If you are receiving an account-based pension, or transition to retirement income stream (TRIS), you need to make sure the super laws are complied with. The fund needs to pay at least the minimum pension and if the pension is a TRIS, no more than the maximum permitted can be paid.

The consequences

If the pension does not comply with the pension rules, it is taken to have ceased at the beginning of the financial year for tax purposes. From the start of the income year when the pension rules are not met, any payments you receive are treated as a series of lump sums. In addition, any income earned on investments in the super fund used to support your pension in that tax year will be taxed in the fund at 15%.

From 1 July 2017, if you are receiving a TRIS, any income earned on investments used to pay the TRIS is taxed in the fund at 15%. If the TRIS is in retirement phase the income will be tax free, however, if the pension rules are not met, the income earned by the fund on the TRI’s investments will be taxed at 15%. If your TRIS does not meet the pension payment rules, there may be a breach of the preservation standards and a penalty may apply.

If your pension does not meet the rules in one year but meets them in the next year, the fund will be required to commence a new pension for you at the beginning of that financial year. A recalculation of the taxable and tax-free component will be required, as well as a revaluation of fund investments to work out the opening balance.

Some SMSFs may pay more than one pension. Any shortfall in the payment of one or more of those pensions will mean that any income earned on investments used to support the pension(s) will be taxed in the fund at 15%.

Exceptions to know about

In rare circumstances, the ATO will allow a pension to continue although the minimum pension amount may not have been paid. This occurs where the fund may have made an honest mistake resulting in the underpayment, which was out of the control of the trustee. Once the trustee becomes aware of the shortfall, any catch up payment must be made as soon as practicable.

If your fund makes a payment in the current or a future year to compensate for the shortfall, it will be counted against the minimum pension amount in the year in which the shortfall occurred. It will not result in the stopping and starting of a pension and there will be no need to recalculate the proportioning rule for the taxable and tax-free components. The amount used to pay the pension will continue to be a current pension asset and all payments will continue as income stream benefits and not lump sums.

If the pension that is being paid by the fund is underpaid by a small amount, no more than 1/12^th of the minimum pension payment for the year, the ATO will accept the pension as meeting the rules in some situations. If the shortfall is greater than 1/12^th then the ATO will consider the case on its merits. Any payment to compensate for the shortfall must be made within 28 days of the trustee becoming aware of the underpayment. If other conditions set down by the ATO are met, the pension will be considered as meeting the requirements for the year in question.

What would the ATO do?

Here are some examples of how underpayments of an account-based pension are likely to be treated by the ATO: 

Example 1

Rod’s SMSF did not meet the minimum payment requirements for the 2018 financial year due to a typo error in the pension calculation. There is a small shortfall of $1,000, which is equal to 5% of the minimum pension payment. In deciding whether the shortfall would be accepted by the ATO, the trustee of the SMSF would need to consider:

• Whether the payments were made during the year correctly and the underpaid amount was due to an honest mistake,
• That the size of the underpayment did not exceed 1/12^th of the minimum pension payment for the year;
• Once the error was detected, that the shortfall was paid as soon as possible in the next financial year.

It would be expected that the ATO would accept the shortfall as the fund has corrected the error within their guidelines. Because of this, the pension will not need to cease and a new pension commence in the next financial year after the shortfall has occurred. Also, the income earned on investments used to support the pension will be tax exempt.

Example 2

Haley is the trustee of her SMSF and made an electronic transfer of a pension payment on 30 June, which fell on a weekend. Under the superannuation rules, the payment of a pension is treated as having taken place when the member receives it. This didn’t occur until 3 July when it was credited to her bank account. Unfortunately for Haley’s SMSF, a pension payment that is received after 1 July is counted against pension payments in the next year. This meant there was a shortfall in pension payments.

If Haley was to have the pension payment on 30 June, she would need to show that the delay in payment was outside her control, which may not be possible in the circumstances.

Not meeting the pension rules can mean additional tax, or possible penalties, in some cases. It also can mean that the pension will need to be recommenced in a future year and will require revised calculations and new documents – something to be avoided at all costs. 

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.