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Meg on SMSFs: Four ways super pensions are better in SMSFs

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

Superannuation pensions in retirement phase are brilliant for members of any fund, not just SMSFs. They allow super to be converted into an income stream to live on in retirement and the fund itself stops paying income tax on some or all of its investment income (rent, interest, dividends etc).

For some people, the tax break is so large in an SMSF that it pays no tax and in fact receives a full refund of all its franking credits every year.

Same tax rules but not same opportunities

All super funds follow the same tax rules so in many ways, SMSF pensions are just the same as any other superannuation pension. But there are some aspects of running an SMSF that make it the preferred structure from which to pay a superannuation pension.

Here are four ways a pension in an SMSF may work better.

1. Easier to start with no need to move assets

In a public fund, members who start pensions need to set up a new account in that fund and explicitly move some of their existing accumulation super balance into it. That generally means application forms, waiting for requests to be processed, providing information to confirm they are eligible to start and more. Public funds allow members to choose specific investments for their super and the member will also need to choose which ones to move across to the pension account.

In an SMSF there’s no need to do any of these things. Because the members and trustees are all the same people, pensions can be started instantly. Of course, there is documentation to prepare and it’s every bit as important as in a public fund but the documentation can follow after the pension starts. The critical member request and trustee decision to start can be immediate.

And there is no need to move assets or set up new bank accounts. Everything stays exactly the same but the fund’s accountant does some extra work in the background to track the new pension account.

2. Payment timing flexibility

There’s no rule that says people with pensions must take their pension payments as regular monthly or fortnightly amounts. But many public funds require it for practical reasons. When there are thousands of people drawing pensions, it makes sense to impose some rules to simplify the administration involved.

SMSF members are free to do whatever they want, subject to the law, and the law is not prescriptive here. The only requirement is that the member takes enough to meet the minimum payment rules each year. Some people do this by arranging regular bank transfers but others might do something completely different.

For example, some people don’t take any pension payments during the year but then withdraw the whole minimum amount in one go. Others go to the extreme of having their personal credit card or other bills paid by their SMSF each month (each payment is a pension payment). And some even just take payments when they want them. With online banking, it’s as simple as hopping online and transferring money as and when it’s needed.

Essentially, it’s whatever works for the members concerned.

3. Members of a couple act together

It's common for couples who share an SMSF to think about their pension payments together. For example, they might decide to draw $10,000 per month (combined) and arrange a single monthly direct transfer to their personal bank account. Behind the scenes, their accountant will divide each payment up between them (or between their various accounts if they have multiple pensions) but they don’t need to take separate payments.

This is different to pensions in non-SMSFs where each pension account must make its own cash transfer to the relevant member.

In a retail fund where the members choose their own investments, treating each pension account as a self-contained ‘pot’ may mean a sale of an investment in one account (to pay the pension) even though another account has plenty of cash.

A good example is someone who has both a pension and an accumulation account. The accumulation account might be receiving contributions and investment income and so is building up cash. But that cash can’t be used to pay the pension.

An SMSF is quite different. Pensions are paid from the fund’s bank account which is generally shared by all members and all accounts. It’s common to find that the cash flow for pension payments is coming from contributions (even contributions made by other members) and investment income across the whole super fund investment portfolio, not just part of it.

Again, behind the scenes the fund’s accountant makes sure everyone gets their fair share but in a practical sense, it means minimising costs by sharing cash more effectively.

4. Draw additional amounts as needed

The ability to share cash can even have ramifications beyond pension payments. It’s common for members of both SMSFs and retail or industry funds to withdraw more than they have to in some years. Those extra payments don’t have to be treated as pension payments and there are often good tax reasons to treat them differently.

For example, in some cases, it’s better to treat extra amounts as withdrawals from an accumulation account or as different types of payments (called ‘partial commutations’) from pension accounts.

Once again, this is easy to set up in an SMSF. The member can simply provide standing instructions to the trustee that once they’ve taken at least their minimum pension out of the fund, subsequent payments should be treated in a particular way. They don’t need to keep track of exactly when that happens. And they don’t need to take the extra amounts from a separate bank account. In a public fund they would have to do all these things.

First among equals for pensions

In many ways, super in an SMSF and a public fund is the same, but moving into pension phase is one of those times when it’s often easier to have an SMSF.

