While providing income for retirement is the obvious purpose of a pension paid from a self-managed superannuation fund (SMSF), there are some issues to think about before drawing a pension from your SMSF.
In particular, it pays to consider:
- tax rates in accumulation phase vs pension phase
- the value of imputation credits
- transition to retirement pension
Tax rates in accumulation phase vs pension phase
The first issue to consider when starting a pension is that returns from your investments will move to a zero tax status from the concessional tax rate that super funds pay during their accumulation phase.
While in this accumulation phase, the fund’s investment earnings such as interest, dividends or rental income from investment properties are taxed at 15%, and any realised capital gains will most likely be taxed at 10%. (Note that for superannuation funds, capital gains on investments held for at least 12 months are entitled to a one-third discount, which reduces the effective tax to 10%.)
It is commonly the case that income derived by an SMSF may be used to pay a pension to one member in pension phase whilst the other members of the fund are still in accumulation phase.
In such cases, as long as the investments generating the pension stream are clearly identified and segregated from those that are still allocated to members in accumulation phase, then the super rules should allow these investments to be exempt from income tax. That is, there is neither 15% levied on investment returns, nor 10% on net capital gains.
The value of imputation credits
Most pension-paying SMSFs have shareholdings that are fully entitled to dividend imputation credits. In these circumstances, imputation credits from franked dividends and in some cases from trust distributions can be valuable.
In the SMSF’s hands, these tax credits are used to reduce the amount of income tax payable and, if the credits exceed the total tax payable, the amount will be refunded by the Tax Office once the tax return is lodged.
This is an extra benefit for an SMSF and results from its low (15%) or zero tax rate (depending if it is in accumulation or pension phase).
When a fund receives a fully franked dividend, the imputation credit will not only offset tax payable on the dividend itself, it may offset tax payable on the SMSF’s other income (including concessional contributions) or be refunded.
However, remember that in this scenario is that the SMSF must have held the dividend-paying shares for at least 45 days at the time the dividend is paid in order to be eligible to claim the imputation credit, and the fund’s investment strategy document should record that it will invest in dividend paying equities.
Transition to retirement pension
If the fund member was born before July 1960, they will be able to start a pension from age 55, combined with transition to retirement (TTR) rules. This means that the member can receive a TTR income stream, which will give them the potential to enhance their pre-retirement earnings through greater tax effective investment returns.
Extra earnings may be able to be put back into super by way of concessional contributions. This can be especially valuable as an added boost for anyone who has lower amounts put away in retirement savings.