Critical considerations highlighted with pension commencement

“Before commencement, we need to understand what governing rules of the fund will allow the fund to pay from an income stream perspective,” Mr Dunn explained.

“Now generally a deed will be broad enough in its application that it will allow for a pension that can be paid in accordance with the superannuation laws, or there may be some specific references to the types of pensions that could be paid, and they may be account-based pensions or market-linked pensions or legacy pensions and the like.”

Understanding the characterisation of those pensions, Mr Dunn said, or the form in which they can be commenced, is absolutely critical to the process.

Mr Dunn said SMSF professionals also need to be aware of the preservation rules and conditions of relief that will allow benefits to be moved.

“A condition of release must be met so that we can get the retirement phase exemption in respect of those pensions,” he noted.

Mr Dunn said it is also critical that SMSF professionals contemplate any final strategy considerations before the pension has been commenced.

“Once a pension has been commenced, we cannot add to the capital of that income stream unless we actually cease that. The Commissioner’s views on that are clearly set out in TR 2013/5,” he cautioned.

“We must also ensure that our assets are valued to their market value. So we have that requirement within SIS reg 8.02 B, that talks about the market valuation and the valuation guidelines that we need to follow for the purposes of not only establishing the income stream, but obviously for financial statement reporting purposes, as well as we look to calculate the ongoing pension requirements year on year.”

Once SMSF professionals get to the point of commencing the pension, they will then need to contemplate the purchase price in line with any transfer balance cap considerations, explained Mr Dunn.

“If we are starting that income stream for the first time, where we will create a transfer balance cap event against that individual’s transfer balance account, then they have $1.7 million available to them,” he noted.

Mr Dunn noted that the general transfer balance cap was indexed from $1.6 million to $1.7 million from 1 July 2021.

“So if we did have previous reported amounts against an individual’s transfer balance cap, the level of indexation is going to be different to a just standard $100,000 increment. It’s that personal cap that now comes into play around the proportional indexation,” he explained.

“If someone has previously used all of their transfer balance cap, then they are done and dusted because that available cap space at any one point in time was in fact nil. So therefore, they have no indexation or $100,000 being the general cap increase multiplied by the available cap space of zero means they remain at $1.6 million,” he stated.

The other vital consideration is the reversionary status of the income stream, he said.

“Is that pension in the event of the members death to be paid to one or more tax dependants, a spouse or child, for example, someone in an interdependent relationship or a financial dependant and the level of reversion?” he explained.

“Now, ordinarily, we see pension set up in a way whereby I, John citizen, hereby have my pension revert to Jane. So there’s an inference that it’s 100 per cent of that benefit that may actually revert. Now that doesn’t necessarily need to be the case, it may be that a reversionary percentage has been set, or it could be that we have a dollar amount, or it could even be linked to a member’s total superannuation balance at a specific end of year, or even a transfer balance cap amount as well. So there are various ways that the reversion can take place.”

SMSF professionals also need to make decisions around how assets are to be structured.

“Are we setting aside specific assets, or do we actually have assets segregated by default by virtue of the entire fund supporting retirement phase income streams, and therefore, do we have what are known as deemed segregated periods? Or do we have a pool of assets whereby we are simply allowing mum and dad to consolidate that together,” he said.

“We may have a combination of accumulation and pension balances, whereby we would be required to obtain an actuary certificate, whether that is by virtue of the accounts in there, or we may simply be forced to do so because of the operation of the disregarded small fund asset rules.”

Documentation is also a critical part of the process, said Mr Dunn.

“We need to evidence the concept of request and acceptance between the trustee and member.

“So we formalise the agreement and the terms and conditions of that income stream with the member as the recipient, and the fund as the holder of that for the benefit of the individuals,” he stated.

Finally, there is transfer balance account reporting to consider, he said.

“Once we move to retirement phase, we have that requirement to assess the credits against the transfer balance cap for that individual once that nil cashing condition has been met. We need to report that process and do documentation around the condition of release,” he said.