The Federal Government’s $1.6 million transfer balance cap (‘TBC’) measure is likely to adversely impact couples who have pension entitlements exceeding $1.6 million. This articles outlines some of the implications in relation to death benefit pensions.
The key TBC provisions are in div 294 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’) inserted by the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Cth).
The transfer balance cap and transfer balance account
A lifetime limit on the total amount a member can transfer into tax-free pension phase applies from 1 July 2017. This lifetime limit is implemented through a personal TBC that applies to all fund members in retirement phase.
A member’s personal TBC comes into existence if they are a ‘retirement phase recipient’ on or after 1 July 2017 and this personal cap is set to the value of the general TBC for that financial year. The general TBC is $1.6 million for FY2018 (as indexed in future years). For example, all fund members who are in receipt of an existing account-based pension (‘ABP’) on 1 July 2017, and those who commence an ABP during FY2018, will have a personal TBC of $1.6 million.
This means that net earnings and growth on the assets supporting pensions are ignored when applying an individual’s personal TBC.
Death benefit pensions under the TBC
Typically, a TBA credit arises on the commencement of a pension. However, s 294-25 of the ITAA 1997 provides that a reversionary pension counts as a credit to a reversionary beneficiary’s TBA.
This means that a reversionary pension paid to a surviving spouse on the death of the first spouse (eg, by way of a reversionary ABP) will impact the surviving spouse’s personal TBC. This may create an excess problem despite the deceased spouse’s pension having already been tested against their personal TBC. This is because a person’s TBA ceases on death under s 294‑45 of the ITAA 1997, subject to special rules concerning child pensions. Accordingly, the TBA of a deceased member does not carry over to a surviving spouse.
However, there are special rules that modify the timing of when a death benefit pension is credited to a recipient’s TBA in respect of a death benefit:
- If the deceased member died before 1 July 2017, and the pension was an automatically reversionary pension, the credit occurs on the later of:
- 1 July 2017; or
- at the end of the period of 12 months from the day the pension first became payable (eg, following the deceased’s death).
For example, if dad died prior to 1 July 2016 leaving an automatically reversionary pension to mum, a credit would occur on 1 July 2017. However, if dad died on 2 January 2017, then a credit would occur on 2 January 2018.
- If the deceased member dies after 30 June 2017, and the pension is an automatically reversionary pension, the credit occurs 12 months after the day that the pension first becomes payable (eg, from deceased’s death).
For example, if dad dies on 2 August 2017, then a credit would occur on 2 August 2018.
Thus, for deaths after 1 July 2017, where there is an automatically reversionary pension that reverts from dad to mum on dad’s death (or vice versa — we will not repeat this below and will refer to dad as the one who dies), the credit to mum’s TBA occurs 12 months after dad’s death. This provides a period of time for the surviving spouse to seek advice and adjust their superannuation and pension position to minimise any excess TBC.
However, there is no 12 month grace period available where a new or fresh pension is paid to mum on dad’s death (eg, where dad dies without an automatically reversionary pension or where dad’s superannuation benefit is 100% in accumulation phase). Therefore, in these cases, a credit will instantaneously occur in mum’s TBA on starting her new pension.
Though the provisions about credits in s 294-25 of the ITAA 1997 only refer to a ‘reversionary beneficiary’, the ATO confirms in its draft ATO Law Companion Guideline (‘LCG’) 2016/D9 that the pension must be an automatically reversionary pension, consistent with the ATO’s view in TR 2013/5, to be eligible for a 12 month TBA deferral to apply.
Having a 12 month grace period provides a critical planning strategy. However, this strategy can only be achieved if quality SMSF documentation is in place. More specifically, the ATO in LCG 2016/D9 states at ):
A reversionary beneficiary is the nominated beneficiary of a superannuation income stream that automatically reverts to the nominated beneficiary on the death of the original superannuation member. In these cases, the superannuation income stream does not cease, as the reversionary beneficiary is immediately entitled to receive it. If the fund’s trustee has any discretion about which beneficiary becomes entitled to the superannuation income stream, the interest is not a reversionary interest, and the beneficiary is not a reversionary beneficiary.
Further, the ATO in TR 2013/5 states at :
A superannuation income stream automatically transfers to a dependant beneficiary on the death of a member if the governing rules of the superannuation fund, or other rules governing the superannuation income stream, specify that this will occur. The rules must specify both the person to whom the benefit will become payable and that it will be paid in the form of a superannuation income stream. The rules may also specify a class of person (for example, spouse) to whom the benefit will become payable. It is not sufficient that a superannuation income stream becomes payable to a beneficiary of a deceased member only because of a discretion (or power) granted to the trustee by the governing rules of the superannuation fund. The discretion (or power) may relate to determining either who will receive the deceased member’s benefits, or the form in which the benefits will be payable.
The ATO take a strict legalistic view of what constitutes an automatically reversionary pension, and accordingly, this standard must be satisfied. Many superannuation fund documents (including SMSF and large superannuation fund deeds and pension documents) will fail to satisfy this requirement because the trustee’s discretion is not adequately limited (or, what lawyers refer to as ‘fettered’).