 

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.

For more articles and papers from Heffron, please click here.

 

24 Comments
Mark
May 07, 2023

https://www.ato.gov.au/Super/Self-managed-super-funds/Paying-benefits/Conditions-of-release/#Retirementundersuperlaws1

Just a query on the above, my interpretation is that one could access their SMSF earlier than preservation age if they do not meet any other condition of release as long as the elect to take Superannuation as a pension and not a lump sum.

Would this be correct?

I'll likely email the ATO as well for clarification but if anyone could answer this it would be greatly appreciated.

Abel
April 05, 2023

Although this article is geared towards SMSF, I wonder why more industry/retail funds don't implement strategies to help protect retirees funds from sequential risk (for example, using the buckets approach). Only a few seem to do that. Knowing that your decision making abilities diminish with age, it would be good to have alternatives to having to do it on your own.

David m
April 02, 2023

Our firm closes approximately 20 SMSFs per year from clients who have followed the advice of an accountant when all they really wanted was input to the decision making process, control and not to be ripped off in commissions or high managed funds. Would have been good to balance in the article what goes wrong especially in retirement. Like dementia, which creeps up and only becomes apparent down the track. Elder abuse - online banking can make this become even easier - no pesky super forms or advisers to contend with. Managing your own fund is great for a small group of interested and wealthy investors but nowhere near the number currently in Australia.

Mark
April 03, 2023

I use the direct share option in my industry fund and it has served me well. I will be independently wealthy in my retirement from it.

People say I should have gone self managed to have more control and make more money, to me that is debatable and an unknown.

I could well have lost a lot of money chasing big gains on speculative stocks that went nowhere or even backwards.

For the convenience of still being able to choose the stocks in the ASX300 and have the fund do all the administration, on balance, I can't complain about the position I'm in.

David O
April 03, 2023

I agree. We very rarely hear people talking about super funds offered via wrap accounts. They offer many of the attributes of SMSFs including low fees and control over investments without the ongoing challenges of trustee responsibilities, compliance, coping with ageing members, death etc

Meg Heffron
April 22, 2023

Fair point David - I suspect there will always be SMSFs opened for the wrong reasons and not closed quickly enough when buyer's remorse first sets in OR they outlive their purpose. I wrote an article in Firstlinks a few months ago about when I might close my SMSF - and I hadn't thought of elder abuse at the time so a highly relevant addition.

Every SMSF will stop adding value at some point and should be closed. Different people will reach that point at different times. All that said, I'm not sure I'd agree that SMSFs are only for a small group of wealthy people. I've seen plenty of people who wouldn't consider themselves overly wealthy derive a lot of value out of their SMSF.

Pensioner
March 31, 2023

Agree with Meg's comments. However, if your investments are primarily shares and cash, you can achieve all of the above and more by using the self invest option of a big super fund.
In addition, the self invest option costs peanuts in admin fees (usually capped at a few hunderd dollars per annum), charges no investment management fees other than the amount embedded in an ETF and pays franking credits immediately on receipt of the cash dividend. All the compliance work is handled by the super fund on your behalf. Too easy!

Jack
April 01, 2023

As you say there are some advantages in not being the trustee of the super fund.
There are also some disadvantages in not being the trustee.

You must keep a portion of your money in one of the fund’s managed investment options to pay your regular pension. Australian Super requires that you hold 13 months forward pension payments in cash. Other funds limit the allocation of assets to self-invest to 85%.

The trustee of the fund owns the shares, not the member and the dividends are paid to your account by the Fund, not the share registry. The “shares” you think you own can be sold without your knowledge or consent and the member does not automatically benefit from share ownership – eg. buybacks or share splits.

Your franking credit is paid the same day as the dividend. That clearly shows that they are paid by Fund, not the ATO; the ATO only pays the franking credit refund after completion of the tax return after 30 June. This arrangement depends on Fund policy not legislation and can be easily changed

You are on your own; the fund offers no advice and you take all the risk of the investment decisions; the fund accepts no responsibility for your investment outcomes. On top of that, you are charged extra to use you own broker

Meg Heffron
April 22, 2023

I'm really surprised it's possible to do (1), (3) and (4) above as easily in a big super fund as an SMSF, Pensioner. I think many big super funds offer excellent investment flexibility but it's mostly managed within each account. So if you have 4 accounts (1 pension, 1 accumulation each for 2 members) then none of the big funds I've looked at would allow you to pool cash across all 4 (a key part of (3) above).

