The pension proportioning rule: how the tax-free percentage of your pension is locked in forever at the moment you start it

Every super interest contains two underlying components. The tax-free component is money that has already been taxed before entering super, or is tax-free by nature — non-concessional contributions made from after-tax money, government co-contributions, and certain legacy elements like the pre-1 July 1983 service period. The taxable component is money that has been taxed concessionally inside super or has not yet been taxed — concessional contributions (employer Super Guarantee, salary sacrifice, personal deductible contributions), the earnings the fund has accumulated on those contributions, and rollovers from taxable elements (ATO — components of a super interest, https://www.ato.gov.au/individuals-and-families/super-for-individuals-and-families/in-detail/components-of-a-super-interest, accessed 6 May 2026). Within the taxable component, most public-offer fund balances are entirely taxed element (already tax-paid in the fund at 15%); untaxed element typically only appears in certain government scheme balances. For a typical industry-fund member who has been receiving SG contributions across a long career, after years of compounding earnings the balance is overwhelmingly taxable component, with a small tax-free portion from any voluntary after-tax contributions. The exact composition depends on the contribution history and fund earnings, but the practical position for most members at retirement is something like 95% taxable and 5% tax-free.

When the member commences a pension — converting some or all of their accumulation balance into account-based pension — the proportioning rule under section 307-125 of the Income Tax Assessment Act 1997 (https://classic.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s307.125.html, accessed 6 May 2026) calculates the tax-free percentage of that pension at the commencement moment. The tax-free percentage equals the tax-free component divided by the total commencement balance. For a pension commenced with $1,000,000 of which $200,000 is tax-free component and $800,000 is taxable component, the tax-free percentage is 20%. That percentage is then locked in for the life of the pension. Every subsequent pension payment is treated as 20% tax-free and 80% taxable. Every subsequent lump sum withdrawal from the pension uses the same proportion. The pension grows or shrinks in dollar terms over time as earnings are credited and payments are made, but the percentage stays fixed.

The lock-in is absolute. A common misconception is that subsequent contributions might improve the existing pension's tax-free percentage. They don't. Any contribution made after a pension commences goes into the member's accumulation account, not into the existing pension. The existing pension's components remain in their locked proportion regardless of what happens elsewhere in the member's super. To change an existing pension's tax-free percentage, the only mechanism available is to fully commute the pension back to accumulation, aggregate it with any other accumulation balance (including any new contributions), and then re-commence a new pension — at which point the new pension's tax-free percentage is calculated fresh using the aggregated components at that re-start moment. Note this commutation also potentially impacts transfer balance cap space and may involve resetting other entitlements, so the analysis isn't purely about the components.

Why does the proportioning rule matter? For pension recipients under age 60, the taxable taxed element of pension payments is included in assessable income with a 15% tax offset where the recipient meets a relevant retirement condition or is on a disability pension. The tax-free component is non-assessable. So a 58-year-old drawing $50,000 a year from a pension with 20% tax-free percentage receives $10,000 tax-free and $40,000 in assessable income (with the 15% offset against the tax otherwise payable on that $40,000); the same person with 50% tax-free percentage receives $25,000 tax-free and $25,000 assessable. For pension recipients age 60 and over, super pension income is generally tax-free regardless of the components, so the proportioning rule has less direct income-tax impact for the member personally. The rule's larger consequence shows up at death — and that is where the planning attention typically needs to focus.

When a super member dies and a death benefit is paid, the tax treatment depends on the recipient's tax-dependant status under ITAA 1997 s.302-195 and the components of the benefit (https://classic.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s302.195.html, accessed 6 May 2026). For tax-dependants — surviving spouse, minor children, financial dependants — the death benefit is tax-free regardless of the components. For non-tax-dependants — typically adult independent children — the lump sum is taxed: tax-free component is tax-free; taxable taxed element is taxed at 15% plus the 2% Medicare levy (effectively 17%); taxable untaxed element is taxed at 30% plus Medicare (effectively 32%) under the rates summarised in the ATO's death benefits guide (https://www.ato.gov.au/individuals-and-families/super-for-individuals-and-families/in-detail/death-benefits, accessed 6 May 2026). For most retirees with public-offer fund balances paying out to adult independent children, the relevant rate is 17% on the entire taxable component. A $1,000,000 death benefit with 95% taxable component going to two adult children produces $161,500 in tax. The same balance with 30% tax-free component (achieved through pre-pension recontribution) produces $119,000 in tax — a $42,500 saving for the children, generated entirely by the proportioning decision made decades earlier when the pension was commenced.

The recontribution strategy exploits the proportioning rule directly. The mechanics are straightforward for a member over preservation age who has met a retirement condition of release: withdraw a lump sum from accumulation phase (typically tax-free for over-60 retirees), then re-contribute the proceeds as a non-concessional contribution. The recontributed amount is 100% tax-free component because NCCs by definition are after-tax money. The member then commences (or re-commences) a pension with the now-improved proportion. A member who would naturally have had 5% tax-free percentage may, through recontribution of $300,000 of cap-eligible NCC under the FY25-26 three-year bring-forward, achieve 25% tax-free percentage on a $1.2 million pension — shifting $240,000 of the eventual death benefit from the taxable column to the tax-free column. The strategy requires available NCC cap (subject to TSB gates and bring-forward eligibility), and the withdrawal-and-recontribution mechanics need fund coordination, but for clients with adult independent children as intended beneficiaries, the recontribution is one of the few large-dollar levers available in super estate planning (MoneySmart — super and death, https://moneysmart.gov.au/grow-your-super/super-and-death, accessed 6 May 2026).

