There’s a lot to understand if you have an SMSF member whose retirement is just around the corner. With the right information and tools, you can help your client smoothly transition to retirement.
To start with let’s look at their Member Statements.
The Member Statement sets out all the important details about your client’s superannuation account at the financial year end. The Member Statement should include your Preservation Components and your Tax Components.
The Preservation Components are split into 3 types: Preserved, Restricted Non-Preserved and Unrestricted Non-Preserved. The main thing that needs to be understood about Preservation is that the Preserved/Restricted Non-Preserved amount is money that can’t be accessed and the Unrestricted Non-Preserved is money that can be accessed.
All the members superannuation becomes accessible once they turn 65 years of age. There are other personal circumstances that can result in super becoming Unrestricted Non-Preserved, such as total and permanent disablement, so it is important that you encourage your clients to keep you informed of any changes in circumstances so that you can properly update their Preservation Components.
For the Preserved/Restricted Non-Preserved money that can’t be accessed, a Condition of Release needs to be met to convert this into accessible money. Retirement is just one of several Conditions of Releases which allow a member to access your superannuation. See here for a full list of Conditions of Release: http://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/cth/consol_reg/sir1994582/sch1.html
The notion of retirement isn’t as straightforward as it might seem, and careful evaluation of your client’s circumstances is required to make sure they properly meet the definition.
If they don’t meet the definition of Retirement, there may be other Conditions of Release that allow them to access their superannuation. Importantly, there are severe penalties that can be applied if they access their superannuation early so it is a good practice to keep your client’s educated about being on the lookout for promoters or other people who try to encourage them to ignore the rules.
As well as understanding when benefits can be accessed, you also need to understand how benefits are taxed to help your clients plan for retirement. The Member Statements will show the Taxable and Tax-Free Components. The Tax Components determine how tax applies to any superannuation that is withdrawn from the SMSF. What tax applies depends on age, the type of benefit withdrawn (lump sum or pension) and the amount withdrawn. Personal circumstances, like total and permanent disablement can also affect how tax is determined so again, encourage your clients to keep you informed so that their benefits are taxed correctly.
As well as understanding how tax will be applied to any benefits your client’s withdraw now, they may also be interested to understand how these components are ultimately taxed when paid to their adult children so that is another important aspect you can assist them to understand
Starting a Pension in an SMSF
After your client’s have understood their current superannuation account, and options to access it, how it will be taxed now and, in the future, they come to the decision about how to withdraw the super, as a pension or as a lump sum.
Many SMSF members opt to start a pension so they will need your help in understanding how they work. Put simply, a pension is all about withdrawing money from a superannuation account over time. So even though a member could withdraw your super at any time (once it is Unrestricted Non-Preserved), they choose to leave it in the SMSF and just withdraw some of the balance each year.
Having a pension in an SMSF changes how the Preservation Components work and how the SMSF is taxed. Firstly, the amount set aside to commence your client’s pension will be moved to a separate Member account (“Pension Account”).
The Preservation Components of their Pension Account are fixed percentages when a pension is commenced. For example, if their super account has $500,000 total consisting of $400,000 Taxable Component and $100,000 Tax-Free Component and you start a pension, their Pension Account will be 80% Taxable and 20% Tax-Free.
Whilst the pension is on foot, these percentages do not change, so in dollar terms, if the Pension Account does grow by more than is withdrawn in a year, the dollar amount of their Tax-Free component becomes larger. That is why is it important to have a good understanding of how this works before commencing a pension so that you can optimise the tax outcomes for your clients.
Any pension payment received is considered income in the Pension Member’s hands and the Taxable amount may be taxed at their marginal rate depending on their age, usually with a 15% tax offset applying. Once they are 60 years old, any pension amount they withdraw is no longer taxed in their own name.
How the SMSF itself is taxed changes when a pension starts. If the SMSF is made up of only Pension Accounts in a financial year, it will have no taxable income and no tax to pay, it will be tax-free. Otherwise, in most cases, you will engage an Actuary to provide a percentage to be applied to reduce the taxable income of the SMSF. That means, the SMSF pays less tax and more money stays in the SMSF to continue to pay their pension.
As with everything else SMSF, it is important to document the pension properly. To document the pension, your client needs to decide how much is to be set aside in the Pension Account and if they want the pension to be paid to their spouse when they die (reversionary). If they do choose to revert it to their spouse, using a pension deed to document the pension, means that the spouse is party to the arrangement so they can more easily enforce their right to receive the reversionary pension. Importantly, the Australian Taxation Office (ATO) state that the commencement day cannot precede the date of the Member’s request or application so any pension documents you put in place should be prospective and not retrospective. Link to TR 2013/5
Once your pension is in place, your client’s need to make sure that they meet the requirement to withdraw a minimum amount each financial year. Usually, the minimum pension is calculated when the SMSF Financial Statement s are prepared so it helps to lodge on time and if possible, well before the end of the financial year. The pension withdrawals must be made in cash and if members are paying them via online transfer, they need to be received in their personal bank account before the end of the financial year. If your client fails to withdraw their minimum pension amount in the financial year, the Pension Account and the amount of tax the SMSF pays may be impacted so maintaining up to date accounts and close communication with your pension clients is vital.
Since 2007, Keep It Simple Super has helped Financial Advisers and Accountants deliver best practice SMSF compliance with simple, hassle-free client solutions
We work closely with our clients to customise their SMSF service so they can easily and confidently grow their SMSF businesses.
Why our clients love us:
Our “Simple” philosophy
Our win/win approach to all aspects of what we do
Our attention to detail
Our proactive approach to compliance
The clear value that we provide