If you're a trustee of a self-managed super fund (SMSF), there are some things to consider when starting or stopping a super income stream, or pension.
When we say SMSFs, we are including former SMSFs unless otherwise indicated.
This information applies to:
- taxed, complying super funds
- commencing a super income stream in the form of an account-based pension
- including a transition to retirement income stream (TRIS), on or after 1 July 2007.
You can find information about paying or considering paying an account-based pension to a member in Taxation Ruling 2013/5: Income Tax: when a superannuation income stream commences and ceases.
This ruling focuses on when a super income stream commences and ceases, and when a super income stream is payable. These are important for trustees when determining:
- whether the fund can apply the exempt current pension income (ECPI) provisions
- the income tax treatment applicable to payments from the fund, including the correct calculation of the tax free and taxable components.
A super income stream is an income stream that's a pension according to the Superannuation Industry (Supervision) Regulations 1994 (SISR).
We use the term:
- pension – when referring to the operation of the Superannuation Industry (Supervision) Act 1993 (SISA) or SISR
- super income stream – when referring to the operation of the income tax laws.
An income stream can't be a pension in accordance with the regulations, unless it meets two fundamental requirements:
- payment occurs at least annually
- a minimum amount is paid to the member each year (for an account-based pension).
A super income stream exists when all of the following apply:
- a member is entitled to a series of payments that relate to each other
- the payments are periodic, whether paid annually or more frequently
- the payments are made over an identifiable period of time
- the pension standards of the SISR have been met.
A liability to make a single payment for one year is not a series of payments and will not satisfy the requirements of being a super income stream.
Creating a separate superannuation interest in a SMSF
Once a super income stream commences, you're required to treat the amount supporting the income stream as a separate interest in accordance with the income tax laws.
You must determine the value of the separate interest, including the amount of its tax free and taxable components, when the super income stream commences. The proportions of the tax components of this separate interest will be the same proportions of the member’s original non-pension interest just prior to the commencement of the income stream (proportioning rule).
The proportioning rule prevents members from selecting which tax components their super income stream will be paid from.
Value of the assets supporting a pension
Before the commencement of a pension, you must establish the value of the super benefits that are to support the pension. This means determining the market value of the assets supporting the pension on the commencement day of the pension. The valuation needs to be based on objective and supportable data. This is similar to valuing assets for the purpose of financial reports,
A reasonable estimate of the value of the account balance can be used when a pension is started part way through the year.
Super pension standards
Once an account-based pension commences, you must ensure you meet the pension standards in the SISR. This includes meeting the minimum pension payment requirements.
If the pension standards are not met in an income year, both of the following apply:
- a super income stream ceases for income tax purposes
- we consider the trustee has not been paying an income stream at any time during the year.
You should also maintain appropriate records that reflect:
- the value of the pension at commencement
- any benefit (pension) payments made
- the account the payment was paid from
- the earnings from assets set aside to support the pension.
- Timing of a pension payment
- Record keeping requirements
- COVID-19 frequently asked questions – self-managed super funds – on our Legal database
A general characteristic of an account-based pension is the need to pay an annual minimum pension amount.
The minimum amount that has to be paid from the pension account depends on several factors, including:
- the recipient's age
- their account balance
- the commencement date of the pension.
If the pension commences:
- on a day other than 1 July – work out the minimum amount for the first year in proportion to the number of days remaining in the financial year, including the start day
- on or after 1 June in the financial year – no payment is required to be made in that financial year.
For pensions in existence on 1 July; if the pension ceases on any day other than 30 June, work out the minimum amount in proportion to the number of days the pension was on foot in that financial year
Note: Pension payments for 2019–20 above the reduced minimum withdrawal rate, taken before 25 March 2020, cannot be re-categorised as a lump sum or commutation. This is even if a valid minute or election from the member was in place before the government announced the reduction.
- Pension standards for self-managed super funds
- Minimum annual payments for super income streams
- COVID-19 frequently asked questions – self-managed super funds – on our Legal database
Partial commutation payments
A partial commutation payment that is not rolled over to another super fund, can only count towards the annual minimum pension payment amount if the payment was made before 1 July 2017.
A partial commutation occurs when a member receiving a pension requests to withdraw a lump sum amount which is less than their total pension entitlement. As there's still an obligation to continue to pay pension benefits, a partial commutation doesn't result in the cessation of the pension.
The taxable and tax-free components of any partial commutation payment must have the same proportions as those determined for the components of the separate interest that supported the pension when the pension commenced.
Remember, there are additional commutation restrictions if the pension from which the partial commutation is made is a transition to retirement income stream (TRIS). Failing to consider the commutation restrictions that apply to a TRIS may result in a breach of the payment standards. There may be income tax consequences for the member and the fund.
In-specie partial commutation
The payment that results from a partial commutation is a lump sum for the purposes of the super laws. A lump sum payment includes a payment made by way of an asset transfer, known as an in-specie payment.
Partial commutation payments made from 1 July 2017 will not count towards minimum annual pension payments. This is regardless of whether the payment is made in cash or in-specie.
