“Tax-free retirement” is one of the most-used phrases in Australian superannuation, and one of the most misunderstood. It does not mean a self-managed super fund escapes tax entirely at every stage; it describes what happens once a member commences an account-based pension and moves Assets into the retirement phase. At that point two distinct things become tax-free: the Earnings on the assets backing the pension, and the pension payments themselves for members aged 60 or over. But those benefits come wrapped in rules — a ceiling on how much can enjoy them, and a minimum you must draw each year. Here is what actually happens when an SMSF starts an account-based pension.

 

Commencing an account-based pension

An account-based pension (ABP) is the most common retirement income stream paid from an SMSF. To start one, a member must first meet a condition of release — typically reaching preservation age (now 60) and retiring, ceasing employment after 60, or reaching age 65. The trustees then formally commence the pension: they document it, fix the opening balance on the commencement day, and begin paying a regular income stream from that account.

The starting balance matters, because it sets the “value” that counts against the member’s transfer balance cap and drives the minimum payment calculation. Once commenced, the pension account is a separate interest within the fund, and no further contributions can be added to it — new money must go to an accumulation account instead.

 

What “tax-free” really means

There are two separate layers of tax relief, and it helps to keep them apart.

At the fund level, earnings — both income and capital gains — on the assets supporting a retirement-phase pension are Exempt Current Pension Income (ECPI), taxed at 0 per cent. This is the shift from the 15 per cent that applies in the accumulation phase.

At the member level, pension payments drawn by someone aged 60 or over from a taxed SMSF are tax-free: they are not included in assessable income and do not need to be declared. Together, these two features are what people mean by a “tax-free retirement”. The relief flows to earnings inside the fund and to the income paid out of it.

 

The transfer balance cap ceiling

The tax-free retirement phase is not unlimited. The transfer balance cap limits how much each person can move into retirement phase across all of their super. The general cap was $2 million in 2025–26 and was indexed to $2.1 million from 1 July 2026, rising in $100,000 increments in line with CPI.

Everyone has a personal transfer balance cap. Only a member who had never started a retirement-phase income stream before 1 July 2026 receives the full $2.1 million; those who commenced a pension in an earlier year may have a lower personal cap, because proportional indexation gives a smaller top-up to anyone who has already used part of their cap. Amounts above the cap generally cannot stay in the tax-free phase — they can remain in accumulation, where earnings are taxed at 15 per cent, or be withdrawn if a condition of release is met. The same $2.1 million figure now also aligns with the total super balance threshold used for non-concessional contribution eligibility.

 

Minimum drawdown requirements

Because an account-based pension is designed to pay retirement income rather than shelter Wealth indefinitely, the law sets a minimum annual payment. It is calculated as a percentage of the Account Balance at 1 July, and the percentage rises with age:

  • Under 65: 4 per cent
  • 65–74: 5 per cent
  • 75–79: 6 per cent
  • 80–84: 7 per cent
  • 85–89: 9 per cent
  • 90–94: 11 per cent
  • 95 or more: 14 per cent

In the year a pension starts, the minimum is pro-rated for the number of days remaining. These are minimums, not maximums — an account-based pension can generally pay more, and a member who needs additional funds can also take lump sum commutations, subject to the fund’s rules and preservation requirements. The temporary 50 per cent reduction in minimum drawdown rates that applied during the COVID-19 period ended on 30 June 2023, so the standard percentages now apply in full.

 

Why the minimum is not optional

Failing to pay at least the minimum in a financial year carries a serious consequence. The pension can be taken not to have been in retirement phase for the whole year, meaning the fund loses the ECPI exemption for that year and the relevant earnings are taxed at 15 per cent instead of 0 per cent. There is limited ATO relief for small, honest and inadvertent breaches under the Commissioner’s general discretion, but it is not automatic and cannot be relied upon.

 

A hypothetical illustration

For illustration only: Priya, aged 63 and retired, starts an account-based pension in her SMSF with an opening balance of $1.5 million on 1 September. Because she is under 65, her minimum drawdown rate is 4 per cent, pro-rated for the part-year in which the pension commenced. From the following 1 July, her minimum is 4 per cent of the balance at that date. The pension payments she receives are tax-free because she is over 60, and the earnings on the $1.5 million backing the pension are exempt from tax. Her balance sits comfortably below the $2.1 million cap, so all of it can be in the retirement phase. This is a general example, not advice or a projection.

 

Key Takeaway

Starting an account-based pension in an SMSF turns fund earnings on the supporting assets into 0 per cent ECPI and makes pension payments tax-free from age 60. But the retirement phase is capped — the general transfer balance cap is $2.1 million from 1 July 2026, up from $2 million — and each pension must meet an age-based minimum drawdown or risk losing the tax exemption for the year.