By Trish Power

A superannuation account in pension phase enjoys a special tax deal but your pension account must meet certain conditions before your self-managed super fund (SMSF) account receives those tax benefits.

If you’re planning to start a pension in your SMSF, then you can anticipate a tax-friendly retirement. The earnings on your SMSF pension account are exempt from tax, and this tax exemption also applies to capital gains on the sale of assets supporting your SMSF pension. Tax-exempt pension earnings are in addition to the tax-free status of benefit payments received from your SMSF as a fund member, when paid on or after the age of 60.

For your SMSF super account to be treated as a pension account, you must withdraw a minimum amount each year from your SMSF pension account as benefit payments. If you fail to withdraw a minimum amount from your pension account, your SMSF pension can be treated as ceasing to exist for the financial year. The earnings derived from what was thought to be your pension account will then be taxable rather than tax-exempt.

The special tax deal on pension earnings also applies to pension accounts administered by large super funds and financial organisations.

Calculating your minimum pension payment

For your SMSF pension account to be treated as a pension account and then to be eligible for tax-exempt earnings, you must withdraw a minimum amount each financial year as pension payments. The minimum amount is based on your age as at 1 July (start of financial year), and the size of your pension account balance.

Your age is used to identify a percentage factor that is then applied to your pension account balance as at 1 July. For example, if you’re aged 63, your percentage factor is 4 per cent. If your pension account balance is $300,000, then your pension payments for the year must be at least $12,000. If you’re aged 66, then your percentage factor is 5 per cent, and your minimum pension payments for the year must be at least $15,000 on a $300,000 account balance.

Failing to pay minimum pension payment

If you fail to withdraw your minimum pension payment amounts for a financial year, then your SMSF pension could potentially be cancelled from the start of that financial year. What this means is that your pension account will be treated like an accumulation account and any earnings associated with that account will be subject to earnings tax, rather than being tax-exempt.

An additional consequence of failing to pay the annual minimum pension amounts is that you’ll have to restart your SMSF pension for the following financial year, which means you will need to recalculate the tax-free and taxable components of the SMSF pension.

Pleading leniency from the ATO

If your failure to withdraw a minimum amount as pension payments is a first offence, the ATO may show some mercy. If the failure is an honest mistake and the amount is considered to be a small underpayment, then the ATO may deem your SMSF pension account to continue, subject to making a catch-up payment. A small underpayment means that the underpayment must be less than one-twelfth of the minimum pension payment required for the financial year. You must also make the catch-up payment within 28 days of discovering your error.

You can also seek the ATO’s discretion in certain circumstances if your situation does fall within this scenario.