SMSF Pension

Are SMSF pensions taxed?

Self-managed-super-fund pensions are not taxed, nor are investment returns and other income achieved by an SMSF that's in the pension phase. However, the annual pension payments to retired members must be at least the minimum amount set by the ATO.

There are other costs to running an SMSF, including setup and ongoing costs. The total costs of an SMSF vary depending on the assets held, and the larger and more complicated the SMSF, the higher costs are likely to be.

SMSF minimum pension amounts

When an SMSF is in the pension phase, it must pay out, over the course of a year, the minimum amount set out by the ATO. This amount is a percentage of the overall fund balance for that member and is based on their age on 1 July of each year, plus any discounts applied by the government. The minimum pension amounts increase as the member gets older.

What is exempt current pension income?

When an SMSF reaches the pension stage, the income the fund receives from investments can be tax-free. This is called exempt current pension income or ECPI, and it can be used to offset the tax liabilities of the SMSF, if the fund has other members who have not yet retired.

Only the income from assets that are used to fund the retired member’s pension is eligible for ECPI. 

ECPI adds an extra level of complexity to SMSF accounting, and professional advice is recommended.

It must also be remembered that the tax-free status of the fund cannot be used to offset the personal income tax of members. 

How is ECPI calculated?

There are two ways that ECPI can be calculated, and the method depends on how the SMSF’s trust deeds were drawn up with regards to its assets.

1. The segregation method is used when the SMSF has assigned the income from specific assets to only pay retirement-phase pensions. That specified income will be tax-free and capital gains and losses will be disregarded. If some members of the fund have not retired, then investment income and capital gains tied to non-pension-assigned assets will still be taxed at 15%.
2. The proportionate method is used when the fund’s income is pooled and distributed proportionately amongst members. In this case, the proportion of the tax-free investment income – as assessed and certified by an accountant or actuary – will match the proportion of the fund to which the retired member is entitled to. The rest will be taxed at 15%.

If any one member has more than $1.6 million in total super immediately prior to the start of the relevant income year (SMSF and other funds), then the SMSF must use the proportionate method to calculate ECPI. There are other rules around the calculation method and professional advice is recommended.

How much can an SMSF member hold in the pension phase?

Ideally, an individual member of an SMSF should have less than $1.6 million in their total super balance when they start their pension phase. If they have more, then they may not be eligible for certain super benefits, and the tax-free status of the income and capital gains of their SMSF is treated differently, i.e. the ECPI must be calculated using the proportionate method.

If you think you will have more than $1.6 million in super at any time, it is wise to seek specialist financial advice.

What do I do if my SMSF balance gets low?

If the balance of your SMSF is running down, then it may be smarter to wind up the SMSF and roll the remaining balance over into a regular low-fee super fund such as an Industry SuperFund. This is because, even when the balance is low, the costs of running the SMSF can remain about the same, and continue to eat significantly into the balance.

References
SMSF pension - ATO