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Why an SMSF pension is tax-free and receives a refund

Much is made of retirees who pay no tax but also receive a tax refund. This view demonstrates a fundamental confusion about how the super system works. Any income generated by an asset belongs to the owner of the asset who is responsible for the tax on that income. In the case of retirees with a SMSF, the owner of the fully franked shares is the SMSF, not the retiree. The retiree is the trustee of the fund with a fiduciary duty to all members of the fund, some of whom may not be retired. As a separate taxpayer, the SMSF has a tax file number and completes a tax return after the fund has been audited.

If the SMSF is an accumulation fund, it pays tax at the rate of 15% on income and concessional contributions. At present, some of the imputation credits help to pay that tax. Any excess imputation credits are presently returned as cash to the fund and this adds to the income produced. It is typically reinvested to grow the fund for future retirement needs. The same applies to retail and industry super funds. No money is withdrawn because super cannot be accessed before retirement.

If the SMSF is paying a pension, the tax rate is presently zero. This also helps to increase the income produced by the fund. This is also true of retail and industry super funds. Since 2007, withdrawals from the fund (both pensions and lump sums) have been tax-free.

Implications for withdrawals

There is no limit on the maximum withdrawal from a super fund. It is possible for a retiree to withdraw their whole super balance at any time. In fact, many people with small super balances do just that as soon as they retire. It may pay off their mortgage or have other uses without interfering with their claim for the age pension.

Retirees, whose assets exceed the assets test and are therefore ineligible for the age pension, will want their super fund to sustain them for as long as possible. The more they take, the quicker the fund is depleted. When their super fund is depleted, most retirees have no choice but to claim the age pension. As most people regard the age pension as only a basic standard of living, most self-funded retirees would want to delay that date as long as possible.

The other problem is that once money is removed from the tax-advantaged area of super, the contribution rules make it difficult to put it back in. Therefore, in order to sustain the super fund for as long as possible, most retirees take no more than the minimum they need or the mandatory minimum required. For the pension fund, the secret to long life is a higher investment return and a lower drawdown rate. In the pension phase, the government assists by reducing the tax rate on investment earnings to zero. The purpose of any super pension fund is to fulfil its assigned task of delaying the member’s claim on the government age pension, possibly indefinitely.

Some countries choose to collect no taxes on contributions or earnings in the accumulation phase but then tax retirement benefits at normal rates. When universal super was established in 1992, the Australian government was not prepared to wait 30 years before it collected tax so it chose instead to tax contributions and investment earnings in accumulation but made the retirement phase tax-free. Either way the aim was to make it possible for the fund to provide retirement benefits for as long as possible.

Minimum pension

The catch, of course, is the minimum pension which at age 55 is 4%, rising to 14% of a member's super balance from age 95. These mandatory withdrawals force retirees to progressively sell assets for cash to satisfy the pension requirement thus depleting their super balance over time. This ensures that money is removed from super and exposed to normal tax. It also reduces the balance of tax-advantaged super, if any, remaining at death that is passed on to dependents.

Australian shares provide an excellent income in retirement. The much-publicised volatility of share prices only requires management if shares are traded. If shares are not traded, an SMSF’s income depends on dividends. The income does not rely on the sale of units with volatile market prices, as is the case in an industry super fund providing a pension.

Removal of the cash refund for excess imputation credits will reduce dividend income to an SMSF by up to 30%. Lower investment returns in the super pension fund means that more assets will need to be sold to meet pension requirements, and that hastens the fund depletion. This policy will cut the lifespan of an SMSF pension fund by many years, depending on its shareholdings.

This makes no difference to the tax-free nature of the withdrawal a retiree takes out the fund.

Periods of low investment returns

The evidence from the GFC is clear. This period of low investment returns had a devastating effect on many super pension funds. The government response to the GFC was to halve the minimum pension requirements. That was useful for those who could afford to live on a smaller pension, but for many who had to maintain their lifestyle, selling all those assets at depressed prices slashed years off the life of their fund. Those lost assets can never be regained because a pension fund cannot accept more contributions.

It is disingenuous and misleading to suggest that some retirees pay no tax but still get a tax refund. The cash refund for imputation credits is received by the fund, not the member. The tax status of the fund is independent of the member’s tax-free cash withdrawals, which are governed by the member’s age and their income needs.

We are facing a tsunami of baby boomers reaching retirement along with their increased life expectancy. We could face a situation where people in their 90s, as well as their children, claim the age pension at the same time! It is short-sighted and financially reprehensible to guarantee that more self-funded retirees will become dependent on the age pension much sooner than they otherwise would. Policy makers need to understand this.


Jon Kalkman is a former Director and Vice President of the Australian Investors Association. This article does not consider the circumstances of any investor.

