SMSF Pension Payment | Taxation Rules for Pension Phase

Superannuation Pension Payment | Understanding SMSF Pension Phase

Your SMSF can pay you a pension but there is a lot to be considered before this occurs. This article will provide a guide on how paying pensions works in a SMSF.  However, we note that we are not covering older style pensions such as market linked pensions (also known as term allocated pensions), lifetime pensions or life expectancy pensions as they are beyond the scope of this article.  Except for very limited circumstances in relation to market linked pensions the only new pension that a SMSF can start is an account-based pension (ABP) and a transition to retirement pension (TRIS).

Importantly the fund’s governing rules must allow the trustee to pay a pension to a member.

Financial advice should be obtained from a licensed financial planner or your SMSF Specialist before deciding to start a new pension from your SMSF. 

What Types of SMSF Pensions can be Paid to Me?

A SMSF trustee can pay new pensions which are account based.  The SMSF must meet the pension standards as per the super laws and regulations to qualify as a pension.

From a taxation perspective an ABP is a “superannuation income stream” with each payment being a “superannuation income stream benefit” (pension payment) must meet the pension standards, and the pension payments are a series of periodic payments. The Australian Taxation Office (ATO) have acknowledged that one annual pension payment can be a series of periodic payments. An example of this is when a SMSF pays a pension member one annual pension payment over a number of years so that there is a series of periodic payments.

To qualify for tax concessions additional rules required to be followed include:

• exempt current pension income (ECPI) is to be calculated using the segregated or proportionate method (otherwise known as the actuarial method) or a mix of both to determine the amount of income to be reduced or excluded from the fund’s tax return
• an actuary is required to certify the ECPI when using the proportionate method
• lodge a member’s transfer balance account report to advise the ATO of the amount of the capital supporting the new pension

Account-based Pension (ABP)

An ABP is a regular income stream of payments made to a member who has retired which is usually when the member turns 65 but in certain circumstances can be before this. It is paid from the member’s pension balance until it is exhausted.

• The pension capital cannot be added to with contributions or rollovers.
• The pension account capital or income cannot be used as security.
• A minimum pension payment must be made at least annually.
• The member can elect to commute or withdraw part of the pension capital as a superannuation lump sum payment.
• Before any partial pension commutation is made the SMSF must ensure the minimum pension payment has been paid or the remaining pension capital is sufficient to make the payment.
• If a pension member elects to commute 100% of the ABP the pension minimum is apportioned to the day the pension ceases and that amount must be paid prior to the pension ceasing.
• An ABP may continue to be paid to a dependant beneficiary if a member dies and there is an automatic reversionary entitlement in place.

An ABP is a retirement phase pension which counts towards a member’s transfer balance cap (maximum amount a person can have in pension phase).  A pension must be in retirement phase to obtain concessional tax treatment.

Transition to Retirement Pension (TRIS)

A non-retirement phase TRIS is also a pension which is account based. A TRIS is essentially the same as an ABP except it has further restrictions which include:

• a member must be at least 60 (preservation age) and below 65
• it is subject to a maximum pension payment
• it cannot be partially commuted except in specific circumstances such as releasing excess contributions, paying Division 293 tax or a payment split under a family law agreement
• no tax concessions apply to a TRIS and the earnings are taxed at 15 %
• there is no limit on the amount of pension capital to start a TRIS
• a TRIS is not in retirement phase and thus it does not count towards the member’s transfer balance cap

The balance of a TRIS is able to be 100% commuted or rolled back into accumulation phase. It automatically transfers to a retirement phase pension when the pension member turns 65.

Are multiple pensions allowed?

Yes.   Multiple pensions can be part of a strategic plan, particularly useful for estate planning purposes. It is important to understand that on death a member’s benefits are not automatically paid out through the member’s estate and the careful structuring of pensions can play a significant role in ensuring benefits are paid out in accordance with the member’s wishes.

The underlying tax components of a pension are locked in at the start of a pension and do not change over its life. When a fund member dies, and their superannuation benefit is paid to an adult child over 18 tax generally applies to the taxed and untaxed components. Underlying tax-free components include personal non-concessional contributions, government co-contributions and small business CGT amounts continue to be tax-free when paid to an adult child beneficiary.

