Aaron Dunn, CEO of Smarter SMSF, and Tim Miller, technical and education manager for Smarter SMSF, stressed in a webinar last week that there is a “quirkiness” in starting a pension on 1 June, when thinking about the requirements and the pro-rata requirements that apply.
Miller said that when starting a pension, it is first necessary to determine the value of the account balance immediately before the pension commences to lock in the tax-free and taxable percentages that will apply to the split of all benefits from that point on.
“Then, if we calculate a pension on the commencement on any day other than 1 July, we have to do a pro-rata calculation for the number of days, including commencement date, up until 30 June. However, there’s a catch within the legislation that says if the pension commences on or after 1 June you don’t have a minimum pension obligation so while you can draw down a pension if you start in the month of June, there is no obligation,” he said.
The advantage of using this strategy is that the fund will be considered to be in pension and therefore considered to be entitled to the exempt current pension income (ECPI) deduction.
Dunn also highlighted the importance of considering how ECPI would function during the pension phase, highlighting the strategic benefit of assessing the pension in case of potential capital gains.
Miller added that to understand how this strategy works in practice, it is necessary to look at the definition of income stream which is considered a series of payments – not a single payment.
“A series of payments can include annual payments, but to be considered annual it means you need more than one year, so if you started a pension on 1 June and you didn’t draw down on the income stream in that year, then not only would you need to draw down in the following year, but then you would probably need to also draw down in the third year as well to ensure that you have a series,” he said.
Dunn emphasised the necessity for a series of interconnected payments before conducting the audit for the year when the pension commenced in June. Not having a pension would result in the payments being treated as lump sums rather than income stream payments, he said.
“You need to very quickly be able to connect the dots and that may mean you’ve got one payment, but you may need to then make that subsequent claim reasonably quickly because these are the questions that would come up within the audit of that particular year,” Dunn said.
