Commuting an SMSF account-based pension

Commuting a pension is the process where a super fund member converts all or part of an existing pension balance into a lump sum entitlement. Depending on the circumstances and the fund’s rules, the commuted amount may be paid to the member, rolled over where allowed or retained in the fund in accumulation phase.

There are a number of circumstances where an SMSF member might consider commuting all or part of their existing pension, including:

• An unexpected need for cash for a large purchase or to help a family member
• A desire to combine multiple pension accounts
• The transfer of additional funds from an accumulation account into a single pension account
• The receipt of a reversionary pension from their deceased partner, which would result in the member exceeding their transfer balance cap
• Where the member wants to reduce the amount held in their pension account.

If this is something you are considering, then you need to be aware of the specific process that SMSF trustees need to follow.

How does it work?

The key point is that a commutation is not simply a cash withdrawal. Trustees need to receive and document the member’s request, understand whether the commutation is full or partial, and make sure any minimum pension and reporting obligations are dealt with before the transaction is completed.

To commute a pension, the member makes a written request to the fund trustees to commute all or part of their entitlement to future pension payments, and to specify whether they want the amount paid out, rolled over where allowed, or retained in the fund in accumulation phase. The trustees then document whether the commutation is full or partial and process the request accordingly.

If the lump sum is paid as an in-specie transfer of an asset to the member, it is important that this is allowed in the SMSF’s trust deed and other governing rules. If it isn’t, the trust deed may need amending to allow the in-specie transfer.

There may also be capital gains tax implications for the SMSF if a capital gain arises where a lump sum payment by way of an in-specie transfer of an asset occurs. A capital gain arises if the asset’s market value at the time of transfer is greater than its cost base.

Where all or part of a member’s pension balance is transferred to their accumulation account, there is no capital gains tax event merely because of that transfer, unless the fund sells or otherwise disposes of an existing fund asset.

What do you need to know?

When a member requests a full commutation from their pension, trustees must ensure the pro-rated minimum annual pension has been paid for the year up to the day the full commutation takes place, unless a specific exception applies, such as a commutation arising because of the member’s death or for certain Division 293 tax payments or a family law payment split.

This ensures the fund earnings on the assets supporting the pension before commutation can be treated as exempt current pension income (ECPI) for tax purposes.

What are the pitfalls?