Phone: (03) 9563 4688

Email: office@aubreypaton.com.au

Address: 17D Chester Street, Oakleigh VIC 3166

Latest Accounting News
Hot Issues
300,000 SMEs utilising $20K write-off, says ATO
‘A bad thing times 10’: ATO set for new SMSF blitz
Capital Gains and Renounceable Rights
Paperwork bungles lead to $38k in payments
Australian Dietary Guidelines and healthy eating chart (PDF)
Former director liable for company’s unpaid tax liabilities
Resources on our site to help you, your family and your friends.
Super for housing measures enter Senate
No Special Circumstances to allow Excess Super Contributions
Housing tax measures progress to Parliament
AirBnb – wrong tax outcome?
Are young investors wasting their youth?
ATO sending 'more letters than ever' on income tax errors
Powerful Budgeting, cash flow and Super Tools available on our site.
Property, unit trusts in ATO's sights
Australian Dietary Guidelines and healthy eating chart (PDF)
Major Bank Levy Passed
NSW tops list as ATO reveals billions in lost super
How is your super going, ready for retirement?
Australia's leading causes of death - ABS
ATO increasing data exchange with international regulators
Illegal SMSF early access scheme leads to $6,000 fine
Our 'hardest' SMSF tasks
Uber drivers hit for 10% tax
Lack of literacy promotes unrealistic goals
Taxpayer failed to prove that payments were “loans”
New STP dates confirmed as ATO goes on compliance blitz
ATO flags compliance project for FY17/18
Items that heat up your depreciation deductions
Articles archive
Quarter 3 July - September 2017
Quarter 2 April - June 2017
Quarter 1 January - March 2017
Quarter 4 October - December 2016
Quarter 3 July - September 2016
Quarter 2 April - June 2016
Quarter 1 January - March 2016
Quarter 4 October - December 2015
Quarter 3 July - September 2015
Quarter 2 April - June 2015
Quarter 1 January - March 2015
Quarter 4 October - December 2014
Quarter 3 July - September 2014
Quarter 2 April - June 2014
Quarter 1 January - March 2014
Quarter 4 October - December 2013
Quarter 3 July - September 2013
Quarter 2 April - June 2013
Quarter 1 January - March 2013
Quarter 4 October - December 2012
Quarter 3 July - September 2012
Quarter 2 April - June 2012
Quarter 1 January - March 2012
Quarter 4 October - December 2011
Quarter 3 July - September 2011
Quarter 2 April - June 2011
Quarter 1 January - March 2011
Quarter 4 October - December 2010
Quarter 3 July - September 2010
Quarter 2 April - June 2010
Quarter 1 January - March 2010
Quarter 4 October - December 2009
Quarter 3 July - September 2009
Quarter 2 April - June 2009
Quarter 1 January - March 2009
Quarter 4 October - December 2008
Quarter 3 July - September 2008
Quarter 2 April - June 2008
Quarter 1 January - March 2008
Quarter 4 October - December 2007
Quarter 2 April - June 2007
Quarter 1 January - March 2007
Quarter 2 April - June 2006
Quarter 1 January - March 2006
Quarter 4 October - December 2005
Quarter 3 July - September 2005
Quarter 2 of 2015
Articles
Change to Early Access Rules
Capital Gains Tax – which year?
SMSFs may be missing out on allowable deductions
Checklist for Employers Year-end
Year-end Tax Planning – Trusts
Year-end Tax Planning – Small Business
Reminders and Tax Strategies for SMSFs pre-year end
Year-end Tax Planning – Individuals
Tips and traps for acquiring SMSF assets from related parties
Overtime Payments May Eliminate Claims for Unfair Dismissal
ACCC issues scam warning
SME Dispute Resolution
Land Tax – Victoria
R&D incentives at risk
ATO adds ‘hot issue’ to its SMSF target list
Additional Super Contributions Not Appropriate for all
Issues arising from an underpaid pension
Salary and Superannuation after the death of an employee
IPA calls for zero pc tax rate
Budget 2015 - some professional opinions
Australian Government - Budget 2015
Looming end to SMSF Borrowings?
ATO warns SMSFs on franking credits scheme
Lump Sum Payments - Employer Reporting
Small business tax cuts 'not enough', says IPA
Issues arising from an underpaid pension

 

Recent ATO rulings and interpretations emphasise the need to understand the rules about paying account-based income streams and transition to retirement pensions.



       


The pension standards in the Superannuation Industry (Supervision) Act and regulations (SIS Act and Regs), which have been there for many years, are a precursor to whether the fund will qualify for tax exemption for income earned on investments that are supporting the pension. The exempt income on pension investments is called Exempt Current Pension Income (ECPI) and Subdivision 295-F of the Income Tax Assessment Act 1997.