Managing a TBA
A member’s personal TBC is tracked through their transfer balance account (‘TBA’). A TBA is an account which tracks debits and credits. Broadly, amounts in retirement phase (ie, the pension capital on commencement of a pension) are credited to the TBA. Conversely, amounts commuted from retirement phase (eg, when a pension is converted to a lump sum payment or rolled-back into accumulation) are debited to this account. The net account balance of the TBA called the ‘transfer balance’ (ie, total credits minus total debits) reflects a person’s remaining TBC cap space. Importantly, credit and debit amounts are fixed at the time they are recorded in the TBA and do not reflect changes in underlying asset values.
Managing the TBA issues by commutation of the surviving member’s pension
One of the primary ways of managing a potential excess TBC problem caused by a death benefit pension is by commuting the surviving member’s own pension to create sufficient personal cap space through a debit to their TBA. This strategy can work because a commutation (whether partial or full) of pension capital results in a debit to the member’s TBA which may free up sufficient cap space in the member’s personal TBC to enable a death benefit pension to be received without an TBC excess.
The TBC provisions also anticipate that a negative transfer balance in a member’s TBA can occur, potentially enabling a death benefit pension above $1.6 million to be received by a surviving spouse if the surviving spouse’s own pension interest has experienced significant growth.
From 1 July 2017, spouses may want to work towards achieving more parity in relation to their superannuation account balances to provide greater planning flexibility to manage their TBCs.
However, as noted above, only those fund members with quality superannuation documents that provide an automatically reversionary pension will be eligible for the 12 month grace period in relation to the timing of the credit to the surviving spouse’s TBA.
Example from the explanatory memorandum
The explanatory memorandum to the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Cth) provides a useful example outlining some options on a member’s death (refer to example 3.10):
Kurt and his wife Katherine are retired. In July 2017, Katherine commences a superannuation income stream with $1 million and Kurt commences a superannuation income stream with $1.6 million.
Kurt has exhausted his transfer balance cap. On 31 October 2018, Katherine passes away, leaving Kurt as the sole beneficiary of her remaining superannuation interests, now worth $800,000.
At this time, the superannuation interest that supports Kurt’s superannuation income stream has a value of $1.4 million (the value of both individual’s superannuation interests have been reduced over time by the drawdown of superannuation income stream benefits).
However, as Kurt started the superannuation income stream with the full value of his transfer balance cap he cannot transfer further amount into the retirement phase without reducing his transfer balance first.
Kurt may take Katherine’s superannuation interest of $800,000 as a death benefit lump sum, which would have to be cashed out of the superannuation system.
Alternatively, he could partially commute $800,000 of his superannuation income stream, retaining it in the accumulation phase, and take a death benefit income stream of $800,000. Kurt would still have his original superannuation income stream in the retirement phase (now supported by a superannuation interest of $600,000) and would also have $800,000 in accumulation. If Kurt chose this option, he would not need to cash any of Katherine’s stream by $401,414.
Excess personal transfer balance cap
Individuals who exceed their personal TBC will need to commute their superannuation income streams back to accumulation mode (in full or in part) and any notional earnings (see below) on any excess TBC will be subject to tax.
An excess transfer balance tax is payable by the member on the deemed notional earnings on any excess TBC amount. This tax is assessed for the financial year in which a member breaches their TBC. The excess transfer balance tax is 15% on notional earnings for FY2018, and from 1 July 2018 onwards, it is 15% for the first breach and 30% for second and subsequent breaches.
Notional earnings accrue on any excess transfer balance based on the general interest charge (currently around 9%). Notional earnings accrue daily until the breach is rectified and are generally credited towards an individual’s TBA (subject to a transfer balance determination being made by the ATO).
Thus, there is an incentive to remain within a member’s TBC.
There are also substantial changes to transition to retirement income streams (‘TRISs’) from 1 July 2017.
Firstly, TRIS assets will no longer be exempt from tax from 1 July 2017. A TRIS account is not considered to be in ‘retirement phase’. TRIS members will therefore have an incentive to convert to an ABP as soon as they can to obtain a pension exemption. In many cases this will be when they attain age 60 and cease an arrangement of gainful employment. On satisfying this condition of release, the TRIS can convert into an ABP. DBA Lawyers’ documents automatically convert a TRIS to an ABP upon the member attaining a relevant condition of release.
Secondly, a TRIS will not be eligible to be transferred to a reversionary beneficiary on the death of a member — only ABPs can continue to be paid to a reversionary beneficiary after 1 July 2017. Many members with a TRIS that have planned to revert their TRIS on their death to their surviving spouse will need to revise their estate planning. This change may come as a surprise to many.
The new TBC measure is likely to have a significant impact on the succession plans of all fund members who collectively with their spouse have more than $1.6 million in superannuation.
A surviving spouse’s personal TBC will need to be carefully managed to avoid an excess TBC, and in some cases, amounts may need to be rolled back into accumulation mode. Only automatically reversionary pensions obtain a 12 month grace period before a credit arises to the surviving spouse’s TBA. A fresh pension, however, is counted from its starting date. Therefore, quality SMSF and pension documents are needed to maximise flexibility in dealing with the TBC.
TRISs are substantially impacted from 1 July 2017 and every member with a TRIS should examine the tax effectiveness, succession and other aspects of a TRIS before 1 July 2017 to determine whether they should continue with them beyond that date.
Given these changes, every member who has a pension or who should have one, should review their position with the assistance of a suitably qualified adviser.
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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.