As we head into a new financial year, many SMSF investors will be thinking about using their super fund to pay a pension for the first time.

Many mistakes are made with pensions because of ignorance of some basic rules. It’s the old not planning to fail BUT failing to plan problem.

Here I’m going to give you nine simple rules that you need to consider:

1. Your fund’s trust deed – what pensions, if any, are permitted? What rules does it demand? Does it permit asset segregation? Does your trust deed permit some or all of the pension’s account balance to be taken as a lump sum? Does your trust deed need to be updated before your pension commences?

2. Why is the pension being paid? – there are three typical reasons – firstly, you’ve requested a pension be paid; secondly you’ve reached an age (for example 65) at which your fund’s trust deed says you have to take your money out as a lump sum or pension or, thirdly, you’ve requested a Transition to Retirement pension.

You’ll need suitable documentation to capture whichever option is relevant. For example, under the first reason you’ll probably need paper-work showing that you’ve retired. Under all options, your SMSF administrator will want to verify your date of birth.

3. Product Disclosure Statement (PDS) – when a super fund pays a pension, the trustees should issue a PDS to the pensioner. There are formal detailed rules that specify what should be in a PDS. ASIC has also issued guidelines, which assist financial product issuers to decide what should and shouldn’t be in these documents.

Most of you won’t have time to go through the legislation and other documentation. Fortunately your fund administrator’s trust deed supplier has probably created a generic PDS, which you can amend for your specific circumstances.

The PDS must specify all the details of the pension and also what information your trustee needs to begin the pension. Obviously, the PDS can’t contradict anything in your fund’s trust deed. Ideally, this information should be detailed on an application form, which you complete. For example:

• commencement date (that is, the official start date of the pension; on this date the assets backing the pension begin to be taxed at 0%)
• the date of first payment (this date is self-explanatory; generally this date isn’t the same as the commencement date)
• specific pension product characteristics (such as the amount of money to be used to buy the pension; the first years’ pension payment; number of pension payments per year; death benefit options, if and when lump sums can be taken, etc.)
• you might want to detail what assets should be sold to make pension payments and in what order.

4. As a member, you formally accept your SMSF trustee’s offer including the initial dollar value for the pension.

If this purchase price is coming from money that’s not already in the fund, then what is its source? Are the proceeds coming from new contributions? Will these contributions be subject to tax when received by the trustee? Or will some or all of these proceeds be coming from super benefits rolled over or transferred from another super fund, an employment termination payment, or other similar type of benefit?

With taxation and rollovers involved, it might be some time before the exact purchase price of the pension is known.

5. The trustee must clarify all the pension’s details. There are two important parts here. Firstly, the value of the assets backing the pension. These must be based on prevailing market value and from here the minimum income payment can be determined.

If you’ve requested an income payment less than the minimum allowed by the super regulations, then at this point the trustee will need to formally communicate this to you.

Once the value of the pension has been set, no new amounts can be added to it via contributions or rollovers.

Secondly, the taxable and tax-free components of the pension – this mightn’t seem a big deal because once you hit 60 years of age your pension payments will be tax-free. However the tax laws demand you keep accurate records here. This can be an important issue for estate planning purposes if your pension assets will be paid to any non-dependant adult children on your death.

6. The SMSF trustee must fully document the pension for its own records – for example, the commencement date, date of first pension payment, how often pension payments will be paid and how.

7. Make pension payments on time and pay the minimum required by the super laws each financial year – a good way to do this is to set up a direct debit facility and make sure your super fund always has sufficient money in the bank to make these payments. All pension payments must be made with cash or cash equivalent, such as cheque or direct debit. Post dated cheques are best avoided.

8. When the pension commences, the SMSF trustee also needs to change their financial accounts – from this specific date, all earnings on the assets backing the pension are tax-free. It’s important you can clearly identify income or capital gains received by the fund from this commencement date onwards.

Don’t forget that in most cases you’ll only get this tax exemption if you get an actuarial certificate each year.

9. And finally – understand that you wear two hats. One as a member and the other as trustee. As trustee, you must deal with yourself as a member impartially. As difficult and as silly as this might sound, this is an important aspect of trusts and super funds laws in particular. This is sometimes referred to as the arm’s length rule.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.