Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 472

Meg on SMSFs: pensions and the power of partial commutations

In a monthly column to assist trustees, specialist Meg Heffron explores major issues relating to managing your SMSF.

A reader recently highlighted a confusing sentence in an article they’d read and asked what on earth it meant. The sentence in question was:

“They have treated any income stream payment amounts above the required minimum pension as a partial commutation to enjoy a transfer balance cap benefit.”

I can see why that was confusing but it is a sentence that captures a lot of good ideas and is worth unpacking.

Classifying a withdrawal

Anyone with an account-based pension in an SMSF can pretty much take whatever they like out of their pension, unless they haven’t retired yet and their pension is still a 'transition to retirement' pension. And once they reach 60, the tax treatment of payments taken from the account is the same no matter what sort of payment it is.

So why would it matter how the payment is classified?

As the sentence suggests, it’s all about the Transfer Balance Cap (TBC). This is the $1.7 million limit (or somewhere between $1.6 million and $1.7 million for some people) on the amount that can be transferred across to retirement phase pension accounts (pensions for people who have retired) over our lifetime.

The amount transferred across is only checked against the TBC when a pension first starts. Someone whose pension account grows over time doesn’t use up more of their cap when that happens and similarly someone whose pension account drops in value doesn’t automatically get some of their cap back. All that matters is what the pension was worth when it started. So how can payments taken later impact the cap?

An example is the easiest way to explain.

The power of a partial commutation

Mary (65) has $1.8 million in super and starts a retirement phase pension with $1.7 million (i.e., she uses up all of her TBC when her pension first starts). She leaves the remaining $100,000 accumulating in her fund. Each year, she takes exactly what she has to from her pension account (the minimum payment) and when she needs extra money, she takes that from her accumulation account.

Her strategy makes sense. She leaves as much as possible in her pension account so a proportion of her SMSF’s investment income (capital gains, rent, interest, dividends, distributions etc) is tax free. The bigger her pension account, the bigger this proportion. It makes sense to run down her accumulation account rather than her pension account.

But what happens when her accumulation account runs out? At that point she would be taking everything she needs from her pension account.

Let’s say that in a particular year, she needs to withdraw $100,000 but her minimum pension is only $60,000. If she makes a specific choice to treat the extra $40,000 as a payment called a ‘partial commutation’, something special happens. The ATO records this and adjusts her TBC records. Instead of having none of her cap left, she gets $40,000 of it back. This doesn’t happen if she just treats the full $100,000 as a pension payment.

So who cares?

Well, if it’s only ever $40,000, Mary probably doesn’t care. But if this happened a few times and over time her ‘partial commutations’ add up to a more meaningful amount (let’s say $300,000) it does matter.

For a start, getting some of her TBC back means she can start more pensions in the future. If she gets $300,000 back, she can start more pensions with a value of up to $300,000. That might sound completely irrelevant to Mary initially – after all, she doesn’t have any more super.

But what if Mary put more money into super at some point? What if she made a downsizer contribution (special contributions for people who sell their home after owning it for more than 10 years and meeting some other conditions)? A key feature of these contributions is that Mary can make one no matter how old she is and how much she already has in super. Or what if she inherited some super from her spouse? All of these might mean Mary has more super in the future that she’d love to convert to a pension. Getting some of her cap back would help her do that.

Use of standing orders

A common approach for SMSF members is to put standing instructions in place with the trustee. They might read something like this:

“Make sure the minimum amount required is taken from my pension account then take anything extra as a payment from my accumulation account. Once the accumulation account runs out, take anything extra as a partial commutation from my pension account.”

In other words, they don’t have to think about exactly how they want to treat their payments every single time, they just make sure they provide the right instructions in advance.

And the ‘in advance’ bit is important. Legally, a commutation only occurs when a member makes a decision to swap some or all of their future pension payments for a lump sum. It’s not possible to do that after the fact. The member must ask for this treatment to apply up front before taking the payment. Otherwise, any payment from a pension account is just a pension payment.

So for a short sentence, it captures a lot of good ideas for anyone receiving a superannuation pension.

For more explanation on why partial commutations are so powerful, see this article.

 

Meg Heffron is the Managing Director of Heffron SMSF Solutions, a sponsor of Firstlinks. This is general information only and it does not constitute any recommendation or advice. It does not consider any personal circumstances and is based on an understanding of relevant rules and legislation at the time of writing.

To view Heffron's latest SMSF Trustee webinar, 'Super contributions unpacked', click here (requires name and email address to view). For more articles and papers from Heffron, please click here.

 

RELATED ARTICLES

Meg on SMSFs: Winding up market linked pensions with care

Meg on SMSFs: Timing and the new super tax

Are death bed benefit super withdrawals effective?

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.