Why are superannuation pensions so much better in SMSFs?
Superannuation pensions in retirement phase are brilliant for members of any fund – not just SMSFs. They allow super to be converted into an income stream to live on in retirement and the fund itself stops paying income tax on some or all of its investment income (rent, interest, dividends etc). For some people, the tax break is so large their SMSF pays no tax at all and in fact gets a full refund of all its franking credits every year.
All super funds follow the same tax rules so in many ways SMSF pensions are just the same as any other superannuation pension. But there are some aspects of running an SMSF that make it the perfect place from which to pay a superannuation pension.
First, it’s easier to get started in an SMSF. In a public fund, members who start pensions need to set up a new account in that fund and explicitly move some of their existing super balance into it. That generally means application forms, waiting for requests to be processed, providing information to confirm they are eligible to start and more. Some public funds allow their members to choose specific investments for their super and if so, the member will also need to choose which ones get moved across to the pension account.
In an SMSF there’s no need to do any of these things. Because the members and trustees are all the same people, pensions can be started instantly. Of course, there is documentation to prepare and it’s every bit as important as in a public fund but the documentation can follow after the pension starts. The critical member request and trustee decision to start can be immediate. And there is no need to move assets or set up new bank accounts – everything stays exactly the same but the fund’s accountant does some extra work in the background to track the new pension account.
And then there is the extra flexibility. There’s no rule that says people with pensions have to take their pension payments as regular monthly or fortnightly amounts. But many public funds require it for practical reasons – when there are thousands of people taking pensions, it makes sense to impose some rules to simplify the administration involved. SMSF members are free to do whatever they want, subject to the law, and the law is not very prescriptive here. The only requirement is that the member takes enough to meet the minimum payment rules each year. Some people do this by arranging regular bank transfers but others might do something completely different. For example, some people don’t take any pension payments during the year but then withdraw the whole minimum amount in one go. Others might even go to the extreme of having their personal credit card or other bills paid by their SMSF each month (and each payment is a pension payment). And some even just take payments when they want them – with internet banking it’s as simple as hopping online and transferring money as and when it’s needed. Essentially, it’s whatever works for the members concerned.
It's also possible, and in fact common, for couples who share an SMSF to think about their pension payments together. For example, they might decide to draw $10,000 per month (combined) and arrange a single monthly direct transfer to their personal bank account. Behind the scenes, their accountant will divide each payment up between them (or between their various accounts if they have multiple pensions) but they don’t need to take separate payments. That’s quite different to non SMSFs where each pension account must make its own cash transfer to the relevant member.
In a retail fund where the members choose their own investments, having to treat each pension account as a self contained “pot” can mean it’s necessary to sell investments in one account (to pay the pension) even though another account has plenty of cash. A good example is someone who has both a pension and an accumulation account. The accumulation account might be receiving contributions and investment income and so is building up cash. But that cash can’t be used to pay the pension. An SMSF is quite different. In an SMSF, pensions are just paid from the fund’s bank account which is generally shared by all members and all accounts. It’s common to find that the cash flow for pension payments is coming from contributions (even contributions made by other members) and investment income across the whole super fund investment portfolio (not just part of it). Again, behind the scenes the fund’s accountant makes sure everyone gets their fair share but in a practical sense, it means minimising costs by sharing cash more effectively.
In fact, the ability to share cash can even have ramifications beyond pension payments. It’s common for members of both SMSFs and retail or industry funds to withdraw more than they have to in some years. Those extra payments don’t have to be treated as pension payments and there are often very good tax reasons to treat them differently. For example, in some cases it’s better to treat these extra amounts as withdrawals from an accumulation account or as different types of payments (called “partial commutations”) from pension accounts. Once again this is incredibly easy to set up in an SMSF. The member can simply provide standing instructions to the trustee that once they’ve taken at least their minimum pension out of the fund, subsequent payments should be treated in a particular way. They don’t need to keep track of exactly when that happens. And they don’t need to take the extra amounts from a separate bank account. In a public fund they would have to do all these things.
Moving into pension phase is definitely one of those times when it’s actually easier to have an SMSF.