One of the biggest fallacies in SMSF administration is that an SMSF trustee is entitled to an account-based pension once they reach their preservation age, which in turn leads to a disregard of the associated cash restriction in relation to the member’s preservation age.
It was easy to understand why the confusion existed as the preservation age was one of the conditions of release, as outlined in the Superannuation Industry (Supervision) (SIS) Regulations, SuperAuditors director Shelley Banton said.
“The SIS Regulations are quite specific about the type of pension that can be started once the preservation age is reached: a transition-to-retirement income stream (TRIS), a non-commutable allocated annuity, a non-commutable allocated pension, a non-commutable annuity and a non-commutable pension,” Banton noted.
“Put simply, once a member reaches their preservation age they are only entitled to commence a TRIS under the cashing restrictions, which means that a 4 per cent minimum and a 10 per cent maximum of the opening member pension account balance must be paid.
“To start an account-based pension with no cashing restrictions, the member must have either reached their retirement age of 65 or reached their preservation age and meet a separate condition of release, that is, retirement, to comply with the regulations.”
She said the problem in practice was that many SMSF advisers were using incorrect pension establishment minutes for members starting an account-based pension under the age of 65.
“The minutes incorrectly state that the member has now ‘reached their preservation age and satisfied a condition of release and wish to commence an account-based pension’,” she noted.
“Getting it wrong can mean significant tax consequences for members receiving benefits in breach of the cashing rules or a condition of release.
“The payments must then be included in the member’s assessable income and are subject to their top marginal tax rates.
“As payment of benefit rules are also operating standards, SMSF trustees can face additional fines of up to 120 penalty units and the fund made non-complying by the regulator.”
She highlighted that the new $1.6 million pension balance transfer cap also needed to be taken into consideration by SMSF advisers.
“Under the 2016 budget proposals, a TRIS will no longer receive an earnings tax exemption from 1 July 2017 onwards and won’t count towards the transfer balance cap,” she said.
Further, when pension establishment documents were unclear, the ATO might not agree a TRIS had started, but instead rule that an account-based pension had been established and adjust the member’s cap balance accordingly, she noted.
“Poor SMSF documentation may have unintended and unwanted consequences in the future,” she said.
“Before starting any pension, it’s best … to check the trust deed to ensure that it allows for the establishment and payment of a pension.
“A feed dated before 2007 may not reflect the change to the super rules, such as allowing for a TRIS or account-based pension.”
It should be remembered any differences between the governing rules and the SIS Regulations could cause a conflict regarding the validity of a pension, she added.
Therefore during the audit, where an SMSF auditor could not confirm a pension had been paid in accordance with the fund’s trust deed and SIS regulation 6.17, the auditor was obliged to qualify the audit report and might be required to lodge a contravention report with the ATO, she said.
“The ATO may then question whether the pension is a complying pension and whether the fund assets have been illegally released,” she said.
“There are no restrictions on a member accessing their unrestricted non-preserved benefits at any time, but the same doesn’t hold for preserved benefits and restricted non-preserved benefits.
“Remember, too, that under the age of 65 the member is also required to meet a condition of release each and every time they commence an account-based pension.
The reason is that a member’s circumstances can change in the short term, such as returning to the workforce and becoming gainfully employed.
“As always, the devil is in the SMSF detail – with significant changes on the way for pensions as a result of the 2016 budget announcements, ensuring that SMSF pension establishment documents are correct may just be the difference between compliance and non-compliance.”