TR 2013/5 was updated in June 2024, introducing a new approach to processing underpaid pensions, requiring SMSF trustees and professionals to understand these changes thoroughly.
The One-Twelfth Rule Still Applies
Before delving into the changes affecting underpaid pensions, it is essential to clarify that the one-twelfth rule remains in effect.
The rule provides limited circumstances in which SMSF trustees can self-assess, allowing an account-based pension to continue. It means that an exception applies only if all the following conditions are met:
- The trustee did not pay the minimum pension amount in that income year because:
- An honest mistake resulted in a small underpayment (which does not exceed one-twelfth of the minimum pension payment in the income year), or
- There were matters outside of their control
- If the income stream were in the retirement phase, the exempt current pension income (ECPI) exemption would have continued if the minimum payment was made.
- When the trustee became aware that the minimum payment was not made, they either:
- made a catch-up payment as soon as practicable (generally within 28 days) in the current income year or;
- treated a payment made in the current income year as being made in that prior income year.
- If the catch-up payment were made in the prior income year, the minimum pension standards would have been met.
- For all other purposes, the catch-up payment is treated as if it were made in the prior income year.
Most importantly, the rule applies at the fund level (not per member or per member interest) and can only be used once. It ensures that the exception remains a special provision for genuine errors or circumstances beyond the trustees’ control, rather than a routine allowance.
Where the exception has previously been used, the trustee can write to the ATO to ask whether the Commissioner will make an exception.
When a Pension Ceases
A superannuation income stream is taken to have ceased for income tax purposes if the requirements for paying the pension are not met in a financial year.
Some of the reasons include exhausting the capital, transferring the pension to another fund without the member’s consent and the death of a member (unless there is a reversionary pension in place).
The most common reason a pension ceases is the failure to satisfy the minimum annual pension payment requirements. When these requirements are not met, the pension is deemed to have stopped from the beginning of the income year for income tax purposes.
As a result, any payments made throughout that income year, or in subsequent years, are classified as lump sum payments. This classification means that the fund is not entitled to claim exempt current pension income (ECPI) in relation to those payments.
While there has been no change to the treatment of underpaying a pension for tax purposes, the new approach applies for superannuation purposes, which will impact SMSF trustees and professionals.
Previously, where the minimum pension was paid in the following year, the pension effectively continued for superannuation purposes.
This is no longer the case.
Commuting A Pension
Starting 1 July 2024, when the pension fails, it cannot be reinstated or continued in future years to meet the SIS requirements.
Any income stream payable from the pension must cease, and a new income stream must commence. The only way that can happen is by commuting the pension.
Commuting a pension cannot happen automatically. A commutation can occur only if there is an agreement between the member and the trustee, with the trust deed playing an essential role in determining the appropriate course of action.
It means that checking the trust deed’s requirements is critical. For example, the trust deed may state that a commutation will take effect upon the trustee’s acceptance of the commutation request.
Starting A New Pension
In line with the definition of “commencement day” under Reg 1.03(1), a new pension commences on the first day of the period to which the first payment of the pension relates.
The commencement day is determined by the terms and conditions of the pension contract between the trustee and the member, the trust deed rules, and Schedule 7 of SIS.
While the commencement day may occur before the due date of the first payment, the commencement date cannot precede the date of the member’s request or application.
The result is that until the trustee identifies that the pension was underpaid in a prior financial year, it sits in limbo without the ability to claim ECPI, which may take several days, months or even years.
Any future payments are treated as lump sums under those circumstances.
No Backdating Documents
It also means that the documentation to commute a pension and start a new one cannot be backdated, because neither action can occur before the member actively learns of the underpayment.
It is not until afterwards, when the member and trustee agree on a course of action, that the necessary documents are commenced to commute the pension and start a new one.
Backdating documents to a date before the underpayment has been identified is fraud and illegal. It carries severe penalties for the trustee and the SMSF professional assisting them. The ATO can also disqualify trustees for serious breaches and refer an accountant to their professional body for disciplinary action.
TBAR Event
Given that ceasing a pension is also a transfer balance account reporting (“TBAR”) event, the SMSF will need to report a debit to the ATO through the TBAR.
As the TBAR event occurs at the end of the income year in which the pension failed, i.e., 30 June, the TBAR will generally be lodged after the due date.
At the time of writing, the ATO has not imposed any penalties for failing to lodge a TBAR on time.
The best practice is to lodge the ‘failure TBAR’ manually via the ATO Portal based on the pension’s value. The value must also include the amount of ECPI the fund would have received had the pension not failed during the year.
Commuting a pension that failed to meet the minimum is not a TBAR event, but starting a new pension will require the assets to be valued at market value and a TBAR to be lodged.
Consequences of Underpaying a Pension
An underpaid pension has different effects on everyone in the SMSF ecosystem.
For an SMSF trustee, the inability to claim ECPI for an undetermined period can adversely affect retirement savings. Additionally, the tax components of the failed pension are mixed with the member’s accumulation account from the start of the year.
SMSF accountants, on the other hand, will have to undertake significantly more work to process an underpaid pension. It will require several complex steps due to the difficulty of processing it through SMSF administration software.
It is also critical that pensions are routinely reviewed before the end of the financial year and in early July to help identify failed pensions sooner. Implementing data feeds in the SMSF administration software can go a long way to mitigating this risk.
Luckily, the ATO has confirmed it will not apply compliance resources to reviewing underpaid pensions before 1 July 2024 if they were commuted correctly in line with TR 2013/5.
SMSF auditors must address the timing issues of when the underpayment was detected and whether the commutation and pension documents were backdated.
They will also need to consider the impact on both financial statements and member reporting, including ensuring that all necessary adjustments have been made to reflect the pension’s cessation accurately.
Moving forward, members may choose to create multiple pension accounts to ensure that pension failures affect only a small portion of their balance, rather than the entire balance, thereby increasing the workload for all SMSF professionals.
Conclusion
Regardless of the complexities and risks associated with an underpaid pension, SMSF trustees and professionals need to remain vigilant and proactive in monitoring pension payments and compliance requirements.
Using SMSF administration software with a data feed will help detect and transparently handle discrepancies promptly. Also, ensuring the minimum is paid before June each financial year will safeguard members’ retirement outcomes, minimise administrative burdens, and avoid regulatory penalties.
Ultimately, adopting a proactive approach that combines careful oversight, timely reviews, and reliable technology will help ensure pension payments are managed accurately and efficiently.
