When a retirement income stream starts, SMSF trustees need to meet the pension standards by:

• Meeting a condition of release
• Reviewing the trust deed to ensure there are no restrictions or conditions on paying a pension
• Guaranteeing the fund has enough cash to pay the pension (liquidity)
• Revaluing the assets at market value
• Recalculating the minimum pension amounts (and maximum if applicable)
• Creating pension establishment documents, and recording the tax-free and taxable component

Basic pension rules

Pension payments must be confirmed and paid in accordance with the rules of the fund’s trust deed and SISR 6.17. Non-compliance will result in the auditor notifying the trustees in the management letter and may also result in a qualified audit report. The ATO may also review the matter and question whether fund assets have been released illegally or if the pension is complying.

It’s important to remember that pensions should be paid in cash to the member’s bank account (or where directed by the member) by 30 June each year otherwise the payment may not count towards the pension.

Additionally, pension payments cannot be accrued or processed via a journal entry because that fails the requirement of ‘cashing’ the benefits and regulation 6.21 of SISR wouldn’t be satisfied.

Minimum pension shortfall

One of the most common issues is not paying the minimum pension during the year. When this happens, the pension ceases from 1 July of that year and the exempt current pension income (ECPI) cannot be claimed.

There is scope to rectify limited situations, such as when an honest mistake is made underpaying the pension by less than 1/12 of the minimum pension payment.

Under these circumstances, the trustee can self-assess and make a catch-up payment within 28 days of becoming aware of the underpayment and continue to claim ECPI. Note that this is a one-time concession available at the fund level only and can never apply to any other member. So, choose wisely!

The Commissioner, however, may still exercise discretion in certain circumstances such as when the trustee can show matters occurred outside of their control. Only a very few cases have had discretion granted where trustees have been able to provide medical certificates for a long-term illness or evidence showing there were genuine bank errors.

Treating lump sums as pension payments

Since 1 July 2017 lump sums no longer count towards the minimum pension payment. However, we are starting to see problems emerge as some SMSF advisers are treating lump sums as a pension payment.

Regardless of whether the lump sum is an in-specie benefit payment or a lump sum in general, the incorrect treatment can have significant risks where the payment is classified incorrectly:

• The pension shortfall may be over the 1/12 rule whereby the pension ceases
• All benefit payments are treated as lump sums
• The fund is not entitled to ECPI and income is taxed at 15%
• There are potential personal tax consequences for receiving a lump sum below age 60
• If the transition to retirement income stream is in accumulation phase without any unrestricted non-preserved components, then lump sums are not allowed which will result in early access compliance issues
• Debit entries may impact the member’s transfer balance cap

Whether treating in-specie payments as a pension is intentional or not, a lack of understanding the risks involved can have far-reaching implications for the fund’s tax position.

Commuting a pension

There are two significant occurrences in the fund when the pension ceases:

• It reverts to accumulation mode at the beginning of that year
• Recalculating all tax-free and taxable components

However, commuting a pension can only occur when a member chooses to commute his or her entitlements, and a valid commutation takes place.

When a member doesn’t choose to commute the pension (i.e. they don’t request it), documentation is still required. A minute should be prepared and signed outlining these circumstances such as:

“The member failed to meet the minimum pension payment during the year, which resulted in the pension ceasing on 1 July 2018. The amount of that pension is now supporting an accumulation account”.

If the member complies with the relevant rules in the following year, then a new pension can be commenced with the appropriate pension establishment documentation put in place.

Conclusion

Even though there are potential problems for SMSF advisers and their clients in administering a pension, it doesn’t need to be difficult.

The main points to remember are to review the payment to ensure the classification is correct, then calculate, document and make sure that the minimum gets paid promptly before the end of the year to ensure continued SMSF compliance.

Shelley Banton, executive manager, technical services, ASF Audits