Meeting Minimum Pension Requirements in SMSFs with Illiquid Property

Most experienced SMSF advisers are already familiar with the limitations inherent in property-heavy SMSFs. Now, as more of these funds enter the pension phase, the long-term liquidity implications are becoming unavoidable, especially where rental income fails to keep pace with increasing pension minimums.

While advisers have a good knowledge of the legislative framework surrounding minimum pension standards, cash payment rules, ECPI implications, the real challenge is supporting trustees in a way that helps them manage cash shortfalls responsibly, making sure everything is properly documented, tax-efficient, and above all, compliant. It’s about avoiding the stress of having to sell assets unexpectedly or accidentally breaching SIS rules.

Drawing on real-world experience, I’ll share practical, forward-thinking strategies you can bring into client conversations, plus the key compliance risks that continue to surface, even in well-managed SMSFs.

When Income Isn’t Enough: Structural Weaknesses Advisers Are Encountering

Many SMSFs were initially established to invest in residential or commercial property, often with good intentions. But liquidity problems typically arise under certain conditions:

• The SMSF holds a single property or property-dominant portfolio with no significant liquidity buffer.
• The SMSF is fully in pension phase, subject to rising minimum pension payment obligations.
• The property is leveraged via a limited recourse borrowing arrangement (LRBA), consuming most rental income in repayments.
• Trustees resist selling property or don’t anticipate future lump sum death benefit payments requiring cash liquidity.

Scenario 1: Two-Person Fund, No Cash Buffer

An adviser recently approached us for help with a client’s SMSF facing a common but tricky issue. The fund held a $900,000 residential property generating $29,000 in annual rent. But the combined minimum pension requirement for the two members was $36,000, leaving a $7,000 annual shortfall.

With no other liquid assets available, and the trustees unwilling or unable to sell the property or contribute further, the adviser needed a compliant and practical way forward.

We worked with them to run detailed cashflow stress tests and explore a range of strategic options. These included discussion on potentially disposing of the property, admitting a new member to inject liquidity, and restructuring pension arrangements.

Throughout the process, we ensured every step was well-documented and aligned with SIS compliance, helping the adviser support their client with confidence and clarity.

Scenario 2: Related-Party Lease Below Market Value

An adviser recently came to us with a concern about an SMSF leasing a commercial property to a related family trust, a setup that’s quite common but can quickly become problematic.

In this case, the fund was charging $20,000 in annual rent, while an independent valuation indicated the market rate should have been closer to $30,000. This can prompt ATO review or investigation, with the rental income being deemed non-arm’s length income (NALI) and subject to tax at the highest marginal rate of 45%.

Even though the main issue here is charging below-market rent, it directly affects the fund’s cashflow. When the rent is too low and especially if the ATO taxes it heavily as NALI, the fund may not have enough cash left to make the required minimum pension payments to its members.

That creates not just a tax problem, but also a serious risk of breaching pension rules.

In such cases, we work closely with advisers to implement comprehensive lease reviews, ensure that rents charged meet market standards, and assist in drafting clear, compliant lease documentation.

By stepping in to help fix the issue, we guide advisers through practical solutions that protect the SMSF from further penalties and ease the pressure on the fund’s cashflow.

What Advisers Should Be Discussing with Trustees Now

Addressing these issues proactively is critical. Advisers must initiate candid conversations and present practical options tailored to each fund’s circumstances: member age, trust deed terms, and appetite for change.

1. Sell the Property to an Unrelated Third Party

A classic solution. Selling while fully in pension phase often eliminates CGT via the ECPI exemption, unlocking liquidity to reinvest in more diversified, liquid assets.

• Use when: Trustees are open to portfolio diversification.
• Adviser tip: Document the revised investment strategy before the sale to satisfy compliance.

2. Sell the Property to a Related Party (At Market Value)

Common but requires careful handling to avoid SIS breaches. Must be supported by a formal, independent valuation and complete documentation.

• Use when: Keeping the property within the family or related business is important.
• Compliance risk: The ATO scrutinises under-valued asset transfers heavily, trustee estimates won’t suffice.

3. Execute an In-Specie Lump Sum Withdrawal

This allows members to take property out of the SMSF as a lump sum, removing the pension payment obligation tied to that asset.

• Use when: Member is exiting or reducing pension balance.
• Legal trigger: Cannot substitute for pension payments. Review trust deed and seek legal advice on stamp duty implications.

4. Add a New Member to Inject Liquidity

Bringing in a new member, often adult children or spouses, who can contribute cash via non-concessional or downsizer contributions, bolsters liquidity without forced sales.

• Use when: Multi-generational wealth strategies align with client goals.
• Caution: Death benefit liquidity should be stress-tested to avoid downstream cashflow surprises.

5. Sell Part of the Property (Structurally Complex)

Selling a share of the property to related or unrelated parties is complex but can free equity while retaining partial ownership.

• Use when: Trustees want to retain majority ownership but need some cash.
• Execution note: Requires co-ownership agreements, legal advice, and clear exit provisions.

Adviser Summary Table: Strategic Options at a Glance

Client Conversations: Key Points Advisers Must Clarify

• Pension payments must be paid in cash; property transfers do not satisfy minimum pension rules.
• Rental income rarely provides sufficient liquidity alone, especially when impacted by LRBAs or related-party leases.
• Fixing liquidity issues cannot be rushed at June; many solutions require lead time for contributions, valuations, or restructuring.
• Related-party dealings bring heightened stamp duty, CGT, and ATO scrutiny.
• Death benefit lump sum payments may trigger unexpected liquidity demands.

Strategic Adviser Checklist: Managing Property-Locked SMSFs

Liquidity problems in pension-phase SMSFs often happen when long-standing investment choices meet changing rules and an ageing member base. Advisers and accountants play a critical role in proactively identifying these issues, engaging clients in timely discussions about restructuring options, and ensuring comprehensive documentation throughout the process.

As an expert in this area, we assist advisers by providing detailed guidance on cashflow management and compliance strategies. Together, we can develop tailored solutions that protect the fund’s tax advantages, ensure adherence to SIS regulations, and reduce the risk of forced asset sales. Good planning, with the right expert help, is essential to managing hard-to-sell assets and making sure pension payments are met smoothly and legally.

Support Your Clients with Confidence

Managing liquidity challenges in property-heavy SMSFs isn’t just about compliance. It’s about giving your clients peace of mind, avoiding rushed decisions, and protecting long-term outcomes. As SMSFs shift into pension phase, advisers and accountants need practical strategies and expert guidance to navigate increasingly complex cashflow issues.

At SMSF Engine, we partner with accountants and financial advisers to deliver seamless support across compliance, pension strategies, in-specie transfers, and complex SMSF structuring. Whether your client’s fund is facing a shortfall, holding a leveraged property, or needs restructuring before June 30, we’ll help you find the right path forward—compliant, tax-effective, and well-documented.

Need help with a property-locked SMSF? Our SMSF Engine team is ready to work with you.

Contact SMSF Engine