Why should a member transfer, merge or change pension conditions in a SMSF

The article covers the following situations

A.      Transfer pension to your SMSF from a pension provider

B.      Merge two or more pension in your SMSF

C.      Change allocated pension, Market Linked Pension or a complying pension to the new Account Based Pension - changing pension conditions.

A. Transfer pension to your SMSF from a pension provider

All pensions which began with a pension provider cannot be transferred to your SMSF - as from 20^th September 2007 only Account Based Pension (ABP) can be commenced from a SMSF.

If you have purchased a Market Linked Pension or a Complying pension with a provider, please be aware of the Centre link benefits which you may lose, should you commute those pensions and commence an ABP in your SMSF.

Some older complying pensions allow 100% exemption in Centre Link Age Pension asset test and some Market Linked Pensions allow 50% asset test exemption, however, all assets of ABP are included in the asset test.

If your Pension Provider is paying you an ABP, including a transition to retirement pension, these pensions can be commenced in your SMSF. This article assumes that the member has established his own SMSF with a bank account and has its own ABN and TFN.

In some rare cases, rules of your pension provider may not allow the pension to be stopped or may have a high exit price, hence, before embarking on this transaction, please check your pension documentation, including your super fund's trust deed that It allows rollovers etc.

Any money used to commence a pension with the members own money (old term un-deducted contributions) and members after tax contributions and some other amounts are called "Tax Free" components. Crudely put, where any entity claims a tax deduction for deductible contributions to a SMSF is called "taxable component" of the superannuation interest of the member.

How to apply for a Roll Over?

Once the application is made to the trustee of the existing fund and before a pension's account balance is rolled over to a new super fund, the originating super fund's trustee must make sure that the pro-rata minimum pension has been paid till the date of the application.

If commutation of existing pension is allowed, the trustee of the exiting pension will sell all the assets supporting the pension (if it allows segregation of assets) and then hold the money in a bank account and then prepare a roll over statement and send a cheque of 100% of the balance of the pension commutation to the new fund with the rollover statement.

In the roll over statement, existing fund trustee will inform the SMSF trustee, the breakdown of "Taxable" and "Tax Free" component of the commutation.

Will the existing fund pay CGT at the time of rollover?

If the existing trustee offers an Individual managed account for the member's pension, those assets, supporting the pension would have to be sold to affect the rollover. When the assets of the existing pensions are sold the money's are still in pension phase and hence no CGT will apply upon sale of these assets. The commutation occurs at the time of rollover.

When this rollover arrives in the SMSF, it arrives in accumulation phase, the trustees can at the same moment merge the money with existing accumulation account balance of the member and commence a pension with the total amount, hence, for practical purposes, the money remains in accumulation phase for only some seconds, which means that income derived from these assets are always tax free.

Can the trustee of the existing fund rollover pension assets in-specie?

Usually not, however, some pension providers offer a more flexible investment choice and hold "individual managed accounts" for each pensioner; in this case it is possible to request the trustee of the existing fund to roll over the assets in-specie to the SMSF. Further, it is possible that some assets can only be transferred in-specie as the investment (such as closed funds) cannot be cashed.

Once the money's and assets are rolled over from an existing fund, the rollover will be added to existing assets of the fund which are in accumulation account to form one superannuation interest for the member.

Further, after (or before) the rollover, the member can add more concessional and non-concessional contributions to the SMSF before commencing a new ABP from the SMSF. Please note that new calculations for "Taxable" and "Tax Free" components would have to be done before ABP is commenced.

Purchase price of new ABP

If the roll over happens and new pension is commenced on any other date, other than 1^st July, annual minimum withdrawal pension payment would have to be worked out and withdrawn by the member pro-rata before 30^th June in that year.

Further, if no money is added to the rollover, then the minimum annual withdrawal amount should not change from the original purchase price. But if full 100% of minimum amount is already withdrawn from the pension provider, before the roll over, when pension is commenced from the SMSF a new minimum pro-rata has to be withdrawn form the SMSF as a new pension has commenced within the SMSF and is not a continuation of the same original pension, unless the pension is commenced in June where there is no need to withdraw a minimum amount before 30^th June.

Click here to order documents required to commence a pension in a SMSF

Is rollover amount counted as a contribution to the SMSF?

