SMSF Technical Education & Strategies

 

The Transition to Retirement Pension

A transition to retirement pension (otherwise known as a TRAP) is a type of income stream that you can commence from your SMSF if you have reached preservation age (currently age 55) and are still working and therefore you don't meet a condition of release to start a regular account based pension.

As the name suggests, this type of pension was introduced to assist members who are in a 'transition phase' to retirement, where you may still be doing some work (say part time or even full time) but need a top up of income from your SMSF assets.

 

TRAP's are actually a type of "account based pension" (ABP), whereby they share many similar characteristics as a regular ABP, but have two significant differences.

 

Firstly, a TRAP has the following characteristics in common with a regular account based pension:

- it is an income stream that you receive from your SMSF cash account over to your individual bank account for you to use for whatever purpose you wish.

 

- 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.

 

- 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.

 

- 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

 

There are two major differences with a TRAP:

1. You cannot take out (commute) any lump sums.

 

2. There is a maximum limit to how much income you can take out each year of 10% of your SMSF account balance on July 1st.

Note that once you retire or fully satisfy another condition of release, you can convert this to a normal Account based pension, and can have access to all of it's flexibility such as taking out lump sums, and no maximum income limit.

 

A common strategy is to combine a TRAP with salary sacrifice. That is, you receive a TRAP income stream with low or no tax, while at the same time limiting the income tax on your work income by salary sacrificing it into your SMSF (paying a maximum of 15% tax instead of your marginal tax rate). See our SMSF strategies page, Salary Sacrifice with a Transition to Retirement Pension for more details.

 

Minimum Drawdown Amount

As with regular account based pensions, there is a minimum dollar amount of total payments that need to be made each year. 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 had her 57th birthday, and has decided to cut back and only work part time. However, Jane currently has living expenses that will exceed those of her part time wages, and would like to get a top up from her SMSF account.

 

As Jane is 57 years old and still working, she does not satisfy a condition of release for her super. However she can establish a TRAP with either part or all of her SMSF account balance (depending on how much she needs) and can accomplish what she is after.

 

Jane decides that she will commence a TRAP with her SMSF account balance of $250,000.

 

The minimum amount of pension (under normal circumstances) she will have to take out each year will be:

 

4% x $250,000 = $10,000 (**halve this for 2010/11)

 

The maximum amount of pension she is allowed to take out each year will be:

 

10% x $250,000 = $25,000

 

In this case, Jane decides she only needs $10,000 over and above her part time income and so chooses that amount. If she needs more, she can take more but only up to $25,000 in total for the year.

 

As Jane is under 60 years old, the pension will not be tax free in her hands, but it will be tax advantaged. The pension amount will be added to her assessable income for the year, however the taxable portion of the pension will attract a 15% tax rebate.