Full commutations of income streams that are cashless and only involve in-specie transfers can result in adverse tax outcomes for SMSFs entirely in pension phase, a technical services manager has said.
Heffron head of SMSF technical and education services Lyn Formica noted the rules governing full pension commutations give rise to the unwanted situation due to their stipulation of when the income stream is effectively cancelled.
“If I take a full commutation in the ATO’s view that causes the pension to cease. Not only does it cease, it ceases when the trustee agrees to honour the request,” Formica said.
“If [it involves] an in-specie transfer the trustee agreement would happen just momentarily before the asset was actually transferred out of the fund,” she added.
“That could cause me a tax problem if I have a fund using the segregated method to calculate the exempt [current pension] income.
“So I was entirely tax exempt, I requested this full commutation, the pension [then] stops, the next day my asset got sold or the next moment my asset got sold, if there are capital gains involved I’ve potentially crystallised that capital gain in a portion of the fund where I’m potentially completely taxable. That’s the last thing we want.”
Formica pointed out the most effective way to avoid this scenario is not to make a full pension commutation.
“How do I avoid that? Make sure there is some pension money remaining. So make sure you structure the lump sum to have enough pension account [left] behind so that you can still pay the minimum pension afterwards,” she suggested.
“That’s the other problem with full commutations, I have to have taken a pro-rata of my minimum pension before the commutation happens.
“Whereas [with a] partial commutation, so long as I’d left enough money behind, I can still pay my minimum pension later in the financial year.”