A superannuation death benefit paid to an adult child can be taxed up to 32% (includes Medicare) if the benefit includes an untaxed source (this is unusual) or up to 17% (including Medicare) on the taxed component.

A popular strategy used to freshen up the tax-free component of a member’s super balance is a re-contribution strategy where the taxed components are swapped for tax free components.  This strategy can be used by a member who is able to withdraw benefits and re-contribute as non-concessional contributions, but care needs to be taken to ensure the member is eligible. Another simple strategy to protect the tax free component of a pension is to draw the most pension payments from a pension with higher taxable component and the least amount from a pension with high tax-free component.

Multiple pensions with different tax components can be used to direct death benefits to various beneficiaries who have different tax circumstances.

There are a lot of planning opportunities involving multiple pensions. Please speak to a SMSF Specialists if you wish to discuss strategic opportunities for your super benefits.

When can I start a Pension from my SMSF?

There are a few limited exceptions but the earliest a pension can be started from your SMSF is generally when you reach your preservation age. A TRIS can be started on turning 60 but before turning 65 and not retired.  Refer to discussion on TRIS above. You can start an ABP when you are retired which includes:

• turning 65
• 60 but less than 65
  • terminating an arrangement under which the member was gainfully employed after 60 -essentially this means resigning or terminating employment after turning 60 OR
  • the trustee is satisfied the member has terminated a gainful employment arrangement in the past (at any time not just over 60) and never intends to become gainfully employed in the future on a part-time or full-time basis -not intending to be employed for 10 or more hours a week

Preservation age

To satisfy a condition of release can be dependent on a member reaching their “preservation age”.  From 1 July 2024 that age is 60.  Preservation age is not retirement, but it can be a factor in determining if a member has met a condition of retirement.

What to Consider when Commencing a Pension in your SMSF?

A brief outline of what should be considered before commencing a new account-based pension includes:

• Has the member turned 65 or retired?
• Does the trust deed allow for a pension?
• Calculate how much the capital value of the pension is
• Has the member received financial advice to establish a pension?
• Update the market valuation of the fund’s assets and obtain evidence of the valuation?
• Prepare financials to or as close as possible to the start date
• Report the transfer balance cap (maximum amount a person can have in retirement phase pensions)
• Ensure the start date of the pension is clearly indicated in the pension documentation
• Prepare the paperwork to establish the pension including the member request, trustee minutes and confirmation to the member
• Start paying the pension
• Identify what are the minimum amount of pension payments required and possibly pension maximum if it is a TRIS
• Consider a product disclosure statement
• Obtain an actuarial certificate at year end to claim a tax exemption

Do I have to meet the Minimum Pension Payment?

Yes a pension minimum payment is required before 30th June or if a partial or full pension commutation the pension minimum or part thereof is required usually before the commutation is done.  The minimum pension payment requirement is based on the pensioner’s age at 30th June from the prior year and a percentage of the pension balance.   The percentage factor increases annually from 4% under 65 to 14% from 95 onwards.

An exception is made when the pension is established in June and no pension minimum payment is required for the initial year.

Is there a Maximum Pension Payment?

A pension benefit payment cannot exceed a maximum 10% of the pension account balance when taking a TRIS.  A member cannot exceed pension withdrawals of 10% of their pension balance which is measured as at the 30th June from the prior year.  However, if the TRIS is started part way through the year the 10% maximum is not apportioned.

Are my Pension Payments Tax Free?

Receiving a pension after turning 60 is tax free to the member and the pension payments are not included in the member’s personal income tax return.  A death benefit pension paid to an eligible tax dependant such as a spouse or minor child under 60 is tax free to the dependant if the age of the member at death was 60 or over.

Does my SMSF pay Tax on Pension Income?

It depends.  Tax applies at the fund level and is determined by a number of factors.  If the entire fund is in 100% pension mode for all of the financial year the fund will be deemed to have segregated assets supporting the pension, and no tax is paid on the fund’s income provided of course there are no exceptional circumstances such as non-arm’s length income (NALI).

