What happens if I don’t pay my minimum pension?

If your minimum SMSF pension is not paid or paid short your pension ceases and the process to  commute your pension and correctly account for and start a new untainted pension is complicated. Your SMSF loses its tax exemption on the income arising from the failed pension and any withdrawals made are treated as lump sums.

Does the ATO have a discretion to disregard the pension shortfall?

The ATO has a discretion to treat the pension as if it has met the pension standards despite a pension shortfall.  The SMSF trustee has to apply to the ATO for that discretion unless the shortfall comes under the 1/12^th rule as per below. Historically, successfully obtaining the ATO’s discretion has not been encouraging but is worthwhile considering since pension shortfalls can have serious consequences.

An SMSF trustee has an opportunity to self-assess the ATO’s discretion to disregard a pension shortfall provided:

• the shortfall must be due to an honest mistake
• the shortfall is no more than 1/12^th of the pension minimum i.e. pension minimum of $4,500 x 1/12 = $375
• a catch-up payment is made as soon as practicable in the following year i.e. within 28 days of the SMSF trustee becoming aware of the underpayment or was in a position where the trustee would have been aware of the shortfall
• the trustee accrues the shortfall in the fund’s financial statements
• the trustee can only apply the self-assessment once and once only

Consequences of a pension shortfall

• The pension ceases for tax purposes on 1^st July i.e. where the pension shortfall was in the 2024/25 year the pension ceases on 1^st July 2024.
• The fund loses its tax exemption on the income arising from the pension.
• Any withdrawals after 1^st July are treated as a lump sum payment which may result in illegal early access to super if the pension is a transition to retirement pension (TRIS) which is not n retirement phase. The member may not have a condition of release when the withdrawal is made as the pension capital is generally preserved and not accessible. If the member is over 60 and they have a condition of release i.e. the member is over 65 or their super balance is 100% unrestricted they can withdraw a lump sum with no tax.
• The transfer balance cap (TBC) regulations differ from the ATO tax ruling (TR 2013/5) and superannuation regulations (SISA), requiring additional administration and calculations to accurately report pensions for TBC purposes and ensure compliance with tax and pension rules under SISA.

The ATO recently reissued TR 2013/5 “When a superannuation income stream commences and ceases”.  The amended ruling changed how the SMSF industry dealt with pensions when there is a shortfall pension payment.  The general belief was that the pension ceased only for tax purposes but an obligation to provide pensions in accordance with SISA, general trust law concepts and the contractual agreement between the SMSF trustee and the member remained until it formally ends.

The following table sets out the old treatment vs the new treatment.

	Before 1/7/24	After 30/6/2024
Pension ceases from 1st July in the failed pension year	Yes	Yes
Pension automatically restarts at 1st July in the following year provided the pension standards are met (excluding death benefit pensions)	Yes	No #
SMSF loses its tax exemption (ECPI) for all of the year of the failed pension	Yes	Yes
Withdrawals from the pension are treated as lump sum payments	Yes	Yes
Lump sums are tax free to members over 60 provided they have a condition of release which may not apply to a member taking a TRIS	Yes	Yes
The underlying tax components were not mixed between the pension and the member’s accumulation balance	Yes	No
The pension remained a separate interest in the fund, but the earnings added to the underlying tax component resulting in a change to the tax-free percentage	Yes	No ##
Each lump sum payment requires the calculation of the tax components and revaluation of the member’s super balance	Yes ###	Yes ###
For transfer balance account reporting (TBAR) purposes the pension ceases at 30th June (in the year of the failed pension) and the value reported assumes the fund is entitled to ECPI ####	Yes ####	Yes

# In accordance with SISA and the agreement between the trustee and the pension member the pension remains on foot until it ceases via written agreement between the trustee and the pension member

## The pension underlying tax components are mixed with the member’s accumulation balance

### Before 1/7/24 the tax components are based on the pension interest whereas after 30/6/2024 tax components are based on the combined pension and accumulation account

#### The TBA regulations require the SMSF trustee to look at the circumstances at that time which means the trustee is not aware of the pension shortfall until after the end of the financial year and therefore has to assume the pension meets the pension standards at 30^th June. The industry has historically valued the pension at 30^th June without the ECPI but this now appears to be incorrect.

To understand the process, separate out what happens for tax purposes and SISA.

