According to the ATO, a pension that’s short paid in the 2015 year will no longer exist on 1/7/2014, and that anything paid out during that year will be as a lump sum.
However, the ruling doesn’t say anything about:
1. How the pension ceases
2. What documentation is needed
3. What happens when the pension is reset the following year
And that’s where TR 2013/5 falls short. It creates uncertainty for SMSF advisers that could result in SMSF compliance issues down the track.
For example, does the pension go back to accumulation mode or stay ‘suspended’ for the year?
Let’s say it goes back to accumulation. Will your SMSF auditor expect to see commutation documents? And what documents are required?
Now let’s say it stays in pension mode, and the member meets the pension rules the following year. How will their new pension assets be revalued? Will it be at market value?
And if it gets overlooked, will the member fail the pension standards in the future?
To get answers to these questions we had a lengthy discussion with the ATO.
We’re glad we did, because we can now tell you how to ensure your clients stay on the SMSF compliance path and keep meeting all the necessary pension standards.
Going back to accumulation
When the pension ceases:
- It goes back to accumulation mode at the beginning of that year
- All of its tax-free and taxable components have to be recalculated
However, a pension can only be commuted when:
- A member chooses to commute their entitlements
- A valid commutation takes place
If your client doesn’t choose to commute the pension (i.e. they don’t request it), you still need documentation. You should also prepare a minute (and get it signed) outlining these circumstances.
Something like this: “The member failed to meet the minimum pension payment during the year, which resulted in the pension ceasing on 1 July 2014. The amount of that pension is now supporting an accumulation account.”
Commencing a new pension
If the member complies with the relevant rules in the following year, then a new pension can be commenced.
It doesn’t need to commence with the same amount as the previous pension. However, because it’s new the trustees need to meet the pension standards by:
- Revaluing the assets at market value
- Recalculating the minimum pension amounts (and maximum if applicable)
- Creating pension establishment documents, and recording the tax-free and taxable components.
We hope this answers any questions you might have about ceasing an underpaid pension.
Shelley Banton, director, SuperAuditors