Transfer balance cap modifications
As the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 is now law, it is critical that advisers have an understanding of the impact of the superannuation reforms on legacy pensions. In particular, the specified defined benefit pension modifications apply to lifetime pensions, fixed term (life expectancy) pensions and market linked pensions. This article will focus on market linked pensions.
The transfer balance cap generally operates to restrict the maximum amount a fund member can transfer or retain in the retirement phase in superannuation to $1.6 million as at 1 July 2017.
This general position is modified, however, where the member is in receipt of a specified defined benefit pension.
Market linked pensions
Broadly, market linked pensions are subject to restrictions which prevent the pension from being commuted or ceased and paid as a lump sum. Generally, the commutation amount in a self managed superannuation fund environment must be applied to commence another complying market linked pension until the pension capital is exhausted.
Therefore, the total balance of a market linked pension can be retained within the retirement phase under the superannuation reforms. Importantly, the market linked pension will not give rise to an excess transfer balance despite the market linked pension balance counting towards the transfer balance cap and exceeding $1.6 million.
The outcome of this situation is that subject to the market linked pension balance, an account based pension may need to be commuted in whole or in part and be rolled back to accumulation phase or paid out as a lump sum to avoid excess transfer balance tax being payable.
In particular, a debit will arise in the member’s transfer balance account when the Commissioner of Taxation notifies the member that they have a non-commutable excess transfer balance. This situation is likely to arise if a member has an excess transfer balance and no remaining account-based pensions to be commuted. Thus, a debit for the remaining excess transfer balance identified in the notice arises in the member’s transfer balance account at the time the Commissioner issues the notice.
Accordingly, a member receiving a market linked pension will only have an excess transfer balance if their transfer balance account exceeds both their personal transfer balance cap and their capped defined benefit balance.
The capped defined benefit balance is the net sum of the credits and debits to the member’s transfer balance account for capped defined benefit income streams (which includes market linked pensions). If a member is solely in receipt of a market linked pension, the transfer balance in their transfer balance account will not exceed their capped defined benefit balance.
Calculation methodology
For the purposes of the transfer balance cap, a market linked pension is valued by multiplying the annual entitlement by the number of years remaining on the term of the product (as rounded up to a full year).
The annual entitlement is calculated as follows:
First payment / days in first payment period x 365 = annual entitlement
Example
For example, Blake is currently receiving a market linked pension and an account based pension valued at $1.5 million.
As the market linked pension payment is $200,000 for FY2018, and the remaining term is 10 years, the transfer balance cap value of the pension is $2 million for the purposes of determining whether Blake has exceeded her personal transfer balance cap.
In this example, as Blake’s transfer balance cap is fully exhausted, she cannot continue to receive her account-based pension without incurring excess transfer balance tax.
Taxation
To the extent the market linked pension payments paid to a member each financial year exceed the capped defined benefit income stream cap, ie, $100,000 (as indexed), 50% of the excess amount paid will be included in the member’s assessable income and taxed at their marginal tax rate.
Defined benefit income cap
The defined benefit income cap (ie, $1.6M/16) is reduced if a member is entitled to receive both types of the following income:
- defined benefit income that is not subject to concessional tax treatment (ie, they are receiving an income stream under age 60); and
- defined benefit income that is subject to concessional tax treatment, for example, where the member is over age 60 or is receiving a death benefit pension and either the member or deceased are over age 60.
The defined benefit income cap is reduced by the amount of the defined benefit income that is not subject to concessional tax treatment (on a proportionate basis if the entitlement commences part-way through the financial year).
For example:
($1.6M/16) x (1 + days remaining in FY / days in FY) = defined benefit income cap
Non-concessional defined benefit income reduces the cap, but cannot contribute towards an excess amount.
Example
Assuming that Blake (age 60) receives a pension payment of $200,000 in the relevant financial year, the first $100,000 will be tax free. The remaining 50% of the payment, being $50,000, will be taxed at her marginal tax rates plus levies.
Exempt current pension income exemption
Any income or growth on the market linked pension capital can continue to be held in retirement phase, and will continue to be exempt current pension income in the fund trustee’s hands and therefore, tax free, as the assets are supporting the trustee’s liability to pay the market linked pension to the member.
Further, under proposed changes actuarial certificates will no longer be required for funds paying pensions that are only allocated pensions, account based pensions or market linked pensions.
Issues with commuting market linked pensions on death
Generally, a market linked pension can be commuted on the death of the member and paid as either a lump sum or pension to one or more of the deceased member’s superannuation dependants (subject to each dependant’s eligibility to receive a pension). A market linked pension, however, cannot be commuted if the term of the market linked pension has been calculated by reference to the spouse’s longer life expectancy of the (reg 1.06(8)(d)(iii) of the SISR).
Thus, where the documents recording the commencement of the market linked pension make it clear that the term of the market linked pension has not been calculated by reference to the life expectancy of the spouse, the restrictions on commuting the market linked pension do not apply. Therefore, the remaining balance of the market linked pension can be paid as a lump sum to the spouse or converted to an account-based pension on the death of the member (subject to the recipient’s eligibility to receive a pension and their personal transfer balance cap).
We note that draft regulations (Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulations 2017) have been introduced that may impact on the ability of a a member to commute or partially commute an income stream to the extent required to avoid an excess transfer balance, despite the pension otherwise being unable to be commuted.
Superannuation death benefits
On Blake’s death, her total superannuation benefits will be paid to her spouse in accordance with a valid binding death benefit nomination. Any death benefits the spouse receives as a pension will count towards the spouse’s transfer balance cap.
Where the spouse is also receiving an account-based pension from their own member benefits, and their account-based pension and the death benefit pension exceed the spouse’s personal transfer balance cap, the spouse can elect to commute their own account-based pension and roll the commuted amount back to accumulation phase (and therefore, retain those benefits in superannuation).
If Blake’s death benefits exceed the transfer balance cap, the excess amount must be paid to her spouse as a lump sum (ie, this amount cannot be retained within superannuation).
Where the pension is reversionary, the spouse will generally have 12 months from the date of death to restructure any pension benefits being received. After this date (ie, the 12 month period), if there is an amount in retirement phase that exceeds the transfer balance cap, excess transfer balance tax may apply and appropriate action will be need to comply with the transfer balance cap rules.
Next steps
Members receiving legacy pensions will need to carefully consider the impact of the superannuation reforms, including from a tax perspective, and whether their existing pensions should be restructured.
We will be hosting a webinar for advisers and members in which we will work through the new provisions and a number of practical examples that will highlight opportunities and strategies when dealing with legacy pensions. To register for the webinar, click here.
Related articles
Death benefit pensions and the $1.6 million transfer balance cap
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.
DBA LAWYERS
16 January 2017
