Pensions are tax exempt.  The only tax paid on any kind of allocated, term allocated or other super pension is paid in the hands of the pensioner, with the pension payments being taxed to various degrees. 

From 1 July 2007, any person over 60 will pay no tax at all on withdrawals from super - whether those be lump sums or pensions.  If you are over 60 and it is after 1 July 2007, you can stop reading this article right now, the rest does not concern you.  Before 1 July 2007, over 60s get taxed in the following manner, and this will be how pensions will continue to be taxed after 1 July 2007 for people under 60.

People under 60 have to declare pension income in their tax return and they pay normal rates of income tax on this, less deductible amounts and a 15% tax offset.

The "deductible amount" is calculated by dividing the "undeducted purchase price" of a pension by the "relevant number".  The relevant number for tax purposes is the same as the relevant number for social security purposes.  The next three lines of this article are exactly the same as the social security article. 

For fixed term income streams including term annuities and term allocated pensions, the relevant number is the term of the income stream.

For allocated pensions and annuities and lifetime pensions/annuities the relevant number is your life expectancy.

When there is a reversionary beneficiary, the relevant number is the greater of the life expectancy of the primary beneficiary or the reversionary beneficiary.

The difference between the social security deductible and the tax deductible is that the social security deductible amount is calculated by dividing the whole account balance by the relevant number, but the tax deductible amount is calculated by dividing only the undeducted purchase price of the pension by the relevant number.

The undeducted purchase price post 1 July 07 will be the Exempt component (see my article on superannuation components) but prior to 1 July 2007 it will be the undeducted component, CGT exempt component and post 94 invalidity component.

So if a fund has $10,000 worth of undeducted contributions, CGT exempt and post 94 invalidity payments (or a $10,000 exempt component), and the whole fund is rolled into a pension, the UPP of the pension will be $10,000.

One other change from 1 July 2007 is you'll no longer be able to choose which components get rolled into the pension.  Prior to 1 July 2007 you could decide whether to roll the undeducted contribution into the pension or leave it in accumulation mode and only roll the other components in.  You had to roll pre and post 83 money together in proportion to each other (they were thus known together as the "pre/post money").  From 1 July 2007, when funds will contain only taxable and exempt, you'll have to roll the two components in together in proportion to one another, you will not be able to commence a pension with only your exempt money, or only your taxable.

The remaining money which is assessable (the component which is not in the undeducted purchase price) is subject to income tax at marginal tax rates, minus a 15% tax offset, to the extent that the pension is not in excess of the RBL.  From 1 July 2007 RBLs will be removed, so you need not worry about those after then.

Example 1: post 1 July 2007 for a person under 60:

A 58 year old male (life expectancy 23.34 years) rolls $100,000 into an allocated pension, comprising $80,000 of taxable component and $20,000 of exempt component.

     Deductible amount = $20,000 / 23.34 = $857. 

Assuming this pensioner withdraws $15,000 of pension that year, he'll have to declare $15,000 - $857 = $14,143 of taxable income.

He will have to pay income tax on that $14,143 at his marginal tax rate, but this tax liability will be offset by a tax offset of up to $2,121.45.  In many cases unless this pensioner has substantial income from other sources (pushing his income tax rate up into a higer bracket) there will be no tax liability on that income anyway.

58 year old male (life expectancy 23.34 years) rolls $100,000 into an allocated pension, comprising $80,000 of pre/post component and $20,000 undeducted component.

     Deductible amount = $20,000 / 23.34 = $857. 

Assuming this pensioner withdraws $15,000 of pension that year, he'll have to declare $15,000 - $857 = $14,143 of taxable income.

He will have to pay income tax on that $14,143 at his marginal tax rate, but this tax liability will be offset by a tax offset of up to $2,121.45.  In many cases unless this pensioner has substantial income from other sources (pushing his income tax rate up into a higer bracket) there will be no tax liability on that income anyway.

With the exception of the components being renamed, the tax calculation hasn't changed at all.   The only difference is that this same tax system applies to people over 60... and as this example shows, for most people that's not an issue anyway because the 15% tax offset would cover their tax liability anyway.

If the pensioner has already used up their RBL, the pension is "excessive".  Its exactly the same calculation with the exception that there is no 15% tax offset.  The assessable portion of the income is entirely assessed at marginal tax rates.

If the pensioner has some RBL remaining, but commences an allocated pension which pushes them over their RBL, the pension will have a 15% tax offset only on the portion below the RBL, the excessive part of the pension will not have an offset.

On 1 July 2007 pensions which are excessive will cease to be excessive, and the 15% tax offset will apply in full for pensioners under 60... or not apply at all to people over 60 who are tax exempt anyway. 

Life