SMSF Technical Education & Strategies

 

The Account Based Pension

With the introduction of the Simpler Super reforms that came into effect on 1 July 2007, the types of pensions that could be offered within a SMSF changed significantly. This article deals with the main pension now available, the Account Based pension.

Account based pensions

Account based pensions are by far the most common and popular pensions available today. An Account based pension is essentially an income stream that you receive from your SMSF account when you retire, or meet some other condition of release that does not have a cashing restriction preventing the payment of these pensions. They involve periodic payments (e.g. monthly, quarterly, yearly etc) going from your SMSF cash account over to your individual bank account for you to use for your living expenses etc.

 

Within your SMSF, you do not need to change your investments, although it would be prudent to ensure an appropriate asset allocation is in place to support a pension's income requirements. You'll also need to do some paperwork within the SMSF to establish the pension.

 

An account based pension will have the following characteristics:

 

- Any income or capital gains derived from the assets funding your pension are tax free within the SMSF. Note that if there is also an accumulation account in the fund, you will need to either segregate the pension assets in the fund or get an annual actuarial certificate if all the fund assets remain pooled together. This is to ensure you receive the tax exemption status.

 

- If your over age 60, the income you receive in the form of pension payments from your SMSF are tax free in your hands. If your between age 55 and under age 60, there are still some tax advantages.

 

- Given the tax free status of income within the pension, any imputation credits from franked Australian shares will be refunded to the fund (after the annual ATO return), effectively enhancing the yield on your investments.

 

- You can withdraw (commute) lump sums from your SMSF account based pension any time you wish. Over age 60, these lump sums are tax free.

 

- The pension payments that you receive do not have to follow any set pattern (e.g. monthly or quarterly etc) even though most do. You just need to make sure that at least the the minimum amount of income payments have been made over the year.

 

- The value of all of the assets funding the pension are assessable as an asset for the Centrelink assets test, however the pension payment is favorably assessed under the income test.

- Once the pension is started, the capital of the pension cannot be added to, other than an increased value of investments. One possible exception to this is an allocation from a reserve. You can also stop a pension (i.e. roll back to accumulation), add money to that balance, and re-start a new pension. Note that any contributions need to adhere to the contribution rules. You can also start a second pension if desired, such that you have multiple pensions.

 

- They do not have a set residual capital value

 

- They cannot continue to be paid to a 'non-dependant' beneficiary in the event of your death - only to 'dependant' beneficiaries. See our estate planning articles for more info on dependants.

 

 

Minimum Drawdown Amount

Account based pensions require a minimum dollar amount of total payments to be made each year, with no maximum. This minimum amount is based on your age, and is calculated as a % of your SMSF account balance at the start of each financial year, 1 July. See below

55 – 64                    4%
65 – 74                    5%
75 – 79                    6%          
80 – 84                    7%
85 - 89                     9%
90 – 94                    11%
95+                          14%

 

** Important note : due to the global financial crisis, these minimums have been temporarily halved for the 2008/2009, 2009/2010, and 2010/2011 financial years. This is known as minimum pension drawdown relief.

 

Example:

Jane has just turned 60 and has decided to retire from her job after 25 years with the same employer. She has notified the trustee of her SMSF (which includes herself) that she wishes to commence an income stream from her SMSF via an account based pension on the 1st of July.

 

Jane has $500,000 in her SMSF account balance on the 1st of July. Therefore, the minimum amount of pension (under normal circumstances) that Jane must at least take out of the fund over the course of the year is:

 

4% x $500,000 = $20,000.

 

(*Note that under the pension drawdown relief this amount is halved, and so would be $10,000.)

 

As Jane is over aged 60, the pension payments would be tax free in her hands. Any other income or capital gains derived inside the pension would also be tax free as there are no accumulation accounts in the SMSF.