Don't waste tax savings from your self-managed superannnuation, or SMSF
Retirees who propose to withdraw more than the minimum annual pension from their self-managed superannuation funds have been warned that not implementing this strategy correctly could see them waste valuable tax-saving opportunities.
Taking a pension greater than the minimum from your super as of July 1 needs to be properly structured, says Bryce Figot, a special counsel with SMSF law firm DBA Lawyers. The reason for this is to avoid missing out on potentially important tax-free entitlements.
The entitlements are access to the tax-exempt investment earnings available to super in the pension phase. Under new super rules that impose restrictions on how much super can be retained in the pension phase (also called the retirement phase), it's important to know how excess pension withdrawals can result in losing tax entitlements.
The minimum pension is based on an age-related percentage of the super in the pension account.
For many SMSF members, especially those in the early stages of retirement, withdrawing only the minimum of 4 and 5 per cent is a common strategy. The minimum is 4 per for retirees under 65 and 5 per cent for those between 65 and 74. At 75 it become 6 per cent and for those aged 80-84 it is 7 per cent.
Larger balances earlier
In the earlier years only requiring the bare minimum is common because that is when an account balance is at its greatest. Those years often also see tax-exempt investment earnings matching any pension withdrawals.
But as time passes and the required minimums increase and account balances decline, managing pensions by withdrawing more than the minimum can become a challenge.
In the past, says Figot, most people have likely been lax about the amounts they have withdrawn after starting a super pension.
Because most will have committed all their super to the pension phase (where earnings are tax-free), if they needed more than the minimum annual payment they will have simply taken this as an extra income amount.
But doing so from July 1, Figot says, has the potential to become a problem because under the new super rules, pension payments above the minimum taken as income will reduce the capital supporting a pension much faster than an alternative strategy of taking any excess as a lump sum payment.
Under the new super rules, where a retiree starts a pension the amount they commit to this will count against the $1.6 million transfer balance cap now permitted under the investment earnings tax-exempt pension rules.
If $1 million is committed to a pension, even though this leaves a $600,000 entitlement still available for any future pension benefits, a retiree can still waste an opportunity if they withdraw more than the pension minimum.
For a 67-year-old retiree with a $1 million pension account, the minimum annual pension payment in the 2017-18 financial year will be 5 per cent or $50,000.
But if this retiree were to withdraw a $74,000 annual pension amount, they could miss out on opportunities if this happened over the long term.
Over 10 years, for instance, $24,000 a year becomes close to $250,000 of the fund's capital that could be wasted by a member.
A couple with $1 million each in a pension could waste almost half a million worth of tax-free entitlements
But if the pension was structured so that the excess above the minimum was commuted and taken as a lump sum, these amounts will be treated as partial commutations, creating the scope to add further capital to the pension balance equal to the commuted amounts.
Get paperwork right
What is most important about this strategy, says Figot, is implementing this prospectively so that it is quite clear that the member has chosen to commute any excess amount above the pension minimum prior to any pension payments being made.
Documentation must state quite clearly how the pension payment and any excess amount will be treated.
For example a strategy could say that all amounts above the relevant account-based pension minimum should be lump sum payments from the member's accumulation interest.
Where there is no accumulation superannuation interest or the accumulation superannuation interest is insufficient to pay the amounts in excess of the relevant minimum pension, these excess amounts should be paid as a partial commutation from a relevant account-based pension.
Figot says where no lump sum/pension commutation documentation exists either before or at the time of payment, the Australian Taxation Office could decide that there was no partial commutation and that the amount was just paid as a pension payment in excess of the relevant pension minimum.
Similarly, where the payments are allocated and the strategy documented "after the fact", the ATO might take the view that the payments did not come from an accumulation superannuation interest as it could not be proven that this was the intention of the member and trustee at the time of payment, and it was not a valid partial commutation.
Where the buck stops
It is important to be aware that the onus of proof where any strategy is concerned rests with a fund member or trustee (depending on the circumstances).
One thing members taking pensions must be aware of is that the ATO can allege false and misleading statements. Where this becomes an issue, in addition to winding back any tax benefit from the "fabrication" of any documents that did not exist before any relevant commutation, the ATO can impose penalties of up to 75 per cent of any benefit claimed plus an interest charge. Other negative implications could also arise.
This suggests that a conservative approach is best for any pension strategy: an approach that amounts to having relevant documentation completed and signed before the payment of any amounts in excess of the minimum payment.
Also important in any strategy is awareness of the ATO's new reporting regime associated with the transfer balance cap.
Broadly this regime involves a need to report certain events that will have an impact on a pensioner's transfer balance cap.