I’ve underpaid my SMSF pension – will my fund lose its tax free status?
SMSF’s paying pensions are tax free … provided they satisfy certain conditions
One of the key attractions of superannuation, and SMSF’s in particular, is that once a fund commences paying pensions, the earnings of the assets used to support the pension payments become tax free. There are, however, a number of rules around this concession including:
- the member has satisfied a condition of release
- the fund actually pays the pension (you can’t just make book entries or do a year end accrual); and
- the amount of pension paid is at least the minimum pension draw-down amount.
SMSF Minimum Pension payment
We have recently seen a number of cases where funds have failed to satisfy the minimum draw-down amount – usually by a small amount as a result of misunderstanding the rules or due to simple administrative or timing errors. Whilst the ATO site has detailed explanations of how to calculate the minimum pension draw-down amounts, it is easy to get this calculation wrong particularly as
- the amount due to be paid is calculated as a percentage of the members opening balance dependent on age
- the percentages have been reduced by the Federal Government in recent years as a concession to the impact of the GFC
- the calculation has a requirement to round to the nearest $10 (ie you may have to round it up). Typically, Trustees calculate the minimum pension payment using the percentage and forget about the rounding requirement. For example, a member aged 66 in pension phase has an opening balance of $100,410. The minimum pension payment percentage for a 66 year old for the year ending 30 June 2012 is 3.75% – this results in an amount of $3,765.38. Unfortunately, many Trustees proceed to pay this amount only to find the rule actually requires the amount be rounded up to $3,770. In such a situation the fund has underpaid the pension, potentially putting its tax free status at risk
Simple errors of a few dollars in pension drawdown could therefore result in a fund been denied its tax free status at a cost of many thousands of dollars (the relevant account would be deemed to have reverted to an accumulation account)
A sensible ATO solution
Fortunately the ATO has just announced a sensible and reasonable solution to this situation. Provided the underpayment is a small amount (defined by the ATO as 1/12 of the minimum annual pension amount which should have been paid) and the fund rectifies the situation with a catch up payment as soon as practicable, then the Tax Commissioner will exercise their discretion and allow the fund to continue to benefit from its tax free status (or to use the ATO’s terminology “allow the fund to continue to claim ECPI”)
Naturally, this concession is subject to detailed conditions and requirements which are described in detail on the ATO website – please refer to Self-managed super funds – starting and stopping a superannuation income stream (pension). You should also consult your own accountant or financial advisor for detailed advice on your situation if you have underpaid your SMSF pension