Multiple pensions: Giving your SMSF a 'sacrificial lamb'
- Extra pensions can help provide a ‘shield’ against unintended mistakes
- They can also provide some estate planning benefits
- Even if they don’t end up providing a benefit, they’re easy to establish
In Increasing your tax-free super: The recontribution strategy we explained how pension accounts could be streamed to different beneficiaries to get the most efficient estate planning result. It’s one of the benefits of setting up multiple pensions, rather than combining everything into a single pension account.
Another benefit is the fact an extra small pension (or two) can act as a ‘sacrificial lamb’ to protect your fund in the event of a pension underpayment. We’ll explore this strategy in more detail below, but first let’s recap the use of multiple pensions in estate planning.
Multiple pensions are useful where you have beneficiaries who qualify as death benefit dependants (for example, your spouse or minor children) and others who don’t (such as adult children).
Where death benefits may become payable, the basic idea is to ‘stream’ as much tax-free super to the non-dependant(s) as possible, since it’s not taxed, regardless of the recipient’s status.
Super with a high taxable component, on the other hand, should be ‘streamed’ as much as possible to death benefit dependants (such as your spouse). That’s because a lump sum death benefit isn’t taxable when paid to dependants, but is taxable (at 15 per cent plus Medicare Levy) if it goes to a non-dependant.
If you have one single mixed component account, you can create a second 100 per cent tax-free super account (and a better overall tax-free/taxable mix) using the recontribution strategy set out in the earlier article. As a result, you end up with two super pensions – one mixed component and the other entirely tax-free and you can ‘stream’ the tax-free super account to non-dependants.
So long as you comply with the non-concessional contributionVoluntary contributions made to your super account out of after-tax income (savings). Non-concessional contributions are not tax deductible and can't be salary packaged. See the ATO website for more information. caps each time, you can repeat this process over and over if you’ll continue to get a better result.
That’s the first benefit of having multiple super pensions.
‘Sacrificial lamb’ back-up plan
The second benefit, or strategy, is more subtle and relies on the basic premise that we are all human and can make mistakes in calculating or timing pension payments. There are also the unforeseen, unexpected events that can cause us to miss the 30 June deadline.
For instance, this year 30 June fell on a Tuesday. Depending on the particular banks involved, a pension payment request lodged on 29 June may not have ended up being paid until 1 July. If this payment was being made in order to satisfy the pension minimum for the year ended 30 June 2015, the total pension paid for the year would fall below the amount required.
To set the scene, if you don’t pay the pension minimum then legally you have breached the minimum payment rules and your whole pension reverts to accumulation from the start of that tax year. The result is that all income attributable to that account gets taxed at up to 15 per cent. Particularly in a year when the sharemarket has been strong, and large capital gainsThe profit that an investor makes when they sell an investment or (if unrealised) the profit they would make if they sold the investment for its value at that time. made, the resulting tax bill could be financially damaging.
In 2013, the ATO introduced a concession for minor, honest mistakes – see ATO website for more details. While it helps, it’s limited in application and won’t fix everything. For example, if you tend to pay a large portion of your annual pension in June you may not be able to satisfy the requirement that the underpayment be less than 1/12th of the total annual pension amount.
The back-up plan, to avoid having all your money revert back to accumulation, is for the trustees to have two or three pensions for each member. Let’s use a simple example to explain.
Example of the sacrificial lamb back-up plan
Joe (aged 67) has a $900,000 balance and takes his adviser’s recommendation to split the balance across three $300,000 account-based pensions.
The minimum pension for 2014/15 is 5 per cent for someone Joe’s age (over 65 and under 75). This means Joe needs to pay a minimum pension of $45,000, or $15,000 from each account with the three-pension strategy.
Let’s assume Joe used only one pension account, was out of date on the rules, and still believed the 25 per cent pension concession (which ended in 2013) was in place. He’d think he only needed to take 3.75 per cent, or $33,750.
His error would be more than 1/12th of the minimum pension, which means he wouldn’t be able to rely on the ATO concession to fix it. If all his funds were in one pension the entire $900,000 would revert to accumulation phase from the start of the year. If his fund had $45,000 of net income, and another $100,000 in realised capital gainsThe profit that an investor makes when they sell an investment or (if unrealised) the profit they would make if they sold the investment for its value at that time., that mistake would cost him $16,750 in additional tax.
With multiple pensions, Joe could choose to allocate the $33,750 to two pensions and sacrifice the third pension. This pension account – the ‘sacrificial lamb’ – would have to revert to accumulation but the others would be safe.
If the capital gainsThe profit that an investor makes when they sell an investment or (if unrealised) the profit they would make if they sold the investment for its value at that time. resided in the ‘safe’ pension accounts, this would reduce the tax bill to $2,250 (saving $14,500). The ‘sacrificial lamb’ strategy protects the fund against greater damage.
Establishing multiple pensions
Setting up multiple pensions is easy to arrange. It’s simply a matter of completing a separate application form and documents for each and then tracking these separately in the annual accounts (which might cause a small increase in administrative costs, so check first).
When you blend the estate planning and risk management strategies together, multiple pensions become a powerful tool that every SMSF trustee should consider.
Liam Shorte is a principal of Verante Financial Planning Pty Ltd (www.verante.com.au), a corporate authorised representative of Magnitude Group Pty Ltd (AFSL 221557). This article is a general information article and to the extent it contains any financial advice it is general advice only. We recommend seeking personal advice on your own circumstances.
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