For each pension that your super fund runs, it must pay a minimum income payment every year.
In addition, those pension payments have to be made with cash or cash equivalent, such as cheques or direct debit.
Making the minimum payment
These rules are quite well known. Now you probably also know that the minimum income is based on your age at the start of each financial year and the market value of assets at that time. As you get older, the government’s super laws increase the minimum that has to be paid.
There are two reasons for these compulsory minimum income increases. Firstly, it means that less of your money is held in super as you get older because the minimum will be more than the income your fund can earn. Secondly, the Government assumes your pension account balance will fall over time and hence the higher minimum goes part of the way to making sure your income doesn’t fall.
What you may not know is that, if the rules of your pension (found in the documentation of your pension and your fund’s trust deed) permit you to take a partial lump sum out of your pension, then that lump sum can count towards your minimum income amount. These small lump sums are often called a partial commutation.
These partial commutations can count towards your pension’s minimum income requirements. However, it has long been thought that these partial lump sums have to be made with cash, cheque or direct debit. If they’re made with other assets – valued at their prevailing market value when paid to you – then it has been assumed they wouldn’t count towards meeting the minimum income requirement.
In a document released in early April, the Tax Office said that it would allow a partial commutation paid with assets other than cash to be counted towards the minimum.
How it works
My wife and I run our own super fund. Apart from a small amount of cash, we are fully invested in Australian shares that pay dividends that increase at least as fast as the inflation rate. As dividends are paid and contributions are made, we invest in more shares to receive an ever-increasing stream of dividends. We avoid overseas equities because of the volatility and uncertainty created by currency fluctuations.
Our plan is that I’ll work until the super fund is receiving dividends that are at least 125% of our income needs in retirement. Why 125%? During the GFC, the value of S&P/ASX200 shares fell by over 50% but the dividends paid by the companies in this index fell by about 20%. You could say that the 125% income payment target is our risk management strategy.
Just before retirement, we’ll hopefully have no debt and we’ll also know what our income needs are down to the last dime.
Why this strategy? It’s simple, very cheap to implement and, most importantly, it works.
If the value of our super fund’s investments increases, then it’s likely that the minimum pension demanded by the super laws will be higher than what we need to live on.
For example, suppose when we reach age 80, then we will have to be paid 7% of the market value of each pensions’ assets (my wife and I are roughly the same age). Suppose at the time these pensions have a market value of $3 million. That means we would have to receive $210,000 in income. Now assume that we only need $150,000 that year to live on.
In the past I had simply accepted that the super fund may have to sell some shares, pay us minimum income and then we would purchase the same investments in our own name with the excess income. In this example, the super would have sold $60,000 worth of shares and we would then purchase those shares in our name.
Now all we will need to do is take a $60,000 partial commutation using the market value of shares used for this payment. We can then hold these shares in our name, reinvest the income if we don’t need it and distribute the shareholdings via our deceased estate. As you can see, the Tax Office has made these transactions much simpler and also a bit cheaper.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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