WHAT YOU NEED TO KNOW

We were recently asked: –

What are the consequences for the member(s) if the pension fails to meet the minimum pension requirement?

Does the pension need to be fully commuted before it can be restarted?

Does the pension really stop?

WHAT DO THE SIS REGULATIONS SAY

SIS reg 1.06 sets out requirements for a benefit to be regarded as a pension. One of the requirements is to meet the standards in SIS reg 1.06(9A), which includes the minimum pension requirement. A failure to pay the minimum pension means a cessation for income tax purposes from the start of the relevant financial year, a removal from the retirement phase for transfer balance cap purposes at the end of the relevant financial year, and it is no longer considered a pension for SIS purposes. But, whilst a failure to pay the minimum pension has caused it to cease for tax, retirement phase and SIS purposes, has the pension itself ceased?

This will depend on the pension documentation and trust deed. The member may still be entitled to payments; after all, a pension is effectively a contract between the SMSF trustee and the member, for which the SMSF trustee has not honoured that contract, as they failed to pay the required pension amount under that contract (it would be expected that the pension document/contract required payment of at least the minimum pension per the SIS rules).

We know where this happens:
The SMSF cannot claim exempt current pension income (ECPI) regarding the pension that failed to pay the required minimum pension. This is not an issue for a transition to a retirement income stream (TRIS) that is not in the retirement phase – but see next point;
All payments from the pension interest are treated as superannuation lump sums. This is not a concern for a retirement phase account-based pension, particularly where the member was at least 60 years of age at the time of each payment. However, where the pension is a TRIS, not in retirement phase, this will likely result in a breach of the preservation rules, leading to all the payments being treated as assessable income under section 304.10 ITAA 1997
For a retirement phase account-based pension (ABP), the fund will be required to prepare and lodge a transfer balance account report (TBAR) with the ATO advising of the pension ceasing to be in retirement phase as on June 30 of the relevant financial year for the value of the pension interest at that same date.
The pension can then restart on a subsequent date. Generally, the pension is re-commenced from an income tax, retirement phase and SIS perspective the next day, July 01. Where the restart is of a retirement phase pension, the SMSF must lodge a TBAR to begin the new retirement phase pension. Further, a re-calculation of the tax components of the commencement value of the pension will be required.
DOES THE NEW PENSION REQUIRE NEW PENSION DOCUMENTS

It would be common for a new set of pension documents to be prepared for the re-start of the pension, similar to documents that would have been prepared when the member originally requested the commencement of their pension. However, in this scenario, the pension has ceased due to the failure to pay the minimum pension, not because the member has requested their pension to be fully commuted (ceased). The member has yet to request to restart their pension (before the following July 01). From the member’s perspective, it’s the same pension, per the original terms, and they’re owed the pension shortfall. Generally, the discovery of the pension ceasing to be in the retirement phase occurs well after the end of the financial year in which the minimum pension is not paid.

So, one approach concerning documentation could be that the trustee records in trustee minutes the following:
advice that the pension(s) did not meet the minimum pension standard for the previous financial year;
the pension(s) ceased for tax purposes, and the fund cannot claim ECPI in respect of the pension(s) for that previous financial year;
the fund is required to lodge a TBAR for the value of the pension(s) on June 30 for the year the minimum pension was not met – reporting that the pension failed by noting in the TBAR ‘Income stream stops being in retirement phase’ as the TBA event type;
the fund is required to re-value the assets and re-calculate the tax components of the pension as of July 01 of the following year;
the fund is required to lodge a TBAR for the value of the pension on July 01 of the following year, which will give rise to a TBA credit in the member’s TBA account;
The affected member(s) have confirmed the continuation of their original pension, notwithstanding that the pension has ceased for income tax purposes and the need for the relevant TBA reporting.

WOULD A NEW STATEMENT OF ADVICE BE REQUIRED IN RESPECT OF THE RE-STARTED PENSION?

Again, it is generally well after the relevant financial year that it is discovered that the minimum pension has yet to be paid and that it ceased to be in the retirement phase on June 30 of that financial year. Further, it is typical for the pension to re-start, for retirement phase purposes, the following day, July 01; however, this is generally before it was even discovered that the pension ceased to be in the retirement phase, the day before on June 30.

So, how can you provide a statement of advice about a new retirement phase pension that commenced in the past? As noted above, the member has not consciously ceased the pension on June 30 and requested a re-start on the following day, July 01. To them, it’s the original pension, albeit there have been consequences of not paying the minimum pension. Rather than a statement of advice, maybe the adviser could reconfirm the original pension advice, that is, that the pension is still suitable for them, confirm that there is a new pension for tax, SIS and transfer balance account purposes, as well as confirmation of the new tax components, and ensure processes are implemented to pay the minimum pension.

AVOID THE PROBLEM IN THE FIRST INSTANCE

All these issues occur due to the minimum pension not being paid or, in the case of a TRIS, the 10% maximum is exceeded. Experience shows that this generally occurs when pension payments are not monitored during the year. SMSF admin and compliance platforms will be able to receive data feeds from banks and track pension payments against the relevant minimum amount. Such platforms can also alert members that they remain below their minimum pension in the lead-up to year-end. The utilisation of this technology can avoid the consequences of failing to meet the minimum pension. Another approach is to arrange a periodical bank authority covering the financial year period to be paid automatically, e.g., monthly. This ensures that at least the minimum pension has been paid by June 30, or in the case of a TRIS, maximum pension payments are not exceeded.

WE’RE HERE TO HELP!

If you have any issues, questions or feedback regarding our monthly SMSF Bulletin or if you’d like clarification or further advice on the content of this month’s edition or any other SMSF audit concern – please in touch with me at +61 416 123 446 or trosati@rosatiwang.com.