An account-based pension has a minimum annual withdrawal requirement based on the account balance and the member’s age as at 1 July of the financial year (or commencement date if the pension started during the financial year). To ensure the fund is entitled to tax concessions, the minimum amount must be withdrawn no later than 30 June each year. Some pension recipients may wish to withdraw more than the minimum required to meet both their living expenses and their lifestyle needs.
For account-based pensions (excluding transition to retirement income streams in accumulation and market linked pensions) these excess payments can be treated as pension payments or lump sum withdrawals. As the outcomes for a fund, its members and their beneficiaries differ subject to decisions made, advance planning for how these withdrawals are treated is essential.
Alternative allocations of excess pension requirements can have an impact on the income tax of the member (where under 60 years of age), the income tax of the SMSF, the member’s Personal Transfer Balance Cap, estate planning outcomes and Centrelink entitlements in some cases.
Eligibility to take lump sums and the personal tax implications
As alluded to, if you’re retired or over 65 years of age and have a retirement phase pension you are eligible to take lump sums, so long as you continue to draw your minimum pension.
Pension and lump sum payments to members aged 60 and over, from a SMSF (Self Managed Super Fund), are tax free to you personally. Between preservation age (currently 58) and age 60, the taxable component of pension withdrawals are subject to tax at marginal tax rates less a 15% tax offset. For this age bracket, where a lump sum is taken, the taxable component is treated as tax free up to the low rate cap. The low rate cap is currently $215,000 (2020/21 Financial Year). Any taxable component above this cap is taxed at 15% plus Medicare.
Options for treating withdrawals as lump sums
Beyond treating all payments as pension payments, there are two alternatives for how any amount above the minimum pension requirement can be accounted for by SMSF trustees, subject to whether the member has an additional accumulation interest or not:
1. Lump Sum Withdrawal from Accumulation Phase account
The excess amount may be withdrawn from an accumulation interest, if one exists and for members under age 65 that have met the retirement requirements. If the fund does not segregate its assets either by choice or by law, this will reduce the portion of the fund that is subject to tax on the earnings, for the current and subsequent years. When the exempt current pension income of the fund is determined by the actuary, it is based on the proportions of the fund in accumulation phase and retirement/pension phase. The higher the actuarial percentage, determined by having more assets in retirement phase, the higher the exempt current pension income deduction and this can result in lower income tax for the SMSF.
An individual’s personal transfer balance cap is not impacted by withdrawals from an accumulation account.
Where amounts above the minimum pension are treated as pension payments, and an accumulation account exists, this means you will be drawing down on the retirement phase interest. As a result, the proportion of the fund in retirement phase is likely to be reducing relative to the accumulation phase balance (unless contributions are still being made). This will potentially have a flow on effect to lowering the actuary percentage and increasing the tax calculation.
2. Lump Sum Withdrawal from Retirement Phase pension account
Regardless of whether there is an accumulation interest or not, members may choose to withdraw the excess as a lump sum/partial commutation from their retirement phase pension account(s). Partial commutations create a debit to an individual’s personal transfer balance account providing additional space within the cap. In contrast, pension withdrawals have no impact on the cap space.
Space under the cap can enable future contributions, rollovers from other funds and potentially higher death benefit pensions to be moved into in a tax-free environment.
Other considerations
The balances available in the fund and the actual withdrawal requirements of the member will largely dictate how the payments are allocated, and in many instances, how benefits are treated will have little or no impact on tax or the transfer balance cap. However, it is important to consider the member’s estate planning needs and how any treatment will impact planned death benefits allocations especially if members are directing different interests to different parties.
Centrelink is also an important consideration. Where members are in receipt of the age pension they will need to determine how the allocation will impact their reported gross annual nominated payments and how any lump sums will be factored into the income deduction calculation for the income test for any pre-January 2015 grandfathered pensions.
Importantly, proper documentation and minutes should be put in place in advance where a member wants to make an election regarding the treatment of their withdrawals. Lump sums from a retirement phase pension account must also be reported on the Transfer Balance Account Report lodged with the ATO. These decisions should not be considered retrospectively, it is essential that proper planning and consideration is given at the start of each financial year and potentially at the commencement of a new pension.
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 regard to your circumstances.