I have just turned 55 and have retired. I am currently living off savings. I intend to start a SMSF in the new financial year. My aim is to earn enough income to support a modest lifestyle and grow my super. Do you need a different SMSF structure from an accumulation fund to enable a tax free environment and payment of a pension. Secondly can I claim imputation credits from the tax man in this tax free environment. Bill
Quite simply, No & Yes!!
The great thing about self managed super is that you are in control within the limits of the legislation. So now that you have turned 55 and assuming you are living 100% off savings and not working, you have met a condition of release for superannuation. This means you can access your super for income (through a pension) or withdraw lump sums.
When you have a self managed fund, you are the trustee and the member. In order to commence a pension, the trustee hat must firstly come on to review the trust deed and make sure that you are allowed to commence a pension from the fund. You’d be amazed how many people don’t regularly update their trust deeds and therefore find that payment of pensions is either not allowed or not mentioned. You just need to upgrade your trust deed if there’s a problem.
Assuming the trust deed allows for pension payments, all you have to do to start a pension is to write to yourself as trustee and apply to start an account based pension. Something like: “I Bill, would like to start an account based based as a member of the Bill Super Fund. My full name is Bill B. McBill and my date of birth is 01/01/1954. I have met a condition of release (over 55, retired with no intention to re-enter the workforce). I would like to commence my pension from 1 July 2009, using 100% of my account balance. I would like to draw the minimum pension and I would like to apply the tax free threshold to this income stream.”
Your accountant, tax adviser, administrator or financial adviser will have a nice form to help with this, but it really is that simple. You don’t need a new structure, simply maintain the existing fund and investments and formalise the request to commence a pension in writing.
You as trustee will then check the value of the member balance, agree to the level of pension payments and resolve in writing to pay yourself a pension.
If any assets are staying in the superannuation accumulation phase, you may run the SMF with segregated assets or use the unsegregated method. So if anything less than 100% of your funds are used to start the pension, you’ll need to speak with your adviser about possibly getting an actuarial certificate for running the self managed fund in pension phase.
The income and capital gains generated by all of the assets that are attributed to funding your pension are exempt from tax within your SMF. This is why pension phase is generally referred to as a zero tax environment.
As a member, you will supply the trustee with a tax file number declaration to determine whether you would like the $6,000 tax free threshold to apply to your new pension income stream. For a 55 year old with no other income, that would be a “Yes please Mr D’Ascenzo!”
The fund then needs to register for PAYG purposes, as personal income tax must be deducted by the fund prior to payment of a pension to you.
If your fund is made up of 100% tax free component, you will have a completely tax free pension even from age 55.
However if your fund contains taxable component and you are aged 55-59, you will possibly have some personal tax to pay, hence the need to register the fund for PAYG. Strategies such a lump sum withdrawal of up to $145,000 and re-contribution back to the fund can help lessen the tax on pension payments (as well as improve estate planning considerations). Then of course, there is the 15% tax offset that applies to the taxable portion of your income to further reduce the self funded tax burden. Once you are age 60, the whole income stream becomes tax free to you personally.
That brings us to the magic of imputation credits within superannuation, especially within the pension phase.
Superannuation in accumulation phase gets taxed at a MAXIMUM of 15%, and as mentioned above, assets attributed to pension phase are tax exempt. So to show the advantage of imputation credits from franked Australian shares, let’s have a look at an example in pension phase.
If your pension assets are $400,000 in cash earning 5% pa, then your tax and income position will be:
$400,000 x 5% = $20,000 tax exempt.
A total return of $20,000 earnings is achieved within the pension. Assuming you pay yourself 5% of the pension starting balance as a pension, then the gross pension payment would be $20,000 over a whole year. So effectively the balance stays neutral.
Instead of holding 100% cash, let’s say you held 100% Australian shares in order to take advantage of the tax benefits from imputation credits and franking. Yes the risk profile of your fund would increase and I’m not suggesting you should hold no cash or not adequately diversify, but we are talking here about tax strategies and notional differences.
So if you put that $400,000 into blue chip Australian shares paying fully franked dividends, your return and tax profile might look like this:
$400,000 x 4% (fully franked dividend) = $16,000 cash tax exempt.
Assuming a 100% franking credit for tax the company has already paid (30% of profit) and because the pension assets are tax exempt, the SMF is entitled to the whole franking credit of $6,857.
A total return of $16,000 earnings + $6,857 franking credit = $22,857 is achieved within the pension. Assuming you pay yourself 5% of the pension starting balance as a pension as before, then the gross pension payment would be $20,000 over a whole year. So effectively the balance in this scenario goes up by $2,857 for the year.
By Jeremy Gillman-Wells, Financial Planner, Bentham Financial Group
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