April 24, 2018

Can someone please advise whether it is possible, under the Labour policy, to transfer franked shares from a SMSF to an APRA-regulated industry super fund, in order to continue to receive ATO refund of unused franking credits?

Jon Kalkman
April 30, 2018

If you are a member of an APRA-regulated fund you do not get a refund from the ATO. I reiterate, the refund goes to the fund not the member. As a member of such a fund, all you ever see is the unit price. If you multiply the unit price by the number of units you hold in the fund, you get your super balance. You accept that unit price on trust as it is calculated by the manager, not set by the market.
The unit price reflects the market value of the underlying assets in the fund, the income earned by those assets, and, we are told the refunded franking credits.
But, because of the lack of transparency in these funds, you will never know what happens to these franking credits and most members aren't interested enough to find out. In the absence of information we are entitled to make assumptions. Such disclosure would make interesting reading.
Control over my investments and associated franking credits is just one more reason to have a SMSF.

May 08, 2018

Thank you, Jon. That is exactly how I understood it too.

Graham Hand
April 23, 2018

A reader points out by email that the Labor policy may mean the person needed to be a pensioner on 28 March 2018, not that they needed to be a member of the SMSF by that date. This would mean an SMSF could gain access to refunds by having a pensioner join the fund after 28 March 2018.

I doubt this is correct, although Labor could change its policy. Here is the exact wording of Chris Bowen's announcement, which I agree is a little ambiguous:

"The Pensioner Guarantee means pensioners and allowance recipients will be protected from the abolition of cash refunds for excess dividend imputation credits when the policy commences in July 2019.

Self-managed superannuation funds with at least one pensioner or allowance recipient before 28 March 2018 will also be exempt from the changes."

Greg (yes, I do have an SMSF)
April 23, 2018

I don't agree with Ramani's comments. Rather than provide an "extreme example", Ramani has framed-up/framed-out to propose the topic under discussion be one of "consider the investor who invests all into Australia, the taxpayer."

If we took that to be our topic it would lead to a debate of the value of a marginal tax systems where a differing tax rate is applied to different groups of taxpayers, or bloated over-spending governments who need to keep growing their tax take - or other structural issues.

I see this debate as being about the appropriateness of creating a franking credit refund exception such that one group of taxpayers is subject to double taxation, to their detriment and to the longer term detriment of the pension system. Not good policy however you look at it.

April 22, 2018

The statement
"It is disingenuous and misleading to suggest that some retirees pay no tax but still get a tax refund. The cash refund for imputation credits is received by the fund, not the member"

At that level this is true - I am self funded retiree (who does not have a SMSF) - I own shares outside of my super. I pay no tax.
Each year I receive a cheque from ATO for the franking credits.

My memory of what happened (and please correct me if I am wrong) was that Paul allowed TAXPAYERS to receive a rebate for the imputation credits when competing their tax returns.
If you were paying no tax then the rebate was ineffectual and no cheque was forthcoming from the ATO.

Some years later Peter (inter alia made super simple) introduced tax fee pension payouts for those over 60 and allowed the ATO to send cheques to people like me even though a tax return was not required per se.

So for a few years now I get a cheque from the ATO for tax (in my mind) that I have not paid.

Sort like a magic pudding.

Am I wrong ?

April 23, 2018

Yes Dee you are wrong on this point.
It is tax that you have paid, it's just that the company has paid it (or withheld it) on your behalf, and you then settle up with the ATO when you do your own personal tax return.
Remember you need to include the tax credits in your income and you pay medicare % on that higher amount also.
In short it means that tax payers will pay very different rates of personal income tax on the same dividends

Warren Bird
April 23, 2018

Dee, please read my original article

Paul Keating didn't quite go far enough when he introduced the imputation system; Peter Costello completed the reform that was first proposed in the Campbell Inquiry.

If you are a taxpayer on a zero tax rate then any tax already paid on your income, by an employer or a company whose shares you own, is refundable. As it should be.

In my view, it's a completely different topic whether tax rates should be changed, but that would be the more honest and effective way of achieving what the ALP's policy purports to have as its objective.

April 20, 2018


Sometimes non-sensical asymmetric self-interested arguments can only be countered with extreme examples. Beneficiaries of changes accept them without a word, only to scream when they are sought to be removed (tax exempt payments for post 60 super members, for instance), as the total burden on the only cohort that produces current goods and services, and hence pays the bill for aged pensioners and past accumulators together in the economic sense, something must give.

There is no talk yet of introducing inheritance tax on asset rich cash poor people relying on the taxpayer while the offspring are sunning themselves for the good news of their demise to claim the inheritance taxfree. Score that for equity.

If we do not takle sustainability now - holistically as you imply and I agree - sustainabiliy will tackle us. It won't be pretty as the several straws in the wind predict. In Detroit, California, France and elsewhere unsustainable burdens on the public purse have seen riots, we do not want them here. Let us opt for the lesser evil.