But if there's something new available that does allow that - fantastic. It's great when big funds innovate to replicate SMSF features - it means everyone with super ends up benefiting somewhere along the line.

Graham W
March 31, 2023

It is wise to have several year's pension payments in cash or term deposits in retirement phase.I don't think having a super fund invested all in shares is a good investment strategy. Having cash to meet pension payments avoids selling shares when there is a downturn. Your accountant should not be the one to sell shares
That is your responsibility or your advisor or broker.

Mark B
March 31, 2023

I tend to disagree about keeping so much cash Graham. I have only just kicked into pension phase but my view is that Super is still a long term asset that can ride the ups and downs of the market. Given that shares (diversified into wherever you feel achieves diversification) can deliver strong dividend income throughout the years that provides the required 4-5% drawdowns required for the pension payments. Thus, so long as you can ride out some of the storms that come along then you also get to ride with the waves when the going is good.
It's served me well through my accumulation years even with experiencing the GFC a couple of years into my SMSF life. That was a little scary at the time though! Even in those years there was a healthy fully franked dividend return.

SMSF Trustee
March 31, 2023

Markb you must have a decent amount in super so that you don't have to manage sequencing risk too carefully.
But the strategy that Graham W uses is one of the most effective ways to ensure you're not selling assets in a down market to meet you 4 or 5% drawdown needs in pension phase.

I'm not saying anything about the rights and wrongs of either approach for you two individuals. But just be aware that your own situation doesn't translate into the best approach for other people. Everyone should get advice about their own risk profile and how best to deal with it. For many it will be to.do what Graham W is doing.

Mark B
March 31, 2023

Yes, there is a very good super balance there that certainly manages the sequencing risk. I also acknowledge that different risk profiles for people mean that they will sleep much better knowing that they have the cash available without market concerns.

I guess the point that I was trying to make was that if dividend income is being generated at the 4-5% mark then that amount is capable of covering the required pension payments particularly if through a SMSF where as Meg says, those drawdowns have flexibility of being taken as and when required.

A falling market would obviously mean those annual pension payments were going lower as the TSB decreased but so long as the person can handle that then in my view there are alternatives than just having cash sitting around. The strong years will hopefully more than compensate in this long term asset.

Horses for courses, just giving an option from the one that seems to be mostly pushed/publicised.

Graham W
April 01, 2023

Over recent years the required levels of pension payments have been reduced by 50% so not a large percentage in cash. As a retired SMSF auditor I would question the Retirement Strategy of a fund invested all in shares.
Over many years I have noted that in a two person fund, only one member is the dominant person managing the fund. I keep reasonable levels of cash to meet pension payments and other required drawdowns. This means my spouse can draw funds and not have to worry about selling shares in the case that I am not able to.

Mark B
April 01, 2023

Investment strategy is high growth targeting CPI + 5%, and is 70% exposure to shares which includes international ETFs. No queries from the auditor but the strategy is clear and being adhered to so he should not be overly concerned. I'm hoping for another 20-30 years so definitely long term.

The 2% drawdown for the last two years has been more than adequately met by the taxable income generated in excess of 6% per annum, excluding asset unrealised gains. I guess this is the point I'm trying to make, the annual income should be considered with regards to amount of cash reserves to service the pension and lump sums if required. In my case due to the growth strategy excess cash was reinvested without a reserves requirement and I would argue if timing not an issue then this will normally be the case until pensions start to exceed 5% pa.

You are definitely correct about the concerns around a dominant SMSF operator. My spouse will be taking steps to close off the SMSF and roll it out should something occur as she isn't as interested. We have instructions for how that will occur and at least selling shares is pretty easy to do which is more than I can say about the property assets!

Rob W
April 01, 2023

Mark B, I absolutely understand where you are coming from as our own SMSF is invested similarly for the same reason - sustainable dividend yield at <6% pa well and truly covers pension payments and I'm in for the long haul (aged 59).

