What I will cover in this article are the facts that must be taken into account when structuring a pension that your clients will love.  We will not have sufficient space to cover every issue that needs to be considered, these will be covered in future newsletters and webinars.

The information that you need in order to consider the issues before commencing a pension are listed below. The list is comprehensive without being exhaustive, for example I have asked no questions regarding the client's position from a social security perspective:

• What is the pensioner's age and the age of their partner or spouse?
• Does the member have dependants that can receive the remainder of the pension on death?
• How can death benefits be paid and who do they need to be paid too?
• Has the client reduced their working hours or fallen on hard times. If so, do they need to top up their employment income with pension income?
• Has the member retired or are they commencing a transition to retirement pension?
• Does the member's benefit contain an unrestricted non-preserved component?
• Should the member's accumulation account be split into two pensions, one containing the unrestricted non-preserved benefit and one containing the preserved component?
• Has the member satisfied a condition of release and turned 60?
• Does the member intend to adopt a cash out and recontribution strategy, or are they intending to make other non-concessional contributions?
• What is the member's taxable income from non-super sources during the year?
• Can the member use a salary sacrifice strategy in conjunction with the pension, to reduce their taxable income?
• What are the tax components of the member's accumulation pension account?
• Does the member have the capacity to make non-concessional contributions to another fund?
• What is the member's estate plan?
• What is the member's investment strategy and will it produce sufficient cash flow to meet pension obligations?
• What is the current net rate of return been produced by the fund assets and will a tax saving result if a pension is commenced?

It seems that there is an enormous amount of information that needs to be collected prior to commencing a pension. All of it is relevant and some, but not all of the information will be used in the examples below. More information on how this information is used in pension planning will be provided in future newsletters and webinars.

When it reduces the amount of income tax payable and enables the in-specie transfer of assets to meet pension payments.

If a member of a SMSF fund has retired and turned 60, the super benefits received by the member will usually be received tax free regardless of whether they are paid to the member as a lump sum or a pension. This is because both pensions and lump sums are received tax free after age 60 when paid from a taxed source.

However if the member is less than 60, then to the extent that the pension is paid from a taxed component, it will be assessed to the member at marginal tax rates less a 15% rebate.

Alternatively if the benefit is able to be withdrawn from the fund as a lump sum because the member has satisfied a condition of release. Then the taxable component is also received tax free up to the threshold of $185,000 for the year ended 30 June 2015, even though the member is less than 60.

When the pensioner elects to receive their pension payment as a lump sum. This election is made under Income Tax Regulation 995.01-3 and is given to the fund trustee before the pension payment is made.

For example Peter has retired at the age of 57 on 1 July 2014. He has heard that there may be benefits in his electing to receive part of his pension as a lump sum rather than a pension.  

Peter's employment income for the year is $180,000, so any pension income received during the year from the fund will be subject at the top marginal rate of 45% plus the Medicare Levy.

As Peter has an accumulated superannuation interest of $1,000,000, the underlying components of which are 100% taxable, then the tax impact of withdrawing $40,000 as a pension from the fund in the 2014/15 year is:

• If $40,000 is paid as a pension, additional income tax and Levies of $12,800 is payable
• If the $40,000 is paid as a lump sum no income tax is payable, as the first $185,000 of the taxable component is received tax free after preservation age.

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To find out more information re "life cycle pensions" you can subscribe to my Webinar Series by clicking here.

To introduce my webinars, I am also offering one ticket to my webinar on 9th Feb 2015 at 1 PM to 2. 30 PM.  to those delegates booking the above seminar (Early bird of $330 expires on 15th Feb 2015) This webinar will cover:

• A review of recent legislative changes
• A review of Government and regulatory announcements
• A review of ATO rulings, determinations and interpretative decisions
• A review of recent case and AAT decisions
• A special topic which may include:
• The life cycle of a pension
• Making the most of super contributions
• Death Benefits: Who, what and when
• What you didn't know about fund investment

The pension income continues to be tax exempt!!

The income continues to be derived tax free because the payment made to the member as a partial commutation of the benefit, continues to be treated a pension payment under Regulation 1.09A (a) of the Superannuation Industry (Supervision) Regulations 1994. As it is treated as a pension payment it is included as a payment measured against the minimum pension payment requirement each year.

Because the "partial commutation payment" is a pension payment, it follows that under Sections 295-385 and 295-390 of the Income Tax Assessment Act 1997, the income derived by the fund is derived for the purpose of meeting current pension liabilities and therefore is derived tax free.

Note if the pension is fully commuted, the payment made following the commutation of the pension is not treated as a pension payment, because on commutation the pensioner gives up their right to a future income stream and therefore the pension ceases.  

The definition of a pension payment under Regulation 1.06(9) of the SIS Regulations also gives rise to some unexpected results. For example, a partial commutation payment for a transition to retirement pension (which can only be made if the account balance contains a non-preserved component) does not count towards the maximum annual amount allowed to be paid from the pension account i.e. the 10% threshold.

So a member pays themselves their full transition pension of 10% and then partially commutes part of the pension and takes it as a lump sum the commuted component will not be measured against the 10% threshold.

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Where a member elects to receive a pension as a lump sum, they are able to have the pension payment made as an in-specie distribution.

The reason for the confusion as to whether a pension can be paid by an in-specie distribution of assets is that when you go to the Superannuation Industry (Supervision) Act to see what the definition of "lump sum" is, you find that it can include the in-specie distribution of assets. In other words if you are paying a super benefit as a lump sum, you can pay the benefit by distributing assets in specie.

Whereas when you go to the SIS Act to review the definition of "pension payment", there is no reference to the in-specie distribution of assets been included in a payment. Accordingly the Regulators, have historically taken the view that "pensions payments" could not be paid by the in-specie distribution of assets.

So the question is, if I elect to receive my pension payment as lump sum, does this mean that I can also receive this lump sum payment as an in-specie distribution.

Peter is a 55 year old with $1m (100% taxable component) of which $200,000 is unrestricted non- preserved.  In 2014/15 he will have to draw a minimum pension of $40,000 which will be taxed because the pension interest entirely taxable.

Suppose however that he elects in advance of the "pension payment" under IT Regulation 995-1.03 that the minimum will be withdrawn as a single lump sum amount. In this case the pension will be taxed as a lump sum and be received entirely tax free. The reason is the pension payment falls within the tax free threshold of $185,000 indexed. So if Peter at 55 years of age, holds an unrestricted non-preserved amount in his pension account and elects to receive this amount as a lump sum, he will be taxed in the same way as a 60 year old in receipt of the same pension.

In addition as the member has elected under IT Regulations 995-1.03 to receive that benefit payment as a lump sum, the trustee is able to pay the pension payment as an in-specie transfer of an asset.

The real benefit of this strategy is:

• By partially commuting the pension and making the benefit payment in-specie, the asset is still held to meet pension liabilities. So any capital gain on disposal of the asset is received tax free.
• The asset is disposed of for capital gains purposes, despite the fact that the gain is exempt from income tax. This means that the cost base of the asset is now market value following the transfer.
• In some cases these assets will be able to be transferred back into the fund as in-specie contributions. Note, to pursue this strategy you will need to ensure that the asset is able to be purchased by the fund under Section 66 of the SIS Act.

This article only scratches the surface when it comes to covering the strategies that are available to structure a pension that your clients will love.

This article is for general information only and should not be relied on without first seeking advice from an appropriately qualified professional.

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