How To Pay Zero Tax On Earnings of Self Managed Superannuation Funds (“SMSF”)

December 14, 2012

How To Pay Zero Tax On Earnings of Self-Managed Superannuation Funds (“SMSF”)
When a superannuation fund is in accumulation phase, it is taxed at 15% on concessional contributions and investment earnings such as dividends, interest and rental income. In addition, it is taxed at 10% on realised capital gains, where it has held the asset for more than 1 year.

However, once a superannuation fund is in pension phase, earnings on investments that have been set aside to pay the pension are not subject to tax at all. Yes, really. Zero tax! That means no 15% tax on investment earnings and no 10% tax on capital gains!

Not only that, any franking credits arising from franked dividends can be offset against the tax payable by the superannuation fund (provided the dividend paying shares have been held at risk for more than 45 days (or 90 days for preference shares). So you can effectively end up with a situation where the SMSF pays no taxes and gets a refund of franking credits on the dividends derived from the shares that have been set aside to pay the pension.  Not a bad way to boost your retirement savings!

The Conditions
The above strategy is not without conditions. We set out some of the issues to consider below.

Eligibility to Pay A Pension
An SMSF is only eligible to pay a pension to a member who satisfies a ‘condition of release’. A condition of release is a specific event under the superannuation laws that allow a member to withdraw benefits from their superannuation fund. Of course, the SMSF’s trust deed also needs to permit it to pay the pension. The most common way of satisfying a condition of release is by age and retirement. For example, a member can satisfy a condition of release if:

  • The member is over 65 years old. In this case, the member need not have retired to satisfy a condition of release.
  • If a member is under 65 years old, the member can be eligible to be paid a pension if they have reached ‘preservation age’ and have retired or semi retired. Preservation age varies between 55 years old to 60 years old, and is dependant on which year the member was born, as set out in the below table. The meaning of retirement and semi retirement for these purposes differs slightly depending on whether the member is over or under 60 years old.
 Date of Birth  Preservation Age
 Before 1 July 1960  55
 1 July 1960 to 30 June 1961  56
 1 July 1961 to 30 June 1962  57
 1 July 1962 to 30 June 1963  58
 1 July 1963 to 30 June 1964  59
 1 July 1964 and onwards  60


Conditions to Obtain Zero Tax Status On Pension Income in SMSF
To be eligible to pay a pension and obtain zero tax status on the earnings generated from investments set aside for the pension, the following conditions have to be satisfied:

  • The investments supporting the pension need to be clearly identified and segregated.  If not, an actuarial certificate is required each year;
  • A minimum amount has to be drawn from the pension balance each year. The minimum amount is based on the member’s age.
  • The capital supporting the pension cannot be increased using contributions or rollover amounts once the pension has started.
  • Before commencing the pension, all the SMSF’s assets need to be re-valued to their current market value.
  • The member cannot use the capital value of the pension or income from it as security for a borrowing.
  • If a member dies, the pension can only be transferred or paid to a person who is a dependant of the member.

Please do not hesitate to contact us on (02) 9713 1199 if you have any queries on the above.