1. SISA

• The pension remains on foot until it is commuted in full being the date when the trustee and the pension member formally agree which is generally in the year following the failed pension – this does not align to the date when the commutation is required to be reported in relation to the transfer balance cap legislation.
• To ensure the trustees follow the pension standards to commute the pension a pro-rated pension minimum is recommended and calculated to the date of commutation and paid prior to that date – for SISA purposes it will be a pension payment but for tax purposes it will be treated as a lump sum payment.
• Provided the pension member can meet the pension standards a new untainted pension can be established following the formal commutation of the failed pension.
• The new pension value is calculated based on no ECPI in the year of the pension failure and up until the new pension is started.
• Standard pension documentation is required.
• The trustee has to ensure the member has a condition of release to start a new pension.

Hint – the ATO have not clarified if a pro-rated pension minimum must be drawn when it relates to a failed pension.  The above is a conservative approach until clarification is received.  If the pension member is over 60 there will be no personal tax on the payments.

2. Tax Regulations

• The fund loses its ECPI from the start of the year of the failed pension.
• The pension ceases at the start of the year and cannot be restarted.
• The underlying tax components of the failed pension are mixed with the member’s accumulation account from the start of the year.
• Withdrawals from the failed pension are treated as lump sum payments.
• The value of the pension is calculated (no ECPI) prior to each withdrawal to determine the correct underlying tax components.

Tax regulations in relation to the transfer balance cap

• The capital amount of the original pension was credited to the member’s transfer balance account (TBA).
• The pension ceases at the 30^th June in the year of the failed pension.
• The failed pension continues to be treated as a separate superannuation interest for all of the year.
• The balance of the pension calculated as if ECPI applied to 30^th June is reported to the ATO in a TBAR and is debited to the member’s TBA. The formal commutation of the pension (per SISA) is not debited to the member’s TBA as the retirement phase pension has already been removed from the system.
• Withdrawals made during the year are not treated as reportable transfer balance events and therefore are not debited to the member’s TBA.

	Balance at 30/6/24	With ECPI -TBAR	Without ECPI
ABP 100% tax free	$1mil
Accumulation 100% taxable	$2mil
Total	$3mil
Balance at 31/12/24 prior to withdrawal		$3.1mil	$3.05mil
Withdrawal 31/12/2024		(20k)	($20k)
Pension Balance at 30/6/25		$1.06mil	$1.05mil
Accum Balance at 30/6/25		$2.19mil	$2.15mil
Total Balance at 30/6/25		$3.25mil	$3.2mil
Total Balance at 20/8/25 prior to withdrawal			$3.21mil
Pension Payment made on 20/8/25 – SIS purposes		($7,400)	($7,400)
Total Balance at 30/9/25 prior to commutation			$3.25mil
Formally commute pension at 30/9/25 – SIS purposes			(1.05mil)
Start new pension 30/9/25 – SIS and Tax purposes			$1.05mil

Transfer Balance Account – Paul’s personal transfer balance cap is $1.9million as he had not previously taken a retirement phase pension and therefore his personal TBC was equal to the general TBC of $1.9million for the 2023/24 year.

Date	Debit	Credits	Balance of Paul’s TBC	Comments
28/03/2024			$1.9mil
28/03/2024		$980,000	$920k	Retirement phase pension starts
30/6/25	$1.06mil		$1.98mil	Commutation for TBA purposes
30/09/25		$1.05mil	$930k	New pension started – Paul can start another pension up to his TBC balance of $930k

Consequences of the pension shortfall

• The pension ceases for tax purposes on 1^st July 2024
• The fund loses its tax exemption on the income arising from the pension
• The $20k withdrawal is treated as a lump sum payment but no tax is payable as Paul is over 60 and he can withdraw a lump sum as he is over 65
• The underlying tax components of the pension and his accumulation account are mixed together from 1^st July 2024
• The taxable components of the $20k withdrawal are $6,557 ($1mil/$3.05mil x $20k) tax free and $13,443 taxable
• The tax components of Paul’s balance at 30/6/25 are tax free ($1mil – $6,557) $993,443 and taxable ($3.2mil – $993,443) $2,206,557
• Minimum pension required until the pension is formally commuted on 30/9/25 (SIS purposes) is .05 x $1.05mil x 51/365 = $7,336 say $7,400
• Pension payment on 20/8/2025 is treated as a lump sum for tax purposes but as Paul is over 60 no tax applies, and he can withdraw a lump sum as he is over 65
• The tax components of the $7,400 withdrawals are $2,290 ($993,443/$3.21milx $13,230) tax free and taxable $5,110
• The tax components of Paul’s balance at 30/9/25 are tax free ($993,443-$2,290) $991,153 and taxable $25,258,847 – tax free percentage is reduced to 30.5%

Meeting your pension minimum payment is essential, as failing to do so can lead to more tax for adult child beneficiaries after your death and impact your SMSF estate planning. SMSF members may begin a new untainted pension if they meet a condition of release, which could be challenging for some.