NAT 70987) form if they withhold tax from a member benefit payment.
If a payment summary is issued, the trustees also need to lodge a PAYG withholding payment summary statement (NAT 3447) with the Australian Taxation Office by 14 August. Both these forms may be lodged using the ATO’s electronic commerce interface software.
6. Determine market value
Australian Taxation Office Superannuation Circular 2003/1 states that the assets supporting the pension must be valued at the net market value on the commencement day.
When determining the asset value of the member’s account balance, the trustees must also account for all income and contributions received during the year.
7. Determine components of member’s account
The tax-free and taxable components of the member’s account must then be determined at commencement. This proportion will be used to determine the tax-free and taxable proportion of each pension payment.
8. Review investment strategy
The fund’s investment strategy should be reviewed to ensure it reflects the member’s retirement needs, and be adjusted if necessary.
Members will often need to hold more cash in the pension phase than in the accumulation phase in order to meet pension payments and other liabilities.
It’s important that the actual investments reflect the objectives and investment strategy. When changing investments, the objectives and strategy should be amended to ensure consistency.
9. Select segregated or non-segregated method
The trustees will then have to decide whether to use the ‘segregated’ or ‘non-segregated’ method to determine the ‘exempt current pension income’ (ECPI), which is not taxable.
Because the option chosen could result in different accounting and taxation outcomes, the trustees should seek advice from their accountant before making the decision.
The segregated method involves the trustees notionally segregating the assets that will be used to support the pension payments.
If this method is used, the trustees are not required to obtain an actuarial certificate to qualify for the tax exemption when they pay the pension.
If the assets supporting the pension are not specifically identified, the pension is considered non-segregated and the trustees need to obtain an actuarial certificate that certifies the proportion of income that is ECPI.
This must be done by the time the fund lodges its tax return for the year. The unsegregated method is more commonly used, as it is easier to administer.
10. Start the pension
The trustees then start paying the pension.
The member must be notified in writing of the applicable minimum payment, as well as the tax-free amount. If the member is under 60, the trustees may need to withhold tax from the pension payments.
All tax must be remitted to the ATO within 21 days from the end of each quarter.
Cecile Apolinario is a technical services consultant at MLC Technical Services.
