What strategies can I consider to reduce tax on a super pension paid from my SMSF?

One of the benefits of retirement is that you can usually start to withdraw your superannuation tax free. That doesn’t mean it’s a rule-free zone.

Note that this article focuses only on SMSFs, so does not consider tax consequences of untaxed funds or capped defined benefit income streams.

How are super pensions taxed?

Provided your super pension complies with the annual minimum payment requirements, there is no tax payable on either the income you receive or earnings (including capital gains) on the investments supporting a retirement phase pension.

However, if you fail to withdraw the required minimum, pension income and assets will lose their tax-free status for the full financial year and all withdrawals will be treated as lump sums. Lump sums generally include taxed and tax-free components.

If you fail to make the minimum payments one year but comply the following year, the tax benefits will be reinstated but you will need to start a new pension. To start a new pension, the fund trustee will need to revalue pension assets at market value and recalculate the minimum pension payment.

The tax commissioner may show leniency and allow an income stream to continue if certain conditions are met. If the failure to pay the minimum pension amount was an honest mistake resulting in a small underpayment, or outside the control of the trustee, and a catch-up payment is made within 28 days of becoming aware of the oversight, the income stream may continue without needing to be restarted. If the income stream was in retirement phase, there will be no loss of tax exemptions for the year the oversight occurred. A small underpayment is deemed to be not more than one twelfth of the annual minimum.

If you have an SMSF paying more than one pension, both need to meet the minimum payment requirements. If one pension complies and the other fails to pay the annual minimum amount, only that one will need to apply for leniency or lose its tax exemptions.

Tax and transition-to-retirement pensions

The taxation of transition-to-retirement (TTR) pensions is a little different.

Since 1 July 2017, earnings on assets supporting TTR pensions are taxed at 15%. Income remains tax free if you are aged 60 or over. If you are younger than 60, the taxable portion of your pension income will be taxed at your marginal rate less a 15% tax offset.

Once you retire after your preservation age or reach age 65, your TTR becomes a retirement phase pension and is eligible for tax-free investment earnings as described above.

If your TTR pension pays out less than the annual minimum, then the consequences discussed above apply. If it pays more than the maximum, your fund may be found to be non-compliant and have its total assets subjected to the highest marginal tax rate.

Pension strategies to reduce tax

In some cases, there may be tax benefits in the timing and amount of pension income and lump sum withdrawals in retirement phase.