Auto-reversionary pensions in your SMSF – Why you must have them

When you retire (or semi-retire) from work, a usual practice is to establish an account-based pension (ABP) from your SMSF to provide retirement income.

When this occurs, the assets funding the pension payments (e.g. cash, shares, property) are transferred from accumulation phase to pension phase.

Whilst you are younger and working full-time, typically all your SMSF assets will be in accumulation phase. The accumulation phase allows you to put money into your SMSF but you can’t take any money out. Earnings on fund assets are taxed at no more than 15% pa in accumulation phase and if an asset is sold and a profit is realised, capital gains are generally taxed at 10%.

Once you reach your preservation age (the age at which you can access your superannuation, generally between 55 and 60) you are able to transfer some (or all) of your SMSF assets from accumulation phase to pension phase. Once assets are in pension phase, you must commence an ABP (or another type of pension). Assets in pension phase do not attract any tax on earnings or capital gains like they do in accumulation phase, and the ABP income drawn from your SMSF will also be tax-free if you are aged 60 or more.

So where does an auto-reversionary pension come in?

An auto-reversionary pension comes into play when a member of your SMSF passes away and there is a surviving fund member (e.g. spouse). If arrangements for an auto-reversionary are in place, the deceased member’s ABP will automatically revert to the surviving spouse (i.e. the pension does not cease). This has been confirmed by the ATO Commissioner in TR 2011/D3. The assets supporting the deceased member’s ABP will therefore remain in the tax-free pension phase. This is an excellent outcome for the surviving spouse (and future SMSF’s beneficiaries) because the fund balance is unaffected as no tax is payable.

What if you don’t have an auto-reversionary pension in place?

The outcome is not as favourable if an auto-reversionary pension is not in place. This is because the ABP will not automatically revert to the spouse upon death, it will cease. When this happens, the assets supporting the pension payments will be rolled back to accumulation phase and at which point capital gains tax (CGT) will be applied to the profits. The CGT must be paid from the SMSF so the fund balance will suffer and the surviving spouse and future beneficiaries will inherit less.

The good news is this scenario can be easily avoided by having auto-reversionary pension arrangements in place. To do this, you must firstly ensure your SMSF Trust Deed allows for the payment of auto-reversionary pensions (not all do). Secondly, you must ensure your SMSF estate planning documents are set up to cater for auto-reversionary pensions. This could be achieved via a definitive binding death benefit nomination or a SMSF Will.

A word of warning. SMSF estate planning is a highly complex area so you should obtain expert advice to make sure auto-reversionary pensions can be paid by your SMSF.

 


This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information.Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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    Financial Planning Expert is an independent financial planning business based in Melbourne. We provide genuinely independent and conflict free financial advice. We’re experts in self-managed superannuation fund (SMSFs) advice and strategy, retirement planning, property and share investment advice, life and income protection insurance, tax planning, asset protection, estate planning and advice for Australian expatriates.