How to withdraw 2% minimum pension for 2011-12 year instead of required 3%
Every cloud has a silver lining and the current turmoil in the share market may come as a blessing to some SMSF pensioners who want to simply ride the troubled times.
Below is a strategy where the pensioner can get away by withdrawing minimum 2% from the pension amount instead of the required 3%. There is another estate benefit which results in a greater tax-efficiency and maintains their super balance. This strategy takes benefit of ASX All Ordinaries dropping from 4608 on 30th June 2011 to 3986 on 8th August 2011, a drop of 13.5%.
Strategy
The idea is to commute the pension on 1st July 2011 and convert the pension account to accumulation account and then on 8th August 2011 re-commence Pension with a new balance and new taxable and tax free proportion.
Background
The trustee must determine components of a superannuation interest at the time of commencement of income stream like an account based pension.
In accumulation phase, the tax free component is a fixed amount, increased only by additional non-concessional contributions. All growth, unrealized gain and earnings increase only the taxable component, similarly any loss or unrealized loss decreases only the taxable component.
But in pension phase (section 307-125 of the ITAA 1997), it is the proportions of the tax free and taxable components at the time to commencement of the pension that determines increase or decrease of the two proportions for the life of the pension.
This means that in pension phase, any growth or earnings (or loss) is proportionately allocated between the tax-free and taxable components based upon the percentage value of the two components in the accumulation account used to commence that pension. Any withdrawal (income stream payments) reduces the two components balances of that pension account in the same percentage.
In other words, whatever is the proportion of taxable and tax free components at the time of commencement of income stream remains "locked in" till that income stream ceases.
Regulation 307-200.05 of the ITAR 1997 provides that once a superannuation income stream 'commences', an amount that supports the superannuation income stream is always to be treated as a separate superannuation interest.
If a member dies in pension phase, from 1st July 2007 only death benefits dependants will be able to receive a reversionary income stream from the superannuation interest. Which means that upon death, the income payments form the pension can continue to be made to the specified death benefit beneficiary (provided they are able to be reversionary beneficiary as per Section 302-195 of ITAA 97) only if they are nominated to be the automatic beneficiary in the pension documents or in the binding death nomination (ITR 2011/D3).
This means that if a pensioner dies and has no tax dependants and has only adult children (over the age of 25 years), only lumps sum can be paid to them, child becomes a Non-death benefits dependant (SISR 6.21 (2A). Any death benefit lump sum paid to Non-death benefits dependant is taxed in the hands of the dependant @ 15% plus medicare levy. Hence, it is very important for the trustee and advisor to track the two components till death of the member and withhold PAYG tax before making any death benefit payment to adult children.
Click here to learn how to commence a pension in a SMSF
Example
To explain the benefits of this strategy, let's take a look at the following example
James is 68 years old, Mary, his wife, passed away couple years back. James has two boys who are both married and working. James has a $1,000,000 balance as at 1st July 2011, with a tax-free proportion (Sec 307 210 of ITAA 97) of 70% and on 8th August 2011 due to share market crash the account is valued at only $750,000.
If James continues with the pension, he will need to withdraw $30,000 before 30th June 2012 (3% for the financial year ended 30th June 2012) and should he die during the year, his kids would have to pay 16.5% tax on the taxable component of his pension: $37,125 (30% of $750,000 or $225,000 times 16.5%).
However, if James fully commutes his pension on 1 July 2011 and converts his pension account to accumulation account and recommences his pension on 9th August 2011 all the unrealized gain in the accumulation account will be allocated to taxable component and the $250,000 unrealized loss will reduce his taxable component.
This means that his accumulation account balance of $750,000 will have only $50,000 taxable component ($300,000 on 1st July 2011 less unrealized loss of $250,000) and in case of his death, his kids will pay only 16.5% on the reduced taxable component or $8250 ($50,000 times 16.5%).
Further, instead of withdrawing $30,000 (3% of $1,000,000 - if he does nothing), he will now need to withdraw only $20,100 (3% of $750,000 for 326 days from 9th August 2011 to 30th June 2012), which is approximately 2% of James $1,000,000 pension balance as on 1st July 2011.
Watch out for:-
This strategy can be used by any one, however please note the following issues:
1. Any roll back from pension phase to accumulation phase should be allowed by your trust deed. Trust deeds from us have this provision.
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2. Any income from 1st July 2011 to 30th June 2012 could be subject to tax @ 15% and any Capital Gain even after 9th August 2011 (pension commencement date) could be subject to tax at discounted rates subject to actuarial determination of exempt pension income, since the fund was not in pension phase for the whole year. It would be recommended that the fund does not realize any capital gain in the financial year. About 11% (39 days out of 365 days - average balance of accumulation vs pension assets and number of days etc) of all income in the fund could be taxable depending on asset value on 30th June 2012. That means if the fund earns $70,000 tax about $1,155 would be paid in tax or lower if pension assets as on 30th June 2012 are higher.
3. This strategy benefits only those funds which are exposed to ASX or other markets which have gone down in value.
