Debunking the myths around pension documentation

Debunking the myths around pension documentation

A lot of SMSF practitioners are confused about the documentation for establishing a pension, and getting the process wrong can result in significant penalties for trustees.

One of the greatest fallacies in SMSF administration is that an SMSF trustee is entitled to an account-based pension once they reach their preservation age.

It’s easy to understand why the confusion exists, as the preservation age is one of the conditions of release as outlined in the SIS regulations.

However, it’s the associated cashing restriction that’s often ignored in relation to the member’s preservation age.

The SIS regulations are quite specific about the type of pension that can be started once the preservation age is reached:

(a) A transition to retirement income stream;

(b) A non-commutable allocated annuity;

(c) A non-commutable allocated pension;

(d) A non-commutable annuity; and

(e) A non-commutable pension.

Put simply, once a member reaches their preservation age, they are only entitled to commence a transition to retirement income stream (TRIS) under the cashing restrictions, which means that a 4 per cent minimum and 10 per cent maximum of the opening member pension account balance must be paid.

To start an account-based pension (with no cashing restrictions), the member must have either reached their retirement age of 65 or reached their preservation age and met a separate condition of release (e.g. retirement) to comply with the regulations.

The problem in practice is that many SMSF advisers are using incorrect pension establishment minutes for members starting an account based pension under the age of 65.

The minutes incorrectly state that the member has now “reached their preservation age and satisfied a condition of release and wish to commence an account-based pension”.

Getting it wrong can mean significant tax consequences for members receiving benefits in breach of the cashing rules or a condition of release. The payments must then be included in the member’s assessable income and are subject to their top marginal tax rates.

As payment of benefit rules are also operating standards, SMSF trustees can face additional fines of up to 120 penalty units and the fund made non-complying by the regulator.

The new pension transfer balance cap of $1.6 million also needs to be taken into consideration by SMSF advisers. Under the 2016 budget proposals, a TRIS will no longer receive an earnings tax exemption from 1 July 2017 onwards and won’t count towards the transfer balance cap.

When pension establishment documents aren’t clear, the ATO may not agree that a TRIS has commenced, but rule that an account-based pension has been established and adjust the member’s cap balance accordingly. Poor SMSF documentation may have unintended and unwanted consequences in the future.

Before starting any pension, it is best practice to check the trust deed to ensure that it allows for the establishment and payment of a pension. A deed dated before 2007 may not reflect changes to the super rules, such as allowing for a transition to retirement income stream or an account based pension.  

It should be remembered that any differences between the governing rules and the SIS regulations can cause a conflict regarding the validity of a pension.

Where an SMSF auditor cannot confirm that a pension has been paid in accordance with the fund’s trust deed and SISR 6.17, the auditor is obliged to qualify the audit report and may be required to lodge an auditor contravention report with the ATO. The ATO may then question whether the pension is a complying pension and whether fund assets have been illegally released.

There are no restrictions on a member accessing their unrestricted non-preserved benefits at any time, but the same doesn’t hold for preserved benefits and restricted non-preserved benefits.

Depending on the member’s age, starting an account based pension will require one of the following approaches:

  1. If the member is aged 65, and over, meeting the preservation age is an acceptable condition of release and minuted accordingly; or
  2. If the member is not yet 65, the establishment minutes should specifically note which condition of release has been met or the member can elect to sign a separate condition of release declaration.

Remember too that under the age of 65 the member is also required to meet a condition of release each and every time they commence an account-based pension. The reason is that a member’s circumstances can change in the short term, such as returning to the workforce and becoming gainfully employed.

Unclear pension establishment documentation can lead to SMSF trustees and their advisers confused about what type of pension has been commenced. While both a TRIS and an account-based require a minimum annual payment to be made, only a TRIS has a 10 per cent maximum annual payment amount.

The consequences for exceeding the 10 per cent maximum payment limit on a TRIS are harsh. Not only has the member actually ‘blown’ their pension for the year, no exempt current pension income can be claimed, and any pension payments taken are classified as super lump sums for income tax purposes and lump sums for SISR purposes.

