One of the benefits of an SMSF is that you can pay yourself a pension. But there are many kinds of pensions and an account-based pension is quite a different beast to a guaranteed pension.
There is no guaranteed aspect to account-based pensions. Once the account balance is zero, no further pension payments can be made. In addition, the minimum pension amount is based on the account balance, which is worked out using the prevailing market values of assets backing the pension. Clearly, as market values fluctuate, the minimum pension payment will move up and down as well. The minimum pension payment must increase as you get older because of Government regulation.
Guaranteed pensions explained
Guaranteed pensions are payable either for the remainder of your life or a definable term. The pension might be paid to your nominated reversionary if they live longer than you. These pensions are sometimes called defined benefit pensions or DB pensions.
These pensions are a bit like a “benefit promise”, that is, the super fund trustee is promising to pay you pension income each year.
The pension payment for DB pensions is fixed when they commence and can only be varied by movements in consumer inflation. That is, there is no reference to account balances, market value of assets or statutory minimum pension payments.
If a super fund with many members pays a DB pension, it will have assets it uses to pay all these pensions (called current pension liabilities) and back-up assets (called non-current pension liabilities). Every year, an actuary has to determine the amount of money that should be in both the current and non-current pension liability ‘pools’. If there is a shortfall, then it is up to someone to make up the difference. If the super fund is run for a specific employer, then it’s up to that employer to put more money into the fund to make good on the promise.
Technically, as the trustee made this promise, it’s up to the trustee to adhere to that undertaking.
Defined benefit pensions in SMSFs – a brief history
Since 1 July 2005, funds with less than 50 members – including all SMSFs obviously – have been banned from commencing new guaranteed pensions.
Like large super funds, smaller funds paying a defined benefit pension also need to get an actuary to look over their DB pensions – and the assets backing those pensions – each year. But if there is a problem with the value of the assets, then who satisfies the benefit promise?
SMSFs that commenced DB pensions before July 2005 can continue the pensions as long as the fund’s actuary every year says the fund has a high probability (that is, more than 85%) of paying all the likely pension payments promised to be paid. Because of the GFC, many of these pensions have failed an actuarial assessment at some stage.
SMSF defined pension – the current state of play
If your fund wants to pay you a guaranteed pension, then your super fund will have to buy a lifetime annuity from a life insurance company. At present, there is only one life company in Australia providing lifetime and longer-term annuities.
With low interest rates, the rates allowed on lifetime annuities aren’t that favourable. It has not always been like this. Most people older than 45 will remember the high interest rates of the late eighties and early nineties when you could buy a lifetime annuity paying an initial annual income of at least 14% followed by annual indexation.
If you buy a lifetime annuity, in most cases the money leaves your fund as a rollover and is paid to the life company.
Alternatively, your super fund will own the policy and you would therefore be the annuitant. The value of the annuity is technically an asset of the super fund but all income payments are directly sent to your personal bank account.
I can’t see any benefit in this second option.
Obviously, your fund’s trust deed needs to allow this investment if it’s the owner. Otherwise the deed just needs to allow you to take the money out of the super fund.
Corman’s pension regulation reform
About two weeks ago, the superannuation minister, Mathias Cormann, released a paper about reforming and updating the superannuation pension regulations.
He proposed a number of adjustments to these rules. It would seem safe to say that the prohibition on SMSFs and other smaller funds providing DB pensions will remain.
One of the major ideas in the paper is the potential for deferred lifetime annuities. The financial services industry, which is very effective at political lobbying, is pushing the government hard to allow these products.
As I wrote in August last year I’m not a fan of these products. I think they’re unnecessary and will be expensive.
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.
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