Warren Bird
April 20, 2018

Hmmm, I've not ever found extreme arguments helpful or effective.

The context here is not, as you assert, an argument about someone getting a tax benefit and whinging when it's removed. It's the discussion that both I and Jon Kalkman have contributed to about the specific proposal to change the imputation system so that those on a zero tax rate don't get treated the same as those on a 15% or higher tax rate. It's nothing to do, per se, with intergenerational wealth issues, but about the silliness of the proposed policy change on its own merits.

I said in my original article that if there's a problem with certain taxpayers being on a zero tax rate then that needs to be addressed by taxing them. So I'm more than open to the sort of discussion you want to have. But as Jon said so well in his conclusion here, the reason for doing that is NOT that they are getting some sort of rort from the system via the dividend imputation scheme. That is patently not true and Mr Shorten's proposal is just really bad policy.

I do wish people would stop derailing the discussion with all these extraneous ideas that create heat, rather than light.

April 20, 2018

There should be a maximum amount that needs to be taken as a pension so as to preserve as long as possible the funds held in superannuation. The minimum pension enshrined in legislation is often far more than people need and should be lowered again to preserve the funds held in superannuation

Peter PITT
April 19, 2018

This article is "SPOT ON"! Maybe Bill Shorten and his Labor supporters should adhere to the realities as stated and have a better informed understanding of the benefits . Current system is fair and equitable to those who have forgone any Govt pensions whether" aged or Disability" over their working life and will NOT be a burden on other taxpayers into the future. PS ( in our case Self funded for last 18 yrs-retired after selling businesses at 47yrs old and having just gone into Pension phase in last few years)

Robert Bouwer
April 19, 2018

This is one of the best articles I have read on this proposed move by the Bill Shorten. It demonstrates what economic vandals the Labor party are.

April 19, 2018

The blurb says the article does not consider the circumstances of any investor. True, but more relevantly, it does not at all consider the investor who invests all into Australia, the taxpayer.

Taking current conditions as God-given, it argues eloquently for the staus quo. The problem is these conditions are the consequence of many ill-thought and transient measures that collectively tip the already wobbly fiscal system into disequilibrium.

Consider the case of a current young worker with family responsibilities obliged to pay tax and medicare, vis-a-vis the parents in pension mode receiving taxfree treatment. Stuff of social disenchantment.

When unsustianbly favourable changes are made the self-serving silence is bettered by the subsequent squeals when balance is attempted.

The taxpayer is cheated, and the taxpayer is us.

Jon Kalkman
April 20, 2018

The shareholder, in this case a SMSF, is not a customer, creditor or employee of a company. The shareholder is a part-owner of the company who wears all the risk of business failure. As a separate legal entity, a company has a legal obligation to pay tax on profits at the company tax rate on behalf of its shareholders. It is described on the ATO website as a withholding tax. Any after-tax profits also belong to the owner/shareholders.

The purpose and effect of imputation credits is to ensure that company profits are only taxed once; in the hands of the shareholder at their marginal tax rate. The cash refund of imputation credits is a refund of the excess tax already paid on behalf of the shareholder because the shareholder has a lower tax rate than the company tax rate. A tax refund is not a tax concession.

Unlike the age pension, the refund of imputation credits does not cost the taxpayer anything, because it is money already paid by the company tax on the owner’s behalf. No additional tax is needed to pay this refund. Self-funded retirees save the taxpayer money – that is why we need more of them!

A single person on the age pension costs the taxpayer $23,600 per year and a couple costs the taxpayer $35,600 per year. That is equivalent to giving a single male $400,000 on retirement (females cost more because they live longer) or $700,000 for a couple. All age pension payments, currently $45bn per year, come from general revenue with no contribution from age pensioners. Any increase in age pension payments, because there are more retirees or they are living longer, will require additional taxation.

Warren Bird
April 20, 2018

I don't usually react like this, but ...

That's complete nonsense Ramani. Making someone who has a zero tax rate pay tax is what would amount to cheating, which is why imputation was introduced in the first place.

Clearly this inter-generational issue needs to be debated and discussed. I suggest we do that as a broad topic in itself rather than confusing it by linking it to any specific measure. Think very carefully, though, about what you've said here. The argument applies to removing any benefit provided to an older person if it means that the 'current young worker with family responsibilities' has to pay a little more tax. No more free train trips for my 90 year old dad in that case, it's grossly unfair on his granddaughter and great-grandson.

Bob Clippingdale
April 22, 2018

You are not alone !we had these same problems when we were young!

Jim L
April 19, 2018

The article states "Since 2007, withdrawals from the fund (both pensions and lump sums) have been tax-free.".

What about trustees and members that are under 60 years of age; aren't pensions and withdrawals taxed on the taxable components at the marginal rate less the Super Income Stream Tax Offset?


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