Steve
May 19, 2023

Mark, you raise some good points regarding dividends covering the annual pension payments. There are a couple of issues that you may have to be mindful about:
1. as you would be aware, the minimum pension requirement (in % terms) increases with age. Whilst dividends do grow, the dividend growth rate has to keep pace with the "growth rate" implicit in the min pension requirement to ensure pension payments do not erode capital.
2. If the equities market suffer any sort of decline after 1 July, that decline does not factor in to the min. pension requirement (in $ terms) for the financial year ahead as it is set in advance. Governments have shown a propensity to overcome this issue by reducing the minimum pension requirement during uncertain times but that usually occurs after the event.

Mark
May 20, 2023

Steve, drawdown rates don't hit 7% until one is 80. Dividends with Franking Credits are over 6% for many dividend paying stocks.

Dollar value of dividends in a downturn on equities usually stay pretty stable.

Dollar value of your portfolio might drop more but dividends don't change that much.

Drawdown doesn't mean you have to spend it all.

Carolyn
March 30, 2023

Hi Meg. So with the draw down of 5% and most shares not making 5% then the accountant wound need to sell off some of the low yielding shares to make up the difference .
Am I correct? I run out own smsf for the past 23 years but still a while to go before retirement.

Meg Heffron
April 22, 2023

Carolyn, at some point it's likely that the SMSF trustee would need to sell some of its assets to make pension payments. And that becomes more and more likely as you get older. By the time you're 85, for example, your pension is required to pay you 9% pa and I expect even a fund doing really well would find it hard to generate that much cash each year.

This is really exactly what pensions are designed to do - draw down capital over time.

John
March 30, 2023

And then there are fees. We have about $2.3m in our SMSF, paying about $3000 per annum in total fees to a large SMSF administration company. Roughly 0.13% of the fund balance. In our public sector industry fund, the fees in pension phase total 0.85%. i.e. 6.5 times as much. Yes, I do have to make investment decisions for our SMSF, executive trades and fill in some forms occasionally. That $16.5k p.a. potentially saved in fees is compo for that effort. If we moved the remaining $1m out of our industry fund into our SMSF there would be no incremental fees payable to our SMSF administrator and we would avoid up to $8.5k p.a. in super fund fees. That's enough to finance a car. Of course, it's not all about fees. Investment performance also matters and I run our SMSF more conservatively than the industry fund, so we are hedging our bets.

SMSF Trustee
March 31, 2023

John, it would seem that you are not using any managed funds in your SMSF. If not, then your fees are a lot higher, but they are taken out of the investment in the unit price so aren't immediately obvious to you. The platform I use enables me to measure my management fees. Admin plus fees for me, given my choice of passive and active funds and asset classes, comes to 0.75%. Not far off the industry fund you're using. (Though I'm aware of other funds that have lower overall fee levels these days, closer to 0.55%. They're all focused on that, since APRA has forced them to be!)

If you're not using managed funds in the SMSF then I assume you have a lot of TD's and direct shares. As you hinted at, that creates a different risk profile. You might think it's more "conservative", but that's debatable as my fund gives me access to high yield corporate bonds, spread globally and well managed, plus property and global shares as well as local shares. I personally regard that as much more conservative than a TD + direct oz shares portfolio as it's better diversified.

You also are pretty well off, with $2.3 mn in your SMSF plus it seems more in an industry fund. Someone with only $300,000 in super (which is actually a bit higher than the average member balance across super funds) would be still paying the same $3,000 admin fee which is 1% of their portfolio. So your comments don't apply to the more typical investor in super.

John
March 31, 2023

Thanks for your helpful feedback. Correct, no managed funds. I have access to FIIG for corp bonds. Our international exposure is entirely outside super. We exited direct investment property over a year ago to enable a better home and REITs are unattractive.

Doug
April 03, 2023

John
We are in a similar situation. Our administration fees are currently about $1500 per year. The administration is easy, a few forms a year and advising dividends, share purchases/sales etc. We also have external investments which return about $35K per year in dividends.
Our investment decisions treat our 3 portfolios ( SMSF and 2 personal accounts) as part of a single investment vehicle. Our returns have been around 12% averaged over the last 12 years since we established the SMSF.
The flexibility of the SMSF has been the best for us.

 

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