The proportioning rule and the payment of super benefits

By Daniel Butler, Fraser Stead on 13/10/2025 in Audit, Contributions, Investments, Pensions, SMSF compliance, SMSF strategy, Taxation, Trustee education

Introduction

The proportioning rule provides that the tax free and taxable components of a superannuation benefit are deemed to be paid in the same proportion as the tax free and taxable components of the member’s superannuation interest. This rule is contained in s 307-125 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
This means that a member cannot decide whether their superannuation benefit is paid from the tax free or taxable component of their interest. Instead, the tax free and taxable components of their benefit will be reflective of the proportion of tax free and taxable components in the member’s superannuation interest. This prevents a member from ‘cherry picking’ just the tax free component from which to pay their benefits to pay less tax.
Having a sound understanding of this rule is key to many super strategies.

Terminology

In this article, we refer to the following terms as they are used in s 307-125 of the ITAA 1997:

Superannuation interest — refers to a member’s accumulation or pension interest as appropriate.

Superannuation benefit — a payment from a superannuation fund to a member either as a lump sum or pension payment.

Tax free component — this generally includes all non-concessional contributions made after 30 June 2007 that are not included in the fund’s assessable income and the ‘crystallised segment’ that broadly includes numerous tax free components that existed prior to 30 June 2007.
Taxable component — this generally includes concessional contributions and net earnings and any capital appreciation from investments in the fund. The taxable component is calculated as ‘the value of the interest less the tax free component of the interest’ (see s 307-215 of the ITAA 1997).

Please note that these terms may have other meanings in other legislation. This article primarily focuses on the meaning of these terms as they are used in taxation and superannuation law.

Superannuation interest

When a member decides to pay a superannuation benefit, the tax free and taxable components of that benefit will be ‘locked in’ at the applicable time. The applicable time to determine the tax free and taxable components of a superannuation benefit depends on whether the benefit is being paid as a lump sum or as a pension:

Lump sum payment — the components are determined just before the benefit is paid.
Pension payment — the components are determined on the date the pension commences.

In an SMSF context, a member can only have one accumulation interest, however, each pension that is commenced will form a separate superannuation interest.

The values of a member’s accumulation and pension interest may fluctuate with market performance. However, the proportions of the tax free and taxable components of a pension interest do not change with market fluctuations as they are ‘locked in’ at the time of commencement. Any income/growth or loss on pension assets will generally count towards the tax free and taxable components in the relevant proportions.

In contrast, income and capital growth on an accumulation interest will generally only count towards the taxable component, decreasing the proportion of the tax free component within the interest. Any capital loss in the accumulation interest will also count as a decrease in the taxable component, and the tax free component is only decreased after the taxable component has been ‘exhausted’ (the tax free component of the interest would then be 100%).

Timing and value

Accordingly, the following general rules should be noted:

Where assets are going to increase in value, the tax free component is maximised by commencing a pension sooner rather than later (locking in the tax free component to grow proportionately).
Where assets are going to decrease in value, the tax free component is maximised by commencing a pension later rather than sooner (allowing the decrease in assets to erode the taxable component).

Accumulation interest

The tax free component of an accumulation interest is likely to remain static while the taxable component fluctuates with market performance.

Let’s assume that Ben has an accumulation interest valued at $200,000 with a $100,000 tax free component (ie, 50% tax free). If Ben’s accumulation account increases in value to $400,000, the tax free component remains $100,000, while the taxable component is now $300,000 (the interest is now 25% tax free).

On the other hand, if Ben’s accumulation interest declines to $80,000, his tax free component is now $80,000 (ie, 100% tax free), as the loss had first ‘exhausted’ his taxable component.

Pension interest

When a pension is commenced, the proportions of the tax free and taxable components are ‘locked in’ at the time of commencement, and each pension payment will reflect that proportion.

Continuing with Ben’s example above, if Ben commences a pension when his accumulation interest had increased to $400,000 with a $100,000 tax free component, each pension payment will reflect a 25% tax free component and a 75% taxable component. This proportion does not subsequently change with an increase or decrease in the value of pension assets.

In contrast, if Ben commences a pension when his accumulation interest had decreased to $80,000 with a 100% tax free component, each payment from this pension interest will be locked in as 100% tax free.

Note that a pension received by Ben after 60 years, is tax free from an income tax viewpoint. However, if Ben is only survived by his adult children who are no longer dependent on him, the taxable component of a lump sum benefit would be taxable to his children. The tax free component would remain tax free.

Conclusion

Getting the timing right on paying a superannuation benefit while monitoring the value of your accumulation and pension interests can make a significant difference for a member’s tax consequences. Understanding the proportioning rule is key to optimising your super strategies.

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