When a member of a superannuation fund commences a pension, they agree to take at least the minimum amount of pension (as set out in the regulations) during the financial year. In the current financial year these minimums are:
| Age of recipient | Percentage Factor 2011/12 |
|---|---|
| Under 65 | 3% |
| 65 – 74 | 3.75% |
| 75 – 79 | 4.5% |
| 80 – 84 | 5.25% |
| 85 – 89 | 6.75% |
| 90 - 94 | 8.25% |
| 95 or more | 10.5% |
In return for taking these minimum payments, the super fund will receive an exemption from tax on income associated with assets that back that pension.
There is not however, any requirement for how the pension should be taken or the timing of the payments. Provided at some time during the financial year the payment is made then the exemption applies. Now this point may be mute for some pension recipients because they require a steady income stream and so draw their pension fortnightly or monthly. However, if you are taking your pension only 6 monthly or annually in arrears (usually because you are taking the minimum only because you have to rather than need to) you are leaving yourself open to paying unnecessary tax if something unexpected happens.
The first of these may be that you contribute more money to the fund and want to add it to your pension. Because money cannot be added directly to a pension account, this requires that your current pension be fully commuted, the new money added, and then a new pension commenced. If you are not taking pension regularly it would be very easy to miss an important step in this process, and this could be very costly. Lets look at an example.
Barry Smith is 64 years of age, has a pension fund with a value of $1,500,000 and takes 2 pension payments during the year, one in January and the final one in June. In December he puts an additional $450,000 into the fund, rolls back the pension and adds the new money. He commences the larger pension now worth $1,950,000 on the 31st of December. Barry knows that he has to take a pro-rated amount for the old and new pensions during the year to meet the minimums. These he calculates as:
| Pension | Minimum Required |
|---|---|
| Old Pension (183/365*1,500,000*.03) | $22,570 |
| New Pension (182/365*1,950,000*.03) | $29,170 |
| Total Minimum |
On the 1st of January Barry takes half this amount ($25,870) and then on the 30th June he does the same. During the year he has taken the minimum amount required of his two pensions, but has he satisfied the regulations?
Unfortunately, the regulations don't simply call for the minimum payments to be met at some time during the year where a pension is commuted. The minimum payment must be met for that pension PRIOR TO commutation. The result in the scenario above is that Barry's fund will lose its tax exemption for the first half of the year. He certainly took the minimum during the proportion of the year where he ran the new pension as the whole $51,740 falls in this period.
If we also assume that Barry made a strong capital gain on an investment in the first half of the year (lets say $500,000 on a long term asset held for many years). Of this 2/3 of the profit would be taxed, giving rise to a tax bill of $50,000. Because of his failure to meet the minimum standards in the first half of the year, this tax would be payable, or using an actuary it could be reduced to around $25,000. A hefty price to pay for a timing difference of 1 day.
Now the example above is to a large extent a matter of planning. But this brings me to the second scenario - Death. The recent ATO draft ruling (TR 2011/D3) tells us that the ATO considers a pension to cease on the death of the recipient unless the pension has an automatic reversion. If it passes by way of binding nomination or trustee discretion then it has ceased on the day the pension member died. This seems to apply even if the spouse (for example) chose to receive the benefits as a pension.
If we take Barry's case above and instead of a contribution/re-commencement we have him die on the 31st of December, the same problem arises. The pension did not meet the minimum standards when he was alive and the pension ceased on his death because it didn't automatically revert to his wife. The tax position for the fund would be the same.
While the first example was one of proper planning, the second is not necessarily so. The unexpected does happen and it could be very costly. Consider paying pensions on a regular basis, even if you don't need the money. If you prefer to receive a more sporadic payment, consider paying it in advance rather than arrears. This may come at a cost due to tax efficiency, but it would be a useful insurance policy against what can be a costly error.