Exempt Current Pension Income (ECPI)

A SMSF which is in partial pension mode will generally have to obtain an actuarial certificate from an actuary who will calculate the fund’s exempt current pension income (ECPI).  The actuary will provide a percentage of ECPI which is applied to all of the fund’s income which reduces the assessable income in the fund’s annual tax return. ECPI does not apply to contributions and NALI.

Refer to our resources page in relation to “actuarial certificates for SMSF”

Transfer Balance Cap (TBC)

The Transfer Balance Cap (TBC) is a cap on the amount of accumulation superannuation an individual member can transfer into retirement phase pension accounts in their lifetime.  The TBC relates to all sources of a person’s retirement phase pensions and not specific to their own SMSF. The original cap was $1.6million on 1 July 2017.  The general TBC is $1.9 million as at 1 July 2024.

Whilst the general TBC is $1.9 million an individual has a personal TBC which is used to measure their total super which an individual can have in pension phase.  An individual who has never used their general TBC, so somebody who is starting a pension for the first time in 2025 financial year can access the general TBC of $1.9 million as being their personal TBC.

The rules can be complex and the easiest way of checking your personal TBC is sign into your “myGov” account.

Your SMSF is required to lodge a transfer balance cap report (TBAR) quarterly with the ATO who keep a record of the movements in a member’s pension balances from all sources.  The report must be lodged by the 28th of the month following the quarter in which the event occurred e.g. starting an ABP on 10 September 2024 must be lodged by 28th October 2024.  There are some circumstances when you need to report sooner which include:

• a voluntary member commutation in response to an excess TBC determination
• responses to commutation authorities

Special rules apply to capped defined benefit income streams which are beyond the scope of this article.

What happens if my SMSF fails to meet the minimum annual pension payment?

• the pension will cease from the start of that income year
• any pension payments made will be treated as superannuation lump sum payments
• this may be problematic if a member does not have a condition of release i.e. if a member is taking a TRIS, they may not meet the definition of retirement, and any withdrawals may be a breach of the payment standards
• no tax concessions are available in relation to that pension
• the pension does not automatically restart and therefore the pension is commuted from the start of the income year and the tax components are mixed with the member’s accumulation account and a new pension subject to super laws can be started but the old pension commutation and new pension have to be reported as part of the TBAR and the transfer balance cap needs to be considered

Is there an exception?

Yes – The SMSF can use a once only lifetime discretion to treat a failure to pay a minimum pension payment as not failing the pension standards which include the following:

• must be a small underpayment – not more than 1/12 of the pension minimum or pro-rated if the pension was started during a year
• must have been an honest mistake or there were matters outside of your control
• the pension would otherwise have continued
• a catch-up payment is made as soon as practicable after the trustee becomes aware of it

A SMSF trustee can apply to the ATO for the commissioner’s discretion if they do not meet the criteria above, but it can be difficult to obtain. The exception also applies to a TRIS. However, if the maximum 10% pension payment for a TRIS is exceeded there is no exception available.

Key Takeaways | Pension Phase

• a super fund does not pay any income tax on earnings from investments when all of the fund’s assets are being used to provide 100% pensions (in retirement phase) for all of the financial year
• a SMSF in partial pension (retirement phase) mode can obtain an actuarial certificate to obtain a percentage to calculate the ECPI (reduction in assessable income)
• calculate the minimum payment amount which is based on a percentage of the pension member’s balance at the prior 30th June unless started part way during the year
• an account based pension (ABP) is designed to reduce the member’s pension account to nil but often a balance remains on the death of a member which can be paid to an eligible dependant and is not automatically required to form part of the member’s estate
• consider if a SMSF member meets the definition of retirement and is eligible to start an ABP
• consider if a member should start a TRIS
• monitor when a member taking a TRIS turns 65 as it automatically transfers to a retirement phase pension and the pension balance is required to be calculated and reported as a TBAR event
• ensure the paperwork clearly reflects when a pension commencement starts
• consider using the once only lifetime ATO discretion if there is a small pension payment failure
• consider the member’s personal transfer balance cap and reporting of TBAR events
• it is important the fund’s assets are valued at market value at the commencement or the commutation of a pension

Do you need help with understanding SMSF Pension Payments?

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