SMSFs unable to pay minimum pension amounts due to a shortfall of cash in the fund can borrow to make those payments, but should note the strict rules in place surrounding that strategy, according to an SMSF technical expert.
Heffron head of SMSF technical and education services Lyn Formica said pensions could only be paid in cash and a number of options existed to generate cash in the fund, including liquidating a non-cash asset, having a fund member making an eligible contribution, adding a new member and trying to complete a rollover before 30 June, or seeking prepayment of rent on a commercial property.
“Pension payments have to be made in cash and it’s not enough to make an in specie transfer of an asset as they are always a lump sum and a lump sum commutation doesn’t count towards the minimum pension requirements,” Formica said during a recent webinar presented by the firm.
She noted that where a minimum pension payment was not made, the pension will be considered to have ceased, but SMSFs could borrow to pay out any pension obligation.
“People are not generally aware of borrowing in this situation and that an SMSF is specifically allowed to borrow to make a payment they are legally obliged to make, such as a minimum pension payment,” she said.
“The requirements are that the amount of the borrowing can’t exceed 10 per cent of the value of the fund and it needs to be repaid within 90 days, so this is not a long-term solution.”
She said it was unlikely banks would lend to an SMSF in this situation, so they would have to use a related-party loan under arm’s-length terms and conditions with a documented loan agreement.
“This can satisfy the minimum pension rules, but there should be the expectation that something else will bring some cash into the fund after the 30th of June that allows the fund to repay that borrowing,” she noted.
“If you are not going to be able to repay the borrowing within that 90-day time frame, then it’s not worth doing because you’re just going to end up with a breach of the borrowing provisions.”
Heffron client relationship manager Sean Johnston added that if a shortfall of cash to pay minimum pension payments occurred regularly, SMSF trustees and members should be encouraged to revise their fund’s investment strategy.
“It is really important when formulating investment strategies to consider liquidity as one of the key factors,” Johnston said.
“If this shortfall is something that’s a recurring issue, then I would suggest to the client their investment strategy is not appropriate because it’s not meeting their liquidity needs and it’s time to go back to the drawing board because they are not considering liquidity correctly or at least appropriately for what they are trying to do.”