By William Fettes ([email protected]), Senior Associate
The $1.6 million transfer balance cap (‘TBC’) imposes a limit on the total amount that a fund member can transfer into an exempt (retirement phase) pension.
The TBC was introduced with effect from 1 July 2017 with the intention of making the tax concessions in superannuation more sustainable by limiting the extent to which large account balance holders can take advantage of the earnings tax exemption that applies to retirement phase pension interests. However, the introduction of the TBC has added significant complexity to what is already a complex system.
Now that the TBC has been law for some time, this article examines key aspects of the measure to help clarify how the rules operate for advisers and SMSF trustees.
All section references are to the Income Tax Assessment Act 1997 (Cth).
NB: This article does not cover the topic of the total superannuation balance which operates in a different manner to the TBC. Click here for further information on the total superannuation balance.
Balance cap versus transfer cap?
When the TBC measure was first introduced on 1 July 2017, it was effectively imposed as a ‘balance cap’ on existing pensions in retirement phase. Accordingly, individuals with retirement phase pensions in place immediately prior to this date were subject to TBC testing in respect of their actual pension balances on 30 June 2017. Therefore, fund members with larger account balances were required to (partially or fully) commute one or more of their pensions prior to 1 July 2017 to ensure they stayed within the cap.
However, for present purposes, the TBC measure functions as a cap on transfers. Therefore, it is generally only when a pension is commenced (or when a transition to retirement income stream (‘TRIS’) enters retirement phase) that the net market value of the pension interest is tested against a person’s personal cap. This effectively means that changes to existing (retirement phase) pension balances over time (including overall growth or losses) are generally ignored for TBC purposes.
What is the cap that applies?
It is important to note that the general TBC is an indexed general threshold that is never directly applied to individual taxpayers. Thus, a person can only ever have an excess arise under the TBC rules in relation to their ‘personal TBC’.
A fund member will commence having a personal TBC on the first day that they start to receive a retirement phase pension (eg, when they first commence an account-based pension). At that point in time (ie, the day they first start to be a retirement phase recipient), the person’s personal TBC comes into existence based on the general TBC for the relevant financial year.
For example, if a fund member commences a retirement phase pension for the first time in, say, FY2022 and the general TBC at that time happens to be $1.7 million (ie, due to indexation), their personal TBC will be $1.7 million.
The transfer balance account
Usage of a member’s personal TBC is tracked through their transfer balance account (‘TBA’). The TBA functions as a kind of ledger to record (for tax law purposes) amounts that are transferred to or from retirement phase for a particular taxpayer. The net balance of a taxpayer’s TBA is known as their ‘transfer balance’ and is determined by calculating the value of all relevant credit events minus the value of all debit events. In simple terms, a taxpayer’s transfer balance reflects how much cap space has been used up in their personal TBC, including in relation to determining an excess transfer balance on a given day. Note that an individual can have a negative transfer balance where applicable debits (eg, from a commutation of a pension) exceed their credits.
Importantly, credit and debit amounts are fixed at the time they are recorded in the TBA (ie, based on the net market value of the assets at that time) and do not reflect changes over time in underlying asset values, outgoings or allocation of returns. The implications of this are that any net earnings or growth on the assets supporting the pensions are not counted towards an individual’s personal TBC.
Transfer balance credits
The following items count as credits towards an individual’s TBA (s 294-25):
- The value of all retirement phase pensions that were in place just before 1 July 2017.
- The value of any retirement phase pension(s) commenced on or after 1 July 2017.
- The value of a TRIS interest at the time it enters retirement phase pursuant to s 307-80 (eg, when the member attains age 65 or satisfies another relevant condition of release with a nil cashing restriction and notifies the trustee of this fact).
- Where a reversionary beneficiary receives an automatically reversionary pension because of the death of the primary pensioner, the reversionary beneficiary will receive a credit equal to the value of the pension interest (including a TRIS) at the time of the death. Note that the credit will only arise 12 months after the deceased’s date of death.
- Notional earnings that accrue on excess transfer balance amounts.
- Payments made by a superannuation provider under a limited recourse borrowing arrangement that was entered into after 1 July 2017 where the payment results in an increase in the value of a pension interest (ie, by shifting value from an accumulation interest) in an SMSF.
Note that s 294-25 also provides for new credits to be prescribed for in the regulations.
(The ‘value’ referred to above is generally the net market value of the assets at that time, eg, the value of the net assets applied towards the commencement of a pension in retirement phase.)
Transfer balance debits
The following items count as a debit to an individual’s TBA (s 294-80):
- A partial or full commutation of a retirement phase pension. Note that when a commutation occurs, the debit value is generally equal to the amount commuted (ie, the value of the amount transferred out of retirement phase). Note that ordinary pension payments do not count as debits.
- The failure to pay the required pension minimum amount in respect of a retirement phase pension. Where this occurs, the SMSF trustee is taken to have not paid the relevant pension during the FY and a debit arises in the individual’s TBA at the time the pension stops being in the retirement phase with the debit value being equal to the value of the pension interest just before the stop time. Typically this form of debit occurs at the end of the financial year, unless the failure arises upon a pension being fully commuted where the pro-rated pension minimum was not paid, in which case it occurs at the time the full commutation occurs.
