Follow these basic steps and stay on the right side of the ATO.
Paying a pension from your self-managed superannuation fund (SMSF) is not difficult but the ATO has reported that many people get the basics wrong.
Here is a checklist of tasks to take into account when paying pensions.
1. Sort the trust deed
The first issue, as always, involves your fund’s trust deed.
Before a superannuation fund begins paying a pension, it’s a good idea to completely review the fund’s trust deed. Many parts of the deed will influence what type of pension can be paid, when pension income can be paid, how those pensions are to be structured, operated and administered, and what type of member can receive a pension. Don’t underestimate the importance of this point.
2. Understand the purpose
Next you need to answer a question: Why is your fund paying a pension? In very broad terms, there are three possible reasons.
- A member of your fund has requested their assets be used to pay a pension. Depending on this member’s age, the trustee should prepare documentation to show that the member’s super benefits can be paid. They need to meet the preservation rules; there are different rules if you’re born before July 1960 and aged between 55 and 59, or if you’re aged between 60 and 64.
- Your fund’s member is aged at least 65 and the fund’s governing rules demand that a pension be paid, or you’re allowed to ask that one be paid.
- The member has requested a Transition to Retirement Pension. That is, the member is over 55 (if before July 1960, as mentioned above) and hasn’t retired.
3. Document the application
The next issue we need to control in relation to pensions involves documentation. You need to obtain from a member an “application form” and, as trustee, you also need to document this pension.
The member completes this application form step after (ideally) reviewing a Product Disclosure Statement (PDS) that the trustee gives them. Issuing a PDS is important even for SMSF trustees.
When your member accepts the trustee’s offer, the member should detail what dollar value of assets the member would like to use to begin the pension.
If some, or all, of this money isn’t in the fund, the member needs to tell the trustee where it is coming from. Are the proceeds coming from new contributions, which will be taxed? Or will some, or all, of these proceeds be coming from superannuation benefits transferred from another superannuation fund?
From 1 July 2013, the super fund member needs to initiate any transfer from other super funds. It can take the transferring fund some time to send the funds through, which means there’ll be a delay before the amount received is known. In some cases – especially from government super schemes – you’ll have to pay upfront taxes on an amount transferred.
The member should also tell the trustee if the amount being deposited in the fund is coming from a pension that is already being paid from another superannuation fund.
You can’t commence the pension until you have all the money for that pension in your super fund.
Your fund member should specify the level of income and any other relevant characteristics of the pension they want.
4. Consider other issues that need to be documented
If the member wishes the pension to be paid to a specific person upon their death (called a reversionary pensioner), they must clearly specify who this person is, their date of birth and their relationship to the member.
If they want lump sums paid if they were to die, will the member use a binding nomination? If so, what type? What does the trust deed permit?
If the member is under 60 when the pension commences, they should also complete a PAYG (pay as you go) declaration, so that the trustee can withhold the correct income tax from each pension payment. (If the member doesn’t provide this declaration, a trustee would need to withhold 46.5 per cent income tax from each pension payment.)
As trustee, your documentation should detail the pension’s characteristics, such as the commencement date, date of first pension payment, how often pension payments will be paid and how they will be made.
You need to do this documentation before a pension commences because otherwise you may be deemed not to be paying a pension and also not permitted to take lump sum payments out of your super fund. Not attending to this basic step can impose significant inflexibility on your retirement.
5. Pay on time
The last issue in relation to paying a pension is quite easy but many get it wrong – make sure you pay pension payments on time. In particular, make sure your fund pays the statutory minimum. For example, for those aged at least 65, but under 75, they must take 5 per cent of their pension’s account balance as income each year.
If you don’t follow this rule, then you’ll be deemed not to have paid a pension. This means the fund earnings would be taxed at 15 per cent for the whole of a financial year.
And finally, this minimum pension has to be based on the net market value of the assets at the start of the year, or if the pension is commenced mid-year, at the time it is commenced.
Tony Negline has worked in financial services for more than 25 years and has been heavily involved in self-managed super funds since mid-1994. He writes about SMSF matters for a wide range of audiences including accountants, auditors, financial advisers and SMSF trustees.