The amount rolled over will not be a contribution for super law purposes. This means the super law contribution rules (especially relevant for those aged over 65) do not need to be satisfied. The lump sum's preservation status will remain unchanged, which means that if a transition to retirement pension is rolled over and the same preservation rules (maximum 10% ) will apply to the new pension within SMSF.

Is commencing a pension a financial product?

Accountants should be careful whilst structuring this transaction as commencing a new pension is considered to be purchase of a financial product. This means if a licensed financial adviser has recommended the transaction, they should issue a statement of advice and detail why rolling over is appropriate as well as all the costs involved.

ARTICLE CONTINUES BELOW THE SEMINAR ANNOUCEMENT

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*** 11 Seats left ***

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SEMINAR: PENSION STRATEGIES

Commencing a Pension from Self Managed Super Fund is Complex - Learn Pension Strategies

We present a great opportunity for advisors to learn interesting SMSF Strategies that can be structured to maximize retirement benefits of their clients.

This 1 ½ hour information packed seminar will include practical examples and must not be missed by advisors who have clients considering moving to pension phase or are already in pension phase. The seminar will be followed by an informal lunch.

TOPICS

What are the complex issues which must be considered before an Account Based Pension can be commenced in a SMSF;
When & How to convert accumulation account to pension phase;
Step by Step process - what happens to un-realized capital gain on assets when a member moves to pension phase;
What are the Pension conditions as per SIS Act and Regulations which need to be complied;
What are the various components of pension amount;
How to calculate purchase price of pension if superannuation interest contains Pre 1983 component;
How does Transition to retirement pension (aka TRIP) works and how to tweak the correct amount of salary sacrifice amount for the client;
Need for Actuarial Certificates whilst member is on TRIP;
Reversionary Pensions Vs Anti-detriment payments;
How to report pension accounts in financial statements and how does proportionate rule works;
How to document account based pensions in case of ATO audit in your claim for deduction against current exempt pension income;
What must clients do, before they turn 65 years including lump sum payments and re-contribution strategies;
Segregated and non-segregated asset strategies;
What happens in case of death of the pensioner;
Common questions and answers arising when moving to pension phase;
Audit Issues of pension funds.

Click here to commence a pension in a SMSF

When

16^th June 2010 Wednesday

11.30 AM Registration for 11.45 AM Start

Venue

Connaught Place

69 Wigram Street Harris Park Sydney

Cost

$110 Including GST for each attendee

*** 11 SEATES LEFT ***

Each attendee will be given full comprehensive notes including worked out examples + a credit note for any SMSF product worth $110.

How to book: online booking

Visit www.trustdeed.com.au/seminar and book online

or Phone 02 9684 4199

Click here to find out how to purchase property in a SMSF with borrowing

Speaker

Manoj Abichandani

SMSF Specialist Advisor (SSA)

SMSF Specialist Auditor (SSAud)

Manoj has worked in SMSF industry for the past 19 years as a tax agent, accountant and Auditor. Currently he audits Self managed super funds and consults as SMSF Specialist Advisor to other accountants. He has helped over 5000 trustees to set up their own funds and currently audits more than 400 funds each year for various accounting firms which puts him in the top 54 SMSF Auditors (as per ATO) in Australia.

He develops Pension strategies and advises trustees & practicing accountants on complex SMSF matters

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FEATURED ARTICLE CONTINUES BELOW

B. Merge two or more pension in your SMSF

It is common for members to be in Transition to Retirement Pension (TRIP) and commence drawing down a pension (TRIP income stream when they reach 55) whilst they remain in the work force and continue making concessional contributions to the SMSF.

All new contributions are added to the accumulation account which the trustee of the SMSF maintains for the member in addition to a pension account and at one point the member can commence a second pension within the SMSF from these accumulation amounts. This is done because any income derived from the assets supporting the accumulation entitlements will be taxable whereas income derived from assets supporting the pension is exempt from tax.

Please note that any contributions (e.g. salary sacrifice or member contributions) made for the member after commencing a pension cannot simply be added into a members existing pension account (Reg. 1.06 (1) (a) (ii)) of the SISR.

How to merge the two pensions

The process to merge the two pensions is very simple. Basically the member needs to request the trustees to merge the two pension accounts. The trustee will commute the two pensions and then commence one pension with the result amount.

This commutation of pensions or "roll back" to accumulation phase is called an "internal roll over". Before the trustee embarks on this transaction, he must check if the current trust deed of the fund allows this transaction, if not, the deed would have to be amended.

