Should I start a pension before 1 July 21?

What to weigh up in deciding whether or not to start a pension before 1 July 2021.

The conventional wisdom is that most people who can start retirement phase pensions should do so as soon as possible. They come with great tax breaks (the fund stops paying tax on some or all of its investment income, including capital gains) and who doesn’t love a tax break?

In fact in the past, a common strategy adopted by those who wanted the tax breaks but didn’t really want income from their pension was to start a retirement phase pension on 1 June. That gave them a whole month where their fund got a tax exemption on some or all of its investment income (because it was providing a retirement phase pension) but didn’t have to make any payments until the following financial year (because the formula for calculating the minimum pension when an income stream starts gives a $nil result for pensions starting on or after 1 June).

But things are slightly different this year.

From 1 July 2021 the transfer balance cap (the limit on the amount anyone can put into a retirement phase pension over their lifetime) will be indexed for the first time. The general limit will go from $1.6m to $1.7m. Not everyone will get the full $100,000 increase. Those who haven’t started any retirement phase pensions at all before 1 July 2021 will see their personal transfer balance cap go up to $1.7m. But those who have already started pensions will get a lower increase – down to $nil for those who used their full $1.6m limit at some point in the past.

This is where timing becomes important in 2020/21.

Someone who has never started a pension but would like to do so “now” needs to weigh up whether the benefits of doing so now are greater than the downside of getting less indexation when the time comes on 1 July 2021.

The answer might be simple.

For example, Mike (62) and Sue (63) have $1m each in their SMSF (and this is all of their super). Their fund owns a property which they are keen to sell in the next few months with a hefty capital gain. Both Mike and Sue have recently retired and won’t be making any further contributions to super in the foreseeable futures. It makes perfect sense for them to start pensions now so that the property can be sold with no tax on the capital gain. 

When the general transfer balance cap is indexed to $1.7m on 1 July 2021 their personal caps will only go up to $1.638m.  But that probably doesn’t matter – even if they make downsizer contributions in the future they will still fall within their (indexed) cap. The only time they might regret missing out on the indexation is when the first one of them dies and the survivor inherits his or her super balance.  Depending on how big their balances are at the time, the survivor might find that a little more of the combined amount could have been left in a retirement phase pension if he or she had waited until 1 July 2021 to start the first pension and received the full indexation entitlement.  But it’s highly unlikely that would be a significant enough benefit to change their strategy.

In contrast, Jim and Nerida might have $1.65m (each) in their SMSF.  They know that if they wait until 1 July 2021, they can convert the whole amount to a retirement phase pension (because their cap will go up to $1.7m).  But if they start now, only $1.6m can be put into a pension.  The sums they need to do are:

• roughly how much tax will I save by having the fund in pension phase during 2020/21 (ie as early as possible); vs
• what is it worth to me (in terms of longer term tax savings) to have my whole super balance in a pension rather than just almost all of it?

The answer will be different for different funds.

The key is that we’re in an unusual year – it pays to think carefully before deciding to start (or delay) a pension.

When calculating an individual's transfer balance cap it's important to get it right. Find out more about how to sign up for our free online calculator here.