Once again, any lump sum payments are included in the member’s assessable income and taxed at their highest marginal rates, without any tax offsets.  The payments are treated as early access to the member’s super benefits, and the audit report qualified on SISR 6.17.

As always, the devil is always in the SMSF detail.  With significant changes on the way for pensions as a result of the 2016 budget announcements, ensuring that SMSF pension establishment documents are correct may just be the difference between compliance and non-compliance.

According to Superannuation Industry (Supervision) Regulations 6.01, a member reaches the preservation age under the following circumstances:

If A Person Was Born:

Their Preservation Age Is:

before 1 July 1960

55

during 1 July 1960 – 30 June 1961

56

during 1 July 1961 – 30 June 1962

57

during 1 July 1962 – 30 June 1963

58

during 1 July 1963 – 30 June 1964

59

after 30 June 1964

60

 

Superannuation Industry (Supervision) Regulations 1994 – Schedule 1 – Condition of Release of Benefits

 

Conditions of Release

Cashing

Restriction

SuperAuditors’ Comments

Retirement (Aged 55-59)

Nil

Member ceased employment and not gainfully employed for more than 10 hours per week

Retirement (Aged 60-64)

Nil

An arrangement under which the member was gainfully employed has come to an end

Terminal Medical Condition

Nil

Illness or injury likely to result in death in 24 months (two medical certificates required, one being from a specialist in the relevant field)

Permanent Incapacity

Nil

Unlikely to engage in gainful employment again (medical certificates required)

Former temporary resident to whom r6.20A or 6.20B applies, requesting in writing the release of his or her benefits

Amount that is at least the amount of the temporary resident's withdrawal benefit in the fund, paid:

(a) as a single lump sum; or

(b) if the fund receives any combination of contributions, transfers and rollovers after cashing the benefits, in a way that ensures that the amount is cashed

This rule does not apply to Australian or New Zealand permanent residents

Termination of gainful employment with an employer who had, or any of whose associates had, at any time, contributed to the fund in relation to the member at any time

1.   Preserved benefits: Non-commutable life pension or non-commutable life annuity

 

2.   Restricted non-preserved benefits: Nil

 

Severe financial hardship

Under paragraph 6.01(5):

(a) in each 12-month period (beg. on the date of first payment), a single lump sum of not less than $1,000 (unless the member balance is less) and not more than $10,000

Under paragraph 6.01(5): (b) Nil.

Cashing restrictions apply unless the member has reached their preservation age. Specific circumstances apply to release of these benefits

Compassionate grounds

A single lump sum being an amount that:

(a) taking account of the ground and of the person's financial capacity, is reasonably required; and

(b) in the case of the ground mentioned in paragraph 6.19A (1)(b) in each 12-month period, does not exceed an amount equal to the sum of:

   (i) 3 months' repayments;

   (ii) 12 months' interest on the outstanding balance of the loan

There are specific grounds for release and requests must be lodged in writing with the Department of Human Services

Temporary Incapacity

A non-commutable income stream cashed from the regulated superannuation fund for:

(a) the purpose of continuing the gain or reward the member was receiving before the temporary incapacity; and

(b) a period not exceeding the period of incapacity from employment of the kind engaged in immediately before the temporary incapacity

In general, benefits may be paid only from the insured benefits or voluntary employer-funded benefits

The member's employment doesn’t have to fully cease but, generally, a member would not be eligible if they were receiving sick leave benefits

Termination of gainful employment with a standard employer-sponsor (where the member's preserved benefits is less than $200)

Nil

Subject to the governing rules of the Fund

The Commissioner of Taxation gives the fund a release authority under section 135-45 in Schedule 1 to the Taxation Administration Act 1953

The restrictions contained in sections 135-75 and 135-85 in Schedule 1 to the Taxation Administration Act 1953

A release authority is obtained from the ATO enabling the fund to refund excess contributions

 

Shelley Banton, director, SuperAuditors

 

Debunking the myths around pension documentation
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