- Where an excess transfer balance arises and the fund member does not have sufficient (retirement phase) pension balance available to commute and resolve the excess, the ATO will generally notify the member in writing that they have a ‘non-commutable excess transfer balance’. In this situation, a debit for any remaining excess transfer balance identified in the notice arises to the member’s TBA at the time that the notice is issued.
- Where a family law payment split is applied to divide a pension between a member spouse and a non-member spouse; this would typically only apply to certain unfunded public sector superannuation funds. (Typically family law payment splits in relation to most superannuation funds including SMSFs will arise on a commutation of a retirement phase pension by a member spouse.)
- Certain events that reduce a member’s superannuation balance (eg, fraud or dishonesty where an individual has been convicted of an offence or a claw back of super contributions under bankruptcy law) can also give rise to a debit. In these circumstances, an affected individual will typically need to apply to the ATO for relief so their TBA is debited to restore their transfer balance: refer to s 294-85.
- Structured settlements (ie, payments for personal injury that qualify under s 292-95) contributed to a superannuation fund under the specific rules will cause a debit to the member’s TBA.
Note that s 294-80 also provides for new debits to be prescribed for in the regulations.
As the full or partial commutation of a pension will create a debit for the market value of the commuted amount, individuals with pension balances that have experienced significant growth since the relevant pension was commenced may have debit value that exceeds all relevant credits to their TBA. Accordingly, this can give rise to a negative transfer balance. The practical effect of this is that the individual’s personal TBC is effectively increased as any new credits to their TBA will be reduced or offset by the negative balance enabling a larger retirement phase pension to be commenced.
Withdrawals above the minimum annual pension amount
As partial and full commutations give rise to a debit to a member’s TBA, it is generally preferable that pension payments above the required minimum annual amount calculated under sch 7 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) are planned in advance. In particular, where a payment above a member’s minimum annual pension amount is planned, the member should consider:
- making the payment from the member’s accumulation interest; or
- partially commuting the relevant pension and withdrawing the commuted amount as a lump sum,
provided the relevant amount compromises unrestricted non-preserved benefits.
If the latter option is taken, a debit will arise to the member’s TBA and this will restore the member’s transfer balance. In contrast, if pension payments are withdrawn above the annual minimum pension amount no debit will arise and the member’s pension account balance will be reduced. This will result in the member’s lifetime personal TBC being effectively eroded.
We offer ‘Payments Above ABP Minimum’ documentation that minimises the TBC problem of paying more than a member’s required annual minimum pension. Broadly, these documents reflect the two options above where a member exceeds their minimum annual pension payments. Click here for further information.
Excess transfer balance earnings
Where an individual is in excess of their TBC, they will be deemed to derive notional earnings on the relevant excess amount which is subject to excess transfer balance tax payable by the member personally. Notional earnings accrue on a member’s excess transfer balance based on the general interest charge (currently 7.98%). These notional earnings compound daily — ie, each day the notional earnings are calculated and credited to the member’s TBA, so that the notional earnings for any particular day will be calculated on the member’s excess transfer balance for the prior day. This process effectively continues until the ATO issues an excess transfer balance determination, or the member ceases to have an excess transfer balance (ie, whichever is earlier).
Members who exceed their personal TBC are required to commute their pension (in full or in part) back to accumulation phase to minimise any excess transfer balance tax.
Where an individual does not remove the excess amount in time, the ATO has the ability to issue an excess transfer balance determination. Broadly, this determination advises the individual of their excess transfer balance, and specifies the amount to be removed (ie, the crystallised reduction amount). Additionally, the determination is made with a default commutation notice that specifies the relevant fund and the relevant income stream from which the excess must be removed within 60 days.
An individual may notify the ATO changing their determination to commute a different pension or pensions.
Excess transfer balance tax
Once the excess amount and excess transfer balance earnings have been removed from retirement phase, the ATO will calculate the amount of excess transfer balance tax a person must pay. Broadly this tax is based on:
|excess transfer balance earnings from the day a person first exceeded the cap until the date of rectification||x||the excess transfer balance tax rate|
Note that notional earning on the excess transfer balance accrue until the excess position is fully rectified. In contrast, the amount of notional earnings credited to the member’s TBA is generally locked in (ie, based on an ATO determination).
The excess transfer balance tax (ie, the tax rate on notional earnings) is 15% for excess transfer balances for first time offenders. An excess transfer balance tax rate of 30% applies for subsequent breaches (see s 5 of the Superannuation (Excess Transfer Balance Tax) Imposition Act 2016 (Cth)). This tax is a personal liability of the relevant member.
The TBC measures enacted with effect from mid-2017 place an important restriction on how much fund members can transfer into a retirement phase pension. Accordingly, these measures have an impact on how exempt income is treated in an SMSF. Indeed, understanding how these measures operate is critical when considering tax effective retirement planning.
Note that the above commentary is a general summary only and is not intended to be relied on as advice.
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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.