Trustees need to be mindful of the governing rules of the fund. The transfer of an asset of the SMSF will constitute a capital gains tax (CGT) event with possible taxation implications for the fund.
Example – Partial commutation
Madeline, a member of the Spring SMSF, is receiving an account-based pension. The balance of her pension account on 1 July 2019 was $400,000. Madeline is usually able to meet her living expenses from the minimum amount required to be paid from her pension account.
On 1 November 2019, Madeline advises the other trustees of the Spring SMSF and requests, in accordance with the governing rules of the fund, she would like to be paid a lump sum of $50,000. This amount is more than the minimum amount the fund is required to pay her for the year and Madeline indicates that she will not require any other payment of the pension for the year.
The partial commutation is paid on 15 November 2019 by the transfer of shares to the value of $50,000 from the fund.
The in-specie payment will not count towards Madeline's minimum annual pension amount. The fund is still required to make the mandatory minimum annual pension amount as a separate payment (or payments) to ensure that the pension does not cease.
This example does not address any CGT consequences for the fund.
Note: If this scenario had occurred before 1 July 2017, Madeline’s pension did not cease as a result of the partial commutation and the amount was not rolled over; the $50,000 in-specie transfer would have counted towards the minimum annual amount she is required to be paid in that financial year.End of example
A full commutation does not count towards the minimum pension payment. It takes effect as soon as your liability as trustee to pay periodic pension payments to a member has been substituted in full, with a liability to pay them a lump sum instead. The account-based pension therefore ceases at this time.
The liability to pay the lump sum arises as a consequence of the full commutation taking effect. Therefore, the super income stream ceases before the time you make the lump sum payment to the member.
The payment of the commutation lump sum is made after the cessation of the account-based pension. Therefore, it can't count towards the minimum annual pension amount.
In order to meet the minimum annual pension requirements up to the time the pension ceases as a result of a full commutation, you, as trustee, should ensure the required minimum annual pension amount has been paid as a separate payment (or payments) prior to the lump sum payment being made.
Maximum pension payment requirements for a TRIS
A transition to retirement income stream (TRIS) needs to meet the standards of an ordinary account-based income stream.
Additionally, the SISR prohibits the total amount of payments, excluding partial commutation payments, made from a TRIS in a financial year from exceeding 10% of the pension account balance. This is unless the member has satisfied a condition of release that has a nil cashing restriction.
Where a fund exceeds the maximum annual payment limit for a TRIS in a financial year, the super income stream is taken to have ceased at the start of that year for income tax purposes.
Tax implications on the super income stream
Once a complying super fund starts to pay a retirement phase income stream to a member, it may be entitled to exempt a portion of the income earned from the fund's assets that are supporting the income stream.
This is referred to as exempt current pension income (ECPI) and applies until the pension ceases.
ECPI does not include assessable contributions or non-arm's length income.
From 1 July 2017, a TRIS where the member has not met a condition of release with a nil cashing restriction will not be considered in the retirement phase. Earnings from assets supporting a TRIS that is not in the retirement phase are not eligible for ECPI. They will be taxed at 15%. This will apply to all TRIS regardless of the date the TRIS commenced.
ECPI also applies to certain retirement phase products such as deferred lifetime annuities which are not currently paying a benefit.
Working out the ECPI
There are two ways to calculate the fund's ECPI:
- The trustee can exempt a portion of the fund’s total income that reflects the proportion of the fund’s super liabilities that are current pension liabilities in respect of retirement phase superannuation income stream benefits. The value of the fund’s super liabilities and current pension liabilities must be certified by an actuary.
- The trustee can segregate assets used to support the retirement phase income stream.
When starting a retirement phase income stream, the trustee will need to consider which method they should use to calculate the fund's ECPI. Should an actuarial certificate be required, it must be obtained by the trustee before lodging the Self-managed superannuation fund annual return (SAR).
Contributions received for a member after the pension has started
If a trustee has started paying a pension to a member and they receive a contribution for the same member, they can't add it to the member's pension account.
A contribution received after a pension has started cannot be added to the capital supporting the pension. All contributions intended to form the capital of the pension must be made before the pension starts.
- COVID-19 frequently asked questions – self-managed super funds – on our Legal database
The most common circumstances for a pension ceasing include:
- When all pension capital is exhausted
- Failure to meet the superannuation pension standards
- The pension is fully commuted
- The member has died.
A super income stream ceases as no super income stream benefits are payable when both the:
- capital supporting the pension has been reduced to nil
- member's right to have any other amounts applied (other than by way of contribution or roll over) to their superannuation interest has been exhausted.
For an account-based pension, the pension ceases when the money funding the pension has run out.
If a fund fails to meet the required super pension standards for an account-based pension in an income year, the super income stream is taken to have ceased at the start of that income year for income tax purposes.
From the start of the income year, the member’s account is no longer taken to be supporting a super income stream. Any payments made during the year will be super lump sums for income tax purposes and lump sums for SISR purposes.
