Commencing Pensions with Concessional Contributions

One of the trip wires of the current super system is that commencing a pension may invalidate a tax deduction for personal contributions.

Consider the following example.  The Member makes a $40,000 contribution to their own SMSF and intends to claim a tax deduction for the entire contribution (the Member is over 50 and entitled to the special concessional contribution limit).  The existing account balance of the member is $150,000 and, once the contribution is made and the prospective tax set aside from the contribution, the account balance will be $184,000.

If the Member commences the pension before the “notice of intention to deduct” (affectionately known as the “s290-170 notice”) has been lodged with the Trustee of the SMSF, the notice will be invalid and the member will not be entitled to claim a tax deduction for the $40,000.

The invalidity of the notice arises because the Trustee will have commenced to pay a superannuation income stream from the superannuation interest to which the contribution was allocated.  The relevant provision is s290-170(2)(c)(iii) of the 1997 Tax Act.  

It does not matter that only part of the superannuation interest has been used to commence the pension.  For example, if the pension commenced with $140,000, the pension would still be based in part on the contribution and the notice would be invalid.

The reason for the invalidity of the notice is two fold.  First, each member’s interest in the SMSF constitutes a single superannuation interest. As and when pensions are commenced, they are carved out from the single super interest and treated as a separate super interest.  When the contribution was allocated to the member, it immediately became part of the of the member’s single superannuation interest. Consequently, commencing a pension that superannuation interest means that the pension will, at least, be based in part on the $40,000 contribution.

The second reason is that the tax free component of a pension is determined at the commencement of the pension having regard to the tax free/taxable components of the superannuation interest from which the pension is carved out.  If it were permitted to lodge a notice after the commencement of the pension, this would retrospectively change the tax free/taxable components of the superannuation interest at the time the pension commenced.

A notice lodged after a pension has commenced will be entirely invalid.

To avoid the invalidity of the notice, the solution is to lodge the notice with the Trustee of the Fund before the commencement date of the pension.  Ideally, the Trustee should also acknowledge the receipt of the notice before the commencement date of the pension.