There are many types of pensions described under the SIS regulations. However, these days all SMSFs, with very few exceptions, can only begin account-based pensions and transition to retirement pensions (TRIPs). In a very small number of cases SMSFs are paying complying lifetime and life expectancy pensions as well as market-linked pensions due to the grandfathering rules that began in 2007. Whatever type of pension the SMSF pays, if the appropriate rules are not met the consequences will be the same – tax is payable on income earned from investments that support the failed pension.


First, let’s look at an account-based pension that fails to meet the rules and then compare it with a transition to retirement pension that does exactly the same thing. Under the rules for an account-based pension there are three essential rules that must be satisfied. Don’t comply with one of these rules and it’s the firing squad for the pension.


Rule 1 is to ensure the pension meets the minimum payment requirements published in Schedule 7 of the SIS Regs. Rule 2 is the pension can only be transferred to another only on the death of the primary or reversionary beneficiary. And Rule 3 is to ensure the capital value of the pension and income earned from it are not used as security for a borrowing.


It is reasonable to expect that Rules 2 and 3 are relatively easy to comply with as it would be unusual for a pensioner to transfer the pension to another person while they were alive, or deceased for that matter, and very unlikely for the pension to be used as security for a loan as those days are well and truly over.


However, in relative terms not paying the minimum pension, especially from an SMSF, would be more common for a number of reasons. In some cases clients may be well off and decide not to draw any pension, some may draw amounts from the fund on an ad hoc basis and not draw enough, while others may just fall short due to small miscalculations of the payment dates, valuation of the fund’s investments and similar events.


In a case study let’s assume that a member of an SMSF, Julia, who is age 62, has used all her balance of $800,000 to begin an account-based pension. Each year she will be required to draw at least four per cent of her account balance from the fund calculated at the time the pension began (pro-rated on a daily basis) or at the start of the financial year. If the pension began on 1 July in the financial year the minimum drawdown amount will be $32,000. If only $20,000 was drawn as a pension from the fund it would not meet the minimum requirements. In view of this the pension will not meet the minimum requirements.


If the pension balance of $800,000 earned $96,000 for the year it now would be taxed at 15 per cent and tax of $14,400 would be payable rather than being tax free if the minimum pension requirements had been met. In addition, the drawdowns received by Julia will be treated as lump sums. On 1 July 2016, if she wishes to continue to receive a pension from the previous balance, new calculations will need to be made as the tax commissioner treats it as an entirely new pension from the start of the next financial year.


Let’s look at the consequences if the pension Julia was drawing from her fund was a TRIP. To qualify as a TRIP Julia must have reached her preservation age and continues to work as well as not meeting a condition of release. As Julia is 62 she is older than her preservation age of 55 and continues to work full time, meaning that she has not met a condition of release. If we assume that Julia began a TRIP with her balance of $800,000 and all the components are preserved let’s see what happens.


If the TRIP began on 1 July 2015 Julia would be required to draw down a minimum pension of at least $32,000 and as TRIPs are subject to a maximum drawdown amount, could not take any more than 10 per cent of the balance ($80,000) each year. There are also restrictions on TRIPs that ensure Julia could not withdraw a lump sum from her TRIP balance until she meets a condition of retirement such as permanent retirement or reaches age 65, whichever is later.


If we assume that Julia has only drawn down $20,000 as a TRIP she will not meet the minimum payment requirements. This means that the income earned on the investments used to support the pension will be taxed in the fund at 15 per cent. In addition, the commissioner will treat the amounts drawn down on the failed pension as a series of lump sums. However, unlike the treatment of the withdrawals from the account-based pension that will remain tax free in Julia’s hands, the series of lump sums from the TRIP will be taxed at full personal rates as they are considered to be in breach of the preservation standards. This applies irrespective of Julia’s age in the case of the drawdown of any preserved components.


Despite all this, the commissioner may be kind enough to overlook the underpayment of the account-based pension or TRIP where an honest mistake has been made that has resulted in a small underpayment or the reason for the underpayment was outside the control of the fund trustees. In these cases a payment is required to be made as soon as possible. A small underpayment of the minimum is where it is no greater than a 12th of the minimum pension required to be paid. Circumstances beyond the control of the trustees would include genuine errors in calculation that resulted in the underpayment or an error by a third party such as a financial institution.


So there you go; make sure your clients meet all the requirements of paying an account-based pension or a TRIP otherwise they may end up with an unexpected tax bill as well as the need to restructure the income stream in the financial year following the failure of the pension. One of the simplest ways of ensuring the minimum pension is paid for the year is to have a direct transfer of money from the SMSFs bank account on a regular basis.


 



Thursday 7 May 2015
Columnist: Graeme Colley, director of technical and professional standards, SMSF Association
www.smsfadviseronline.com.au




24th-May-2015