Where the underpayments relate to a retirement phase income stream, this also means the fund will not be entitled to treat income or capital gains as ECPI for the year.
When a new super income stream commences, you as trustee will be required to recalculate the tax-free and taxable components of the new pension.
One of the most common reasons for not meeting the pension standards is failure by funds to meet the minimum annual pension payment requirements.
There are limited circumstances where the Commissioner of Taxation will allow a pension to continue, even though the trustee has failed to pay the minimum amount of pension.
We have published a Q&A on our website (below). These highlight the conditions to satisfy to allow a pension to continue if a fund fails to meet the minimum pension payment requirements in an income year.
A super income stream ceases when a member or a dependant beneficiary requests to fully commute their entitlements to future super income stream benefits to a lump sum entitlement takes effect.
A request to fully commute a superannuation income stream takes effect as soon as the trustee's liability to pay periodic superannuation income stream benefits is substituted with a liability to pay a superannuation lump sum to the member or dependant beneficiary.
A payment resulting from a full commutation can't count towards the required minimum annual pension payment amount.
The taxable and tax-free components of the commutation payment will have the same proportions as those determined for the separate interest that supported the pension when the pension commenced.
Before fully commuting a member’s pension, you should ensure all minimum annual pension payments are made.
You must also consider the more restrictive commutation rules that apply to TRIS.
If a member fully commutes a pension and retains the amount of the commutation lump sum within the fund, you will be required to recalculate the tax-free and taxable components of any new benefit subsequently paid from the fund.
Example – Minimum payment prior to full commutation
Andre is a member of the Summa SMSF and is in receipt of an account-based pension.
On 1 November 2011 Andre advises all trustees of the Summa SMSF, in accordance with the governing rules of the fund that he wishes to fully commute his account-based pension. The balance of his pension at the time is $60,000.
On 15 November, the trustees transfer assets to him to the value of $50,000 in satisfaction of the lump sum commutation. The trustees also proceed to liquidate the remaining $10,000 to fund the required minimum pension amount in cash. On 30 November, Andre is paid the minimum pension amount of $10,000 in cash.
As Andre’s minimum pension payment was not made prior to the full commutation of his pension, the pension is taken not to have existed for that year of income and any benefits received will need to be treated as lump sums. The fund will not be entitled to treat income or capital gains from Andre’s pension as ECPI in the year the commutation takes place.End of example
Tax implications with a full commutation
As the super income stream ceases at the time the full commutation takes effect, eligibility for ECPI also ceases at this time if the pension was in retirement phase. There may also be CGT consequences as a result of the disposal of assets after this time.
Full commutation paid in-specie
A full commutation can be paid in-specie. The payment that results from a full commutation is a lump sum for the purposes of the superannuation laws. If permitted under the fund’s governing rules, the payment may be in the form of cash or in-specie.
Trustees will need to consider the governing rules of the fund and any CGT implications associated with the transfer of assets in lieu of cash.
A pension ceases as soon as a member in receipt of the pension dies. That is unless a dependant beneficiary is automatically entitled to a reversionary pension.
Minimum pension payments
If a super income stream automatically transfers to a beneficiary on the death of a pensioner (a reversionary pension), you must ensure that the minimum pension payments continue to be made. This includes in the year the member in receipt of the original pension dies.
Where a pensioner in receipt of a non-reversionary account-based pension dies, we won't require a minimum pension payment to be made in the year of death. If the deceased member’s benefits are subsequently used to commence a new pension to a beneficiary, you will be required to ensure the new minimum annual pension amount is paid in the relevant year.
- TR 2013/5 Income tax: when a superannuation income stream commences and ceases
When a pensioner dies
Upon the death of a member, a non-reversionary pension ceases.
From 1 July 2012, Income Tax Assessment Amendment (Superannuation Measures No. 1) Regulation 2013 ensures that, where a member who was receiving a non-reversionary super income stream that was in the retirement phase dies, the fund will continue to be entitled to claim ECPI in the period from the member’s death. This is until their benefits are applied to commence a new super income stream or paid as a lump sum (subject to the benefits being cashed as soon as practicable).
The trustee is also responsible for the correct identification of the tax free and taxable components of payments made from the superannuation interest that was supporting the deceased member’s pension.
If a member in receipt of a non-reversionary super income stream (the original income stream) dies on or after 4 June 2013, refer to the Income Tax Assessment Amendment (Superannuation Measures No. 1) Regulation 2013. This describes an alternative method to determining the tax free and taxable components of the super interest.
If you have a general question about how the super laws operate for an SMSF, you can get written SMSF guidance.
SMSF guidance will not tell you how the law applies to your own SMSF's particular circumstances but will tell you how the super law applies generally.
If you need written advice about how the super law applies to your SMSF's particular circumstances, you can apply for self-managed super funds specific advice (SMSFSA).
A SMSFSA sets out the Commissioner's opinion about the way the super laws apply, or would apply, to your SMSF in relation to a specified arrangement or circumstance.
See also:Information that trustees need to consider when commencing or stopping a superannuation income stream or pension from a self-managed super fund (SMSF).