Starting a pension is a critical component of any member's retirement plans. Getting the process right is, in turn, a critical part of executing those plans. The tax benefits which flow from getting the commencement process right are the glue which holds together all the various components and makes the whole of the member's retirement plans work.
The following is a suggested 10 step check list to follow when starting a pension in SMSF.
1. Consult SMSF Trust Deed
Before commencing a pension, a suitably qualified person should check and review SMSF trust deed to make sure it allows a pension to be paid. Some deeds only permit lump sum payments, for example. Also, many deed provisions will influence when a pension can be paid, who can receive a pension and how pensions areto be operated and administered.
Upon review, any changes to the terms of SMSF trust deed (if any) should be made first before commencing a pension.
2. Put all requests in writing
The Australian Tax Office (ATO) in its capacity as regulator of the SMSF sector, has made it clear that an SMSF pension does not commence until such time as all the terms and conditions of the pension are agreed between the member and the trustees of the SMSF.
It is therefore considered best practice for the member who wants to start a pension to make their request, in writing, to commence the pension.
The request should indicate the pension's intended start date, the level of income required and the frequency of pension payments. The member should provide the trustees of the fund with a Tax File Number declaration and details for the bank account into which the pension is to be paid. Clearly, the member and trustee being the same person know this information already. It is important however that his information be given in writing as part of this process.
The member should also complete either a binding death benefit nomination or reversionary beneficiary nomination to ensure the money is paid in accordance with their wishes if they were to pass away. The nomination must be consistent with the requirements specified in the SMSF's Trust Deed.
3. Validate and record request
As part of the process of recording the agreement between the member and trustees, the trustees need to validate the request by ensuring the member has satisfied one of the relevant 'conditions of release' or that there are sufficient benefits that are already available. They then need to record in the SMSF minutes that a valid request to start a pension has been received and a resolution has been made to pay the pension in accordance with the terms agreed between the parties.
4. Issue a Product Disclosure Statement (PDS)
Trustees of the fund must consider whether they need to provide a PDS if they have not already done so. Some legal firms have created a tailored PDS that has been created for specific Trust Deeds.
5. Register for PAYG Withholding Tax
The trustees must then register for 'pay as you go' (PAYG) withholding tax if the pension is to be paid to a member under age 60 and/or the payments will have a taxable component. This must be done before the first pension payment is made.
6. Determine market value
The trustees must then determine the market value of the assets supporting the pension on the day the pension commences. If this is the beginning of the financial year, the member's account balance for the previous financial year may be used. Where a pension commences part way through the year, when determining the asset value of the member's account balance, the trustees must not forget to account for and add on all income and contributions received during the part-year to the member account balance of the previous year.
7. Determine components of the member's account
The tax-free and taxable components of the member's account must be determined at pension commencement and this proportion needs to be applied to each pension payment. Income earned and accruing capital growth of SMSF assets will also be allocated to the member's account using the same proportions. Even if the member is not subject to tax on their pension payments because they are 60 years of age or older, these components must still be calculated and recorded as they may be relevant for determining the taxable components of some later death benefit lump sum payments that may be made.
8. Review SMSF investment strategy
When starting a pension, it is important to review SMSF investment strategy to ensure it reflects the member's retirement needs and, if necessary, make any adjustments. 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. As always, it's important that the actual investments reflect the objectives and investment strategy.
9. Ensure pension fund income is tax exempt
Income from assets supporting a pension will be tax-exempt if SMSF uses the 'segregated' or 'unsegregated' method. The trustees should decide which option best suits their fund's needs and situation before they start the pension.
Remember that recent changes to the tax and superannuation law, limit the total value of assets supporting any one particular member's pension liabilities. This in turn, limits the tax concessions available to an SMSF paying a pension to one or more members.
10. Commence the pension
The trustees then need to start paying the pension. The member must also be notified in writing of the applicable minimum pension payment as well as the tax-free amount. If the member is under 60, the trustees will need to withhold tax from the pension payments.
Finally, the trustees must ensure all the requirements of a super pension are satisfied for the entire period, being either the part year the pension is paid or the full financial year. Importantly, this includes ensuring the minimum pension payments required by law have been paid. Any other terms and conditions of the pension must also be met.
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Disclaimer and Warning
The information above is of a general nature only. It should not be used as a source to make financial decisions. It's also important to note that the legislation and figures related to this topic tend to change regularly and therefore the information above may not reflect the current status. We recommend that if you are looking for advice on this matter, you should contact us.