The multi-pension structure is a related planning move for members with mixed beneficiary intentions. Where part of the super will go to a tax-dependant spouse (whose tax position is unaffected by components) and part will go to non-tax-dependant adult children (whose tax position is highly sensitive to components), running separate pensions with different proportions can optimise the overall outcome. Pension A — funded primarily by NCC recontribution — has a high tax-free percentage and is BDBN-directed to the children. Pension B — funded by the residual taxable component — has a low tax-free percentage and is BDBN-directed (or reversionary) to the spouse, who pays no death tax in any case. The structure requires that the fund's PDS or trust deed allows multiple pensions, that the BDBN directs each appropriately, and that the proportioning calculation is done at each pension's commencement. Set up at the original pension commencement is materially easier than retrofitting later.

The timing of NCC contributions before pension commencement is the first lever to consider for pre-retirees. An NCC made before pension start is included in the commencement balance, raising the tax-free percentage of the resulting pension. An NCC made after pension start goes into accumulation, with no effect on the existing pension. For pre-retirees with available NCC cap and intended significant pension commencement, the rule of thumb is to contribute before the pension start, not after. The few weeks of timing difference can produce materially different proportioning outcomes. Where the pre-retiree is in a bring-forward window, the staging of the bring-forward across the years before and at pension commencement is a planning matter that should be modelled carefully.

A specific death-benefit consequence is that inherited pension components carry forward. When a deceased member's pension reverts to a surviving spouse or is paid as a death benefit pension, the components of the death benefit are determined at the deceased's death, and the new pension's tax-free percentage is fixed at the death benefit pension commencement moment using those inherited components. The surviving spouse cannot improve the inherited pension's proportion through their own contributions — those go to their own accumulation. So the original member's proportioning decision casts a shadow forward through the spouse's life and ultimately to the spouse's beneficiaries. For families with substantial intergenerational super planning, the original member's pension commencement is a generational decision, not just a personal one.

What do worked planning examples show?

These two cases show how the proportioning rule plays out for typical retiree positions. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — Robert, 64, retired with $1.4 million super, two adult independent children. Robert's super is largely taxable component (5% tax-free, 95% taxable from a long career of SG and salary sacrifice contributions). He plans to commence an account-based pension and has $200,000 of cash savings outside super. On these facts, the rational pathway is to confirm Robert's NCC cap eligibility (TSB at 30 June below the relevant threshold for full or partial bring-forward — for FY25-26, full three-year bring-forward of $360,000 is available with prior-30-June TSB below $1,760,000), contribute $200,000 from cash as NCC into super before commencing the pension, then commence the pension with the improved proportion. The pre-NCC tax-free was 5% (~$70,000 of $1.4m); post-NCC, the tax-free is approximately 17% (~$270,000 of $1.6m). On Robert's death, the death benefit to his children is taxed at 17% on the taxable taxed element under ITAA 1997 s.302-195 since they are non-tax-dependants: under the original 5% tax-free, ~$226,000 in tax; under the improved 17% tax-free, ~$226,000 × (83%/95%) ≈ $197,000 in tax — about a $29,000 saving. With a more aggressive NCC strategy using full $360,000 bring-forward, the saving grows further. The trap to avoid is starting the pension first and then trying to make NCCs afterward — the existing pension's proportion is locked under s.307-125, and the new contributions only build accumulation that is separate.

Case 2 — Helen, 68, two existing pensions commenced at different times. Helen has Pension A ($600,000, 8% tax-free) commenced in 2019 from her industry fund, and Pension B ($400,000, 32% tax-free) commenced in 2023 from her SMSF after a recontribution strategy. She is reviewing her estate planning. On these facts, the rational pathway is to maintain the existing structure (each pension has its locked-in proportion under s.307-125 and changing them requires full commutation and restart with the TBC consequences that entails), but use the BDBN to direct each pension to the intended beneficiary class: Pension A's high taxable component should be paid to her surviving spouse (tax-dependant) or commuted to a death benefit pension for the spouse, where components don't matter under s.302-195; Pension B's higher tax-free component should be paid to her two adult children, where the components matter most. The trap to avoid is treating both pensions as a single pool with averaged components — each is separate, and the structuring opportunity is to direct each to where its proportion is most valuable.

For pre-retirees and retirees, the proportioning rule is the structural feature that makes the pension commencement moment one of the most important decisions in retirement planning. The components at that moment are locked for the life of the pension under s.307-125, and they determine the eventual tax cost of the death benefit to non-tax-dependant beneficiaries. The levers to influence the outcome — pre-pension NCC contributions, recontribution strategies, multi-pension structures — exist only before the lock-in happens. Once the pension is commenced, those levers close. The advice work is to surface the rule before commencement, model the alternatives for the client's circumstances and intended beneficiaries, and execute the right structure at the start. For clients planning to leave super to adult independent children, this is one of the highest-value advice moments in the entire retirement-planning sequence.

Sources

• classic.austlii.edu.au — S307.125
• classic.austlii.edu.au — S302.195
• Australian Taxation Office (ATO) — Death benefits
• Australian Taxation Office (ATO) — Components of a super interest
• MoneySmart (ASIC) — Super and death