How to give your SMSF a boost in retirement
While providing income for retirement is the obvious purpose of a pension paid from a self-managed superannuation fund (SMSF), there are some issues to consider before drawing a pension from your SMSF.
Tax rates in accumulation phase vs pension phase
The first issue to consider when starting a pension is that returns from your investments will move to a zero tax status from the concessional tax rate that super funds pay during their accumulation phase.
While in this accumulation phase, the fund’s investment earnings such as interest, dividends or rental income from investment properties are taxed at 15%, and any realised capital gains will most likely be taxed at 10%. (Note that for superannuation funds, capital gains on investments held for at least 12 months are entitled to a one-third discount, which reduces the effective tax to 10%.)
It is commonly the case that income derived by an SMSF may be used to pay a pension to one member in pension phase whilst the other members of the fund are still in accumulation phase.
In such cases, as long as the investments generating the pension stream are clearly identified and segregated from those that are still allocated to members in accumulation phase, then the super rules should allow these investments to be exempt from income tax. That is, there is neither 15% levied on investment returns, nor 10% on net capital gains.
The value of imputation credits
Most pension-paying SMSFs have shareholdings that are fully entitled to dividend imputation credits. In these circumstances, imputation credits from franked dividends and in some cases from trust distributions can be valuable for an SMSF.
In the SMSF’s hands, these tax credits are used to reduce the amount of income tax payable, and if the credits exceed the total tax payable, the amount will be refunded by the Tax Office once the tax return is lodged.
This is an extra benefit for an SMSF, and results from its low (15%) or zero tax rate (depending if it is in accumulation or pension phase).
When a fund receives a fully franked dividend, the imputation credit will not only offset tax payable on the dividend itself, it may offset tax payable on the SMSF’s other income (including concessional contributions) or be refunded.
One thing to remember in this scenario however is that the SMSF must have held the dividend-paying shares for at least 45 days at the time the dividend is paid in order to be eligible to claim the imputation credit, and that the fund’s investment strategy document should record that it will invest in dividend paying equities.
Transition to retirement pension
If the fund member was born before July 1960, they will be able to start a pension from age 55, combined with transition to retirement (TTR) rules (see accompanying article below). This means that the member can receive a TTR income stream, which will give them the potential to enhance their pre-retirement earnings through greater tax effective investment returns.
Extra earnings may be able to be put back into super by way of concessional contributions. This can be especially valuable as an added boost for anyone who has lower amounts put away in retirement savings.
Not 100% ready to retire? ‘Try before you buy’ with a TTR strategy
Under the superannuation rules, there is scope to access some of your retirement savings in your super fund under an arrangement called “transition to retirement” (TTR). Under this arrangement, a super fund member can ease into retirement by reducing their working hours without reducing their income.
If you are aged between your relevant “preservation age” (see below) but are still younger than age 65, you are generally permitted to withdraw some of your super money each financial year and place it in an account that gives you regular payments, called an “income stream”, to supplement your other income (such as from part-time work).
Preservation age depends on when you were born, and ranges from age 55 if you were born before July 1960, increasing by a year until reaching age 60 if you were born after July 1964.
A TTR income stream allows you access to some superannuation benefits without having to retire or leave
your job completely. This of course depends on your personal circumstances. Under this arrangement you are still be able to “draw down” regular payments from your super fund, however these payments are “non-commutable”, which means it cannot be withdrawn as a lump sum.
A self-managed superannuation fund (SMSF) can pay a TTR income stream provided its trust deed allows it. Also, once such an income stream is commenced, the proportion of fund assets that support the income stream attracts no tax.
The super law provides that for an SMSF, TTR income streams must satisfy the following requirements:
- it must be an “account-based” income stream, which means an account balance must be attributable to the recipient of the income stream
- the payment of a minimum annual amount must be at least 4% of the account balance
- total payments made in a financial year must be no more than 10% of the account balance at the start of each year; this is the maximum amount of income stream benefits that can be drawn down each year
- the income stream is non-commutable
- the income stream can be transferred only on the death of the member to one of their dependants, or cashed as a lump sum to a dependant or the member’s estate, and
- the capital value of the income stream and the income from it cannot be used as security for borrowing.
Note also that TTR plans are not available to members of defined benefit super funds.
Other issues for consideration under a TTR plan include:
Work and pension — If you are receiving a TTR income stream and are continuing to work, your fund (SMSFs included) may also be receiving contributions such as superannuation guarantee payments on your behalf. There must be two accounts to make this arrangement work – one for paying the TTR and the other for receiving contributions.
Allowing a lump sum — While no lump sum payments are allowed while receiving a TTR income stream (as it is non-commutable), once a member decides to retire or turns age 65, the income stream converts to a normal account-based pension and the member can then take out a lump sum as required.
Pension changes tax take — Once a TTR has been started, the income from that portion of the super fund’s balance generally attracts no tax. With an SMSF, for example, if there are two or more members of the SMSF and only one has taken a pension (that is, the other members are still in accumulation phase), then only the portion of the fund’s assets that is attributable to the pension-drawing member escapes paying tax.
Check your insurance cover — If you have arranged to have life insurance cover through your superannuation fund, check with the fund to make sure your life cover does not reduce or even cease.
Please contact us for help regarding any of the above matters.
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