Transfer balance cap modifications
As the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 is now law, it is critical that advisers consider and discuss the implications of the superannuation reforms on market linked pension with relevant fund members before 30 June 2017.
While the capped defined benefit income stream modifications apply to lifetime pensions, fixed term (life expectancy) pensions and market linked pensions, this article will focus on market linked pensions being paid from self managed superannuation funds.
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 capped defined benefit income stream.
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 unless the commutation amount is applied to commence a new market linked pension. This allows the original market linked pension to be varied. For example, the new market linked pension may have a different term, thereby impacting on the minimum and maximum pension payments, or the pension could be made automatically reversionary to leverage off a term dependant on the age or life expectancy of the surviving spouse.
Where a member is receiving a market linked pension commenced just before 1 July 2017, the total market linked pension balance can be retained within the retirement phase under the superannuation reforms. Importantly, the market linked pension by itself 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.
In a previous article, we considered the scenario where a member has both a market linked pension and an account-based pension and the steps required to avoid an excess transfer balance. In this article, we will consider when a member may consider commuting a market linked pensions and the implications of doing so in the context of the superannuation reforms.
First, however, we consider how the special value of a market linked pension is calculated from 1 July 2017 for the purposes of the transfer balance cap.
For the purposes of the transfer balance cap, the special value of a market linked pension is determined by multiplying the annual entitlement by the number of years remaining on the term of the product (as rounded up to a full year).
In particular, s 294-135(3) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’) provides that:
The special value, at a particular time, of a superannuation interest that supports an income stream that is, or was at any time, a capped defined benefit income stream [being a market linked pension] … is the amount worked out using the formula:
Annual entitlement x remaining term
The annual entitlement is calculated as follows:
First payment / days in first payment period x 365 = annual entitlement
The reference to a superannuation interest supporting the fund trustee’s liability to pay an income stream to a member that ‘is, or was at any time’ a market linked pension appears to relate to the special value of a market linked pension commenced before 1 July 2017 for transfer balance cap credit and debit purposes. Thus, this provision appears not to relate to the method of valuing a market linked pension commenced on or after 1 July 2017, even if the funds applied to commence the market linked pension are directly derived from the commutation amount of a previous market linked pension commenced before 1 July 2017 and commuted on or after 1 July 2017. This point is discussed in further detail below.
Axe is currently receiving a market linked pension.
On 1 July 2017, the market linked pension has an actual market value of $1.5 million and a remaining term of 20 years. Therefore, the payment factor under schedule 6 to the Superannuation Industry (Supervision) Regulations 1997 (Cth) is 14.21. The pension payment required (rounded to the nearest $10), plus or minus 10%, in the 2018 financial year is the account balance as at 1 July 2017 divided by the payment factor rounded down to the nearest whole number as follows:
$1.5 million / 14 = $107,140
In contrast, for transfer balance cap purposes, the special value of the market linked pension is as follows:
$107,140 x 20 years= $2,142,800
In this scenario, the special value for transfer balance cap purposes artificially inflates the actual market value of the market linked pension by $642,800.
Thus, as a broad rule, unless the actual market value of the market linked pension exceeds $1.6 million, such that the member receives the benefit of a higher amount being retained in retirement phase and the corresponding tax benefit, the member is likely to be disadvantaged from a transfer balance cap perspective. The tax treatment of any pension payments should also be considered as outlined in our previous article.
In the example above, if Axe’s market linked pension retained its actual market value rather than having a ‘special value’ for transfer balance cap purposes, Axe would ordinarily have been permitted to retain his market linked pension in retirement phase, as well as an account-based pension of $100,000, to bring the total amount retained in retirement phase up to the $1.6 million transfer balance cap. However, because Axe’s market linked pension is a capped defined benefit income stream, the pension’s special value for transfer balance cap purposes well exceeds the actual market value and prevents Axe from retaining or transferring any further amounts to retirement phase.
Commuting the market linked pension
Where fund members are receiving a market linked pension with an actual market value of less than $1.6 million, a strategy to address this disparity may be to commute the pension from 1 July 2017. Expert advice should be obtained, such as legal, actuarial and financial planning advice, before a strategy of this nature is implemented.
Pursuant to s 294-130(1)(b) of the ITAA 1997, a market linked pension falls within the definition of a capped defined benefit income stream for tax purposes if it was in retirement phase just before 1 July 2017. Therefore, a market linked pension commenced on or after 1 July 2017 is outside the definition of a capped defined benefit income stream and accordingly, the ordinary transfer balance cap provisions would apply. In this scenario, the value of the market linked pension for transfer balance cap purposes would be its actual market value.
This has been confirmed by ATO Deputy Commissioner for Superannuation, James O’Halloran, on or about 16 May 2017 (albeit in a non-binding context) when he broadly noted that if a term allocated pension commences after 30 June 2017, the transfer balance credit value is equal to the value of the account balance.
Importantly, we note that where a market linked pension is commuted on or after 1 July 2017, the debit to the member’s transfer balance account is calculated pursuant to s 294-145(6) of the ITAA 1997, being:
 Taurian, K, ‘ATO busts common super reform myths’, Super Adviser, 16 May 2017
The debit value, at a particular time, of a superannuation interest that supports an income stream that is, or was at any time, a capped defined benefit income stream … is the special value of the interest at that time.
Therefore, the debit to the member’s transfer balance account where a market linked pension is commuted on or after 1 July 2017 is the special value calculated in accordance with the formula outlined above, broadly being the annual pension payment entitlement multiplied by the remaining term of the market linked pension (refer to s 294-135 of the ITAA 1997).
We recommend each member with a market linked pension obtains legal advice on the various strategies that could apply before 30 June 2017 as outlined below.
Before any steps are taken, however, to commute an existing market linked pension and commence a new market linked pension, we strongly recommend legal advice is obtained on whether the existing market linked pension can be commuted under the governing rules of the fund and the relevant pension documentation, as well as the requirements that must be satisfied under superannuation law. It is also critical that the terms of any new market linked pension commenced strictly complies with the pension standards under superannuation law and the terms of the fund’s governing rules.
We also recommend fund members seek the advice of an experienced actuary before making any decisions regarding the commutation and commencement of a market linked pension.
Please let us know if you would like to speak to a lawyer in our team experienced in advising on, and documenting the commutation and commencement of market linked pensions. We have developed documentation to record the commutation of an existing market linked pension and the commencement of a new market linked pension. Importantly, our superannuation fund deed has also been updated in light of the superannuation reforms, and permits a market linked pension to be paid pursuant to superannuation law.
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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.
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1 June 2017