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Pension reserves a solid strategy

The use of properly structured pension reserves can be a very powerful SMSF tool as amounts allocated to replenish these reserves will not be not be considered a concessional contribution, a sector expert has said.

“If you look at the law, it says that if you use a pension reserve, it must be used solely for pension purposes, so you can’t use them for other purposes like investment earnings,” NowInfinity principal Grant Abbott told the NowInfinity International Conference in Hawaii last month.

“If you’ve got surplus assets, it’s a no-brainer to create pension reserves.

“With pension reserves, provided you’ve structured and set them up properly, characteristically there are three different methodologies where you are exempt from the concessional contributions.”

The first was where there was a replenishment, Abbott said.

“A replenishment means there’s been a payment out to a member and that payment is then supplanted by an amount coming from the reserve to compensate or meet that payment that went out,” he said.

“So if $100,000 goes out and you can put $100,000 back in, it’s not a concessional contribution.”

Another exemption was where there was a commutation of the pension, he said.

“If you commute completely or if you’re rolling back and adding pension reserves to the new pension you’re starting, effectively you can then top it up with as much money as you want,” he said.

“The final one is that on death you can pay from that reserve, so that money can go to the fund’s beneficiary or to a lump sum.”

In the example of one client with three account-based pensions, one was 100 per cent tax-free, one had a 70/30 per cent tax-free component and one had all taxable components.

Pension payment amounts would have breached the concessional contribution caps.

However, a recent private binding ruling from the Australian Taxation Office allowed a payment from a pension reserve to replenish all three pensions without being treated as a concessional contribution.

Abbott said there was an opportunity to create and allocate earnings to reserves.

“If you’re going to start to build reserves, it’s not a bad idea to create them this year because a lot of your clients have had gains on their investments,” he said.

“If we find that there’s a pullback in the market like a global financial crisis, you’re not going to be able create reserves for four or five years.”

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