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With the $1.6m transfer balance cap (TBC) in effect, consideration should be given to how a fund maximises the amount it has in pension phase.  By achieving this, the fund can therefore maximise tax savings associated with a 0% tax rate compared to an accumulation account that is taxed at 15%.

Consider the following example:

• John and Margaret Smith have an SMSF

• Each member has a balance of $1.5m in accumulation phase

• Both members are 68 and retired

• The fund has $100,000 of taxable income (all investment income, no contributions)

If John and Margaret were to both commence an account based pension (ABP) at 1 July 2018, the pension commencement will lead towards the fund’s income being exempt from tax, resulting in a tax savings of $15,000 ($100k x 15%).

Ensuring the fund remains in pension phase or keeping as much in pension phase as possible is important, as it will keep the fund’s tax savings maximised.

TBAR Fact – When John and Margaret commence their pensions, they will also need to document this on their TBAR (transfer balance account report). Because John and Margaret’s pensions exceed $1m at 30 June 2018, both pensions must be reported to the ATO no later than 28 October 2018 (28 days after the end of the relevant quarter). The fund will have a quarterly reporting requirement.

Both members have used $1.5m of their TBC. The current TBC is $1.6m.

Now consider the following (continued from previous example):

• John makes a rollover of $500,000 into the SMSF on 1 January 2019

John and Margaret’s SMSF now has both a pension and accumulation balance. This will therefore lead to the following deliberations:

1. John and Margaret will be required to obtain an actuarial certificate each year in order to determine how much of the fund’s income is exempt from tax

2. John can commence another account based pension for $100,000 (note, he has already used $1.5m out of his $1.6m TBC, therefore after his new pension is commenced his TBC will be maxed out!)

TBAR Fact – A TBAR will need to be lodged for the March 2019 quarter no later than 28 April 2019 (28 days after the end of the quarter). The TBAR will contain all relevant details of John’s new pension commencement for $100,000.

After this pension has been commenced, John’s pension account could exceed $1.6m in pension phase due to organic growth of his SMSF, however, this will not give rise to an excess.  A members TBC is only affected by a TBAR event (click here for a list of the events).  Investment earnings do not affect the balance of a members TBC, therefore, Johns TBC value is $1.6m.

After the commencement of John’s new account based pension, John asks his accountant what the fund’s minimum pension payment for the year is, and his accountant advises the following:

• John ABP #1 – $1,500,000 x 5% = $75,000

• John ABP #2 – $100,000 x 2.48% (5% / 365 x 181 – total days the pension was in effect for the year) = $2,400

• Margaret ABP #1 – $1,500,000 x 5% = $75,000

Fund Total Minimum Pension = $152,480

John subsequently advises that he would like to withdraw $200,000 from his fund for the year. John then asks how his excess payments above his minimum will be treated as he wants to ensure he is maximising his and Margaret’s TBC as well as the fund’s exempt pension income tax savings.

Here are John and Margaret’s options:

Option 1 – Pension Payments

1. Meet minimum on all pension accounts

2. Allocate excess amount above minimum to pension account with highest taxable component

Benefits:

• Great strategy to assist with removing taxable money from the SMSF

• This in turn can help reduce death benefits tax in the event John or Margret’s benefits are paid to a non-dependent

Further information regarding how death benefits are taxed can be found here

Limitations:

• By allocating the payments above the member’s minimum as a pension, it reduces each member’s pension account. This has a two pronged effect:

1. Decreases each members pension balance

   1. Remember a pension payment does not reduce a members TBC, therefore if the pension account has been exhausted and their entire cap has been used, they cannot commence a new pension

2. Increases the amount of tax the fund will pay

   1. If the fund’s pension accounts decreases and the accumulation balances remain the same, the fund will have more tax to pay in comparison to its previous financial years. This is because the actuarial percentage obtained will reduce because a higher proportion of the fund will be in accumulation phase

Option 2 – Pension Payments & Lump Sums

1. Meet minimum on all pension accounts

2. Treat excess amount above minimum pension as a lump sum from the accumulation account

3. Where the fund has no accumulation account or insufficient funds for the entire payment to be allocated against the accumulation account as a lump sum, treat the payment as a partial commutation for a members ABP.

Benefits of the Lump Sum:

• This ensures each members pension account remains as high as possible

• This also ensures the fund’s potential tax savings is maximised, as its actuarial certificate will be higher in comparison to if the fund treated all member payments as pension payments (as illustrated in Option 1 example)

Benefits of the Partial Commutation:

• Where a member makes a partial commutation payment, the payment is essentially considered to be a lump sum, and in turn the amount treated as a partial commutation will reduce the members TBC.

  • In comparison to treating the excess payments as a pension, it should be remembered that no TBC reduction will occur.

  • Therefore, this strategy should be considered for any fund that makes a payment over and above its minimum

  • Because the members TBC is reduced, the member will then have room to commence a new pension to bring them back up to $1.6m or create more opportunity to commence an even bigger pension in future years.

Limitation:

• Where an excess payment is treated as a lump sum or a partial commutation, appropriate documentation should be prepared accordingly to support the payment

• It is also recommended this documentation is prepared prior to the payment being made as “backdating” can hold serious consequences. Furthermore, the ATO may not accept the payment as a lump sum or partial commutation should the relevant documentation be dated after the payment has been made.

TBAR Fact – Where a partial commutation is made for a member, their TBC is reduced. Therefore, this needs to be documented in the member’s TBAR and lodged with the ATO. If the fund is a quarterly reporter, the payment must be documented in the relevant quarter’s TBAR. If the fund prepares its TBARs on an annual basis, this can be documented in the annual TBAR submitted to the ATO.

It is extremely important that time is made to consider a member’s options when it comes to how its member payments will be treated (pension, lump sum or partial commutation). Failure to do so can result in a members TBC suffering the consequences, in addition to increased tax payable by the fund.