Embarking on your “retirement phase” pension within a self-managed super fund (SMSF) is an exciting step. If you’re thinking of beginning this phase before selling SMSF assets, this guide serves as a starting point for what to consider and how to navigate the process.
Starting a Pension Before Selling Assets
Starting a pension before selling assets within an SMSF is a strategy people consider in the pursuit of reducing their tax liability. Pension payments and earnings on assets in the retirement phase are generally tax-free, meaning more of your investment returns stay in your fund because of the reduced tax environment of the pension phase. Commencing a pension is exclusively for people who have reached their preservation age and met a condition of release.
Here’s a closer look at why one might consider this strategy:
Tax-Free Capital Gains: Once in the retirement phase, any capital gains from the sale of assets supporting the pension are tax-free. If an asset has appreciated considerably over the years, selling it after commencing the pension phase can result in significant tax savings.
Maximiing Returns: Without the tax liability on investment returns and capital gains, more of your earnings remain in the fund. Over time, this can have a compounding effect, leading to an even larger retirement nest egg.
Flexibility: By starting a pension before selling assets, you give yourself the flexibility to choose the most opportune time to sell, without the pressure of immediate financial needs.
Income Stream: Whilst the primary motivation might be tax savings, starting the pension phase also provides a regular income stream, making it easier to manage post-retirement expenses.
How Does the Transfer Balance Cap Impact Your SMSF Pension?
As of 1 July 2023, the transfer cap is $1.9 million. It sets the limit on the super amount you can transfer from the accumulation phase to the retirement phase.
Should You Start Your Pension Before Selling Assets?
Most notably, the income produced from assets, like capital gains, is generally tax-exempt within the retirement phase. If the assets have grown significantly in value over time, a CGT exemption may significantly reduce the tax liability.
Let’s use Irene and Stephen to illustrate the practicalities of starting a pension and its relationship to selling assets.
Irene’s Approach: Irene started her retirement phase pension when she turned 60. Her SMSF owned a property that had significantly appreciated in value over the years.
Even though most of this property’s growth occurred before her retirement, she could sell it post her pension commencement without the SMSF incurring any capital gains tax. This highlights the benefit of timing the start of a pension with the sale of appreciating assets.
Stephen’s Situation: Stephen, unlike Irene, had a substantial super balance. Due to the transfer balance cap, he couldn’t move its entirety into his pension.
As a result, only a portion of his SMSF’s income, including capital gains from asset sales, would be tax-free. Thus, if Stephen’s SMSF were to sell an asset, only a part of the capital gain would be tax-exempt, unlike Irene’s total exemption.
How to Handle Asset Segregation, Valuation, and Liquidity in SMSF
This step-by-step approach can help you optimise your tax benefits, maintain compliance, and effectively manage assets and liquidity during the crucial pension phase.
Eligibility Check:
- – Ensure you’ve reached your preservation age.
- – Check if you meet a condition of release: retirement, transitioning to retirement, or reaching age 65.
Asset Valuation:
- – Correctly value all assets before initiating a pension or selling any assets.
- – Accurate valuation is critical for compliance with the transfer balance cap and calculating the minimum annual pension withdrawal.
Evaluating the Asset Portfolio:
- – Examine all assets within your SMSF.
- – Identify assets for potential sale and those you plan to keep.
- – Obtain expert advice on the ideal assets to retain in the pension phase for optimal tax benefits.
Trustee Documentation:
- – Record the decision to initiate the pension.
- – Document details like the pension’s start date, type of pension, and assets that will support this pension.
Asset Segregation:
- – If choosing to segregate assets, distinctly separate the assets tied to the retirement phase pension from other assets.
- – For non-segregated assets, obtain an actuarial certificate.
Liquidity Management:
- – Ensure your SMSF has sufficient cash to manage annual pension withdrawals — This is crucial to prevent liquidity issues that might force a premature asset sale.
Setting up Dedicated Bank Accounts:
- – Consider creating a separate bank account specifically for the pension phase — This aids in managing pension distributions and tracking pension-related earnings.
Review and Modify Investment Strategy:
- – Adjust the SMSF’s investment approach, factoring in pension requirements, risk preferences, and future liquidity demands.
Routine Monitoring:
- – Regularly track your pension balance and the required minimum drawdowns.
- – Frequently reassess your asset portfolio, adapting to shifting market conditions and ensuring compliance.
Asset Disposal:
- – With the pension phase in place, seek financial advice around the strategic sale of assets based on market conditions.
- – Remember, capital gains on assets dedicated to the pension are generally tax-exempt.
The decision to begin a retirement phase pension and when to sell assets within an SMSF hinges on numerous factors. Each scenario is unique, and what works for one person might not work for another. For comprehensive advice tailored to your situation, please get in contact with your financial adviser.
For information related to SMSF loans, contact us today, or schedule a phone meeting with an SMSF Loan Expert.
