The rules that govern when exempt income arises in relation to the earnings on assets supporting transition to retirement income streams (‘TRISs’) were substantially changed with effect from 1 July 2017. Advisers and SMSF trustees should be aware that there are now two types of TRISs: retirement phase TRISs and non-retirement phase TRISs. Naturally, it is only retirement phase TRISs that give rise to exempt income at the fund level.
Understanding how the current retirement phase rules apply to TRISs is critically important as it affects many areas of superannuation law, including succession planning and the transitional CGT relief. We now examine relevant rules below.
The starting point under the new rules is that TRISs are expressly excluded from being in the retirement phase under s 307‑80(3) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’).
A TRIS can only attain retirement phase status when the individual recipient of the TRIS at the time:
- attains age 65; or
- meets the retirement, terminal medical condition or permanent incapacity conditions of release and notifies the fund trustee of that fact.
Accordingly, the above conditions apply to both newly commenced TRISs (ie, a TRIS commenced during someone’s lifetime) and for a reversionary death benefit TRISs.
This effectively means that a TRIS that has entered retirement phase has not done so permanently, and the non-retirement phase exclusion will be re-applied if a future reversionary recipient fails to satisfy the above conditions.
We now consider the implications of these rules.
Loss of retirement phase status on reversion
We now analyse what happens if a member with a retirement phase TRIS that is automatically reversionary dies where the recipient does not satisfy the retirement phase rules.
If the recipient of the TRIS has not met the requirements in s 307‑80 of the ITAA 1997:
- The TRIS initially reverts for tax purposes, but payment of the TRIS as a death benefit pension is inconsistent with reg 6.21 of Superannuation Industry (Supervision) Regulations 1994 (Cth)which requires death benefit pensions to be superannuation income streams in the retirement phase.
- To comply with the payment standards in reg 6.21, the recipient will need to, as soon as practicable, commute the TRIS and:
- start a new account-based pension in place of the TRIS;
- withdraw the death benefit as a lump sum; or
- pay the death benefit using a combination of the above two options.
- The TRIS will cease for super and tax purposes when it is fully commuted and there will be mixing of tax-free and taxable components if the recipient has an accumulation interest
- The fund’s exempt current pension income (‘ECPI’) exemption in respect of the assets supporting the TRIS ceases on the death of the deceased.
- The extension of the pension exemption under the Income Tax Assessment Regulations 1997 (Cth) is not available as it only applies where ‘the superannuation income stream did not automatically revert to another person on the death of the deceased’.
- The 12-month deferral in the timing of the credit to the recipient’s transfer balance account will not apply as the TRIS was commuted.
As noted above, a superannuation income stream (ie, the tax term for a ‘pension’) that is a TRIS must be in retirement phase in respect of the recipient for the ECPI exemption to apply at the fund-level.
Where a deceased TRIS member and a reversionary recipient of that TRIS are both in the retirement phase, ECPI can readily continue if the SMSF and pension documentation provides for an automatically reversionary pension consistent with TR 2013/5.
However, a unique problem arises in the context of reversionary TRISs where the deceased TRIS member was in retirement phase but the reversionary recipient of the TRIS is not.
Under the tax regulations that have been in place since FY2013, a fund paying a pension that ceased on a member’s death due to it not being automatically reversionary would ordinarily receive an extension to the ECPI exemption in respect of assets supporting that pension provided that the deceased member’s benefits are cashed ‘as soon as practicable’. However, this concession requires that ‘the superannuation income stream did not automatically revert to another person on the death of the deceased’. Accordingly, no extension of the pension exemption is available for TRISs that have reverted for tax purposes even where the TRIS is subsequently commuted due to the reversionary beneficiary not satisfying the requirements in s 307-80 of the ITAA 1997.
Accordingly, unless the death benefit TRIS is commuted on the day of the deceased’s death and a new account-based pension is commenced on the same day, there will be a period of time where no income exemption is available in respect of assets that support the TRIS.
Retirement phase TRISs and the CGT relief
On 20 December 2017, the ATO finalised a revised version of the Law Companion Guideline (‘LCG’) on the transitional CGT relief provisions: LCG 2016/8. The new version of LCG 2016/8 aims to better clarify the operation of the CGT relief, particularly in relation to assets supporting TRISs.
In the prior version of LCG 2016/8, which was finalised on 8 March 2017, there was some ambiguity about whether or not the ATO accepted that the CGT relief could be applied in respect of assets supporting TRISs that were in place for the purposes of 1 July 2017 where the fund never lost the ECPI in respect of assets supporting that TRIS. This ambiguity existed because the text of LCG 2016/8 did not clearly distinguish between TRISs in the retirement phase and non-retirement phase TRISs.
To be fair to the ATO, it should be borne in mind that the concept of a retirement phase TRIS is relatively new as it was enacted via the Treasury Laws Amendment (2017 Measures No. 2) Act 2017 (Cth) which only received Royal Assent on 22 June 2017. However, this still leaves a considerable period of time from 22 June to 20 December 2017 (ie, the better part of six months) where the ATO’s guidance has not been adequately clear on this issue.
Many people will have devoted considerable time and energy to considering theCGT relief over this period of time, and they may now need to review and potentially revise their position in light of the ATO’s changes to LCG 2016/8.
In the latest version of LCG 2016/8, the ATO consider that the CGT relief is only available in respect of assets supporting retirement phase TRISs if the TRIS account balance exceeded $1.6 million and needed to be partially commuted to stay within the member’s transfer balance cap. In this way, a retirement phase TRIS is effectively equivalent to an account-based pension for the purposes of CGT relief eligibility.
We are aware of a number of professional bodies making submissions to the ATO and Treasury, including the SMSF Association, with a view of obtaining a more satisfactory solution in relation to reversionary TRISs where the deceased was a retirement phase recipient. Accordingly, advisers and SMSF trustees should watch this space as developments unfold.
Naturally, some of the issues discussed above would not arise if the TRIS was an account-based pension, however, at this stage Treasury and the ATO appear to be unwilling to acknowledge the possibility of a TRIS ever being able to convert to an account-based pension without the TRIS being commuted and commenced as a new pension, notwithstanding the long-standing industry practice in this area.
Accordingly, at this stage, the only sure-fire way to overcome the above issues is for the retirement phase TRIS member to commute their TRIS during their lifetime so that a new account-based pension can be commenced that can be reverted to an eligible dependant. If, for example, a surviving spouse receives a reversionary account-based pension on the death of a member, there is no need for them to satisfy any condition of release because death, by itself, is a condition of release with a ‘nil’ cashing restriction. Naturally, this involves some upfront administration and costs that need to be weighed up against likely hurdles in the future.
If a retirement phase TRIS member does not commute their TRIS and commence an account-based pension instead, and the intended beneficiary of their death benefits is not likely to be in the retirement phase at the time of the member’s death, the TRIS member should strongly consider making the TRIS non-reversionary so that the extension of the ECPI exemption is available on their death.
SMSF trustees and advisers should also carefully consider how the retirement phase rules apply to TRISs for the purposes of the CGT relief, particularly in light of the ATO’s latest revised version of LCG 2016/8.
* * *
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2000 (Cth).
Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visitor call 03 9092 9400.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.