If the commutation happens on a date other than 1^st July the trustee must ensure that

1. Before the commutation happens minimum pro-rata withdrawal amount is paid to the pensioner;

2. At the time of commencement of new pension, all assets of the fund are taken at market value to work out the minimum withdrawal amount of the new pension.

Click here to update your SMSF trust deed

Following major issues should be considered before consolidation of pensions

1. One Pension means one reversionary beneficiary

When a pension is commenced the member can agree with the trustee as one of the pension conditions, to revert the pension to a dependant in case of death of the member. If the member has two pensions, it is possible to stream or revert to another dependant, However, if two pensions are combined, this opportunity is lost.

2. Proportionate tax components get re-set when pensions are merged

Each pension at the commencement has a set "Taxable" and "Tax Free" value, if two pensions are combined then Taxable & Tax Free components of one pension is combined with the other pension.

It is possible that one pension is has 100% "Tax Free" component and the other pension has a different percentage, at the time of merging it is possible to get a result which may be adverse for the member especially if the member is between 55 and 59 years old. This is because pension withdrawal from "Taxable" component is added in taxable income of the member and any withdrawal from "Tax Free" component is not included in income at all.

For Example

Jane is 57 years old and has two pensions and she is on a TRIP and her taxable income is at the top of 30% marginal tax rate.

Pension Tax Free % Taxable %

Pension 1 500 100 0 0

Pension 2 100 20 400 80

Total 600 400

If the two pensions are merged the tax free component of the new pension is only 60%.

If Jane wants to withdraw $100K from the two pensions, she could withdraw the minimum from pension 2 - say 4% of $500K or $20K and the remanning amount of $80K from pension 1 and only 80% of $20K or $16K will be included in her income. Which means that Jane would have to pay 25% tax (marginal rate of 40% less 15% rebate) on $16K.

However if the two pensions were merged on withdrawal of $100K, 40% of taxable component or $40K will be included in her income. This means that Jane now would have to pay 25% tax on $40K.

Further issues to be considered before consolidating two pensions are as follows:

For estate planning issues once the two tax components are mixed, they can never be unmixed till the whole amount is taken out of super;

Centrelink pension issues with respect to income test;

Before commutation of the two pensions, is the minimum amount of pension is paid in the year;

Does the trust deed allow a roll back of pension;

Does the binding death nomination conflict with a reversionary beneficiary nomination in pension agreement;

Age of the pensioner - can consolidation be delayed - In the above example - Jane can wait till she is 60, after that, if she is not working, she can commute the 2^nd pension and re-contribute $450K without a work test as non-concessional contribution and then the two pension can be from "Tax Free" components.

C. Change allocated pension, Market Linked Pension or a complying pension to the new Account Based Pension - changing pension conditions.

The problem here is that you have an existing pension in the SMSF and want to change to ABP conditions. One of the attractions of ABP is that its minimum amount is lower than minimum amount of other pensions depending on the age of the pensioner.

This means that if the pensioner wants to withdraw a lesser amount, it is better to be on ABP.

The other advantage of ABP is that there is no maximum account, however in other pensions; you cannot withdraw over a certain amount.

Market Linked Pensions and Complying pensions have Centrelink asset test advantages as discussed above however, some older pensions cannot be commuted unless the member dies or turns 65 or retires and any Allocated pension commenced before October 2004 full years pension has to be paid, instead of pro-rata withdrawal before they can be commuted.

Procedure to change pension condition to ABP

The procedure is similar to merging two pensions. The trustee has to commute the pension and merge the resulting balance with any existing accumulation account held for the member, reset the taxable and tax free component of the total amount and commence a pension with ABP conditions.

If the event occurs on a day other than 1^st July, the trustee would have to revalue all the assets of the fund to market value to work out the minimum withdrawal limit for the member. If Land and Buildings is one of the assets of the fund, a revaluation may be required.

Click here to convert your pension to ABP

Conclusion

We have seen above that it is easy to commence an ABP from your SMSF so that the fund enjoys "Tax Free" status, and claim exempt pension income, however correct strategy and documentation is required in case of ATO audit.

Also note that there is no one set formula which will apply to all members.

Manoj Abichandani SSA SSAud
SMSF Specialist Advisor
SMSF Specialist Auditor

Team Leader

Superannuation Technical Division

www.trustdeed.com.au