Super changes – get your cash flow in order
By Mark Ellem
This article has also been picked up by the Switzer Super Report.
The new superannuation changes have focussed our minds mainly on the impact of the reduced contribution caps and the $1.6 million transfer balance cap. However, there are other less obvious things that we need to consider such as changes to pension commutations and the subsequent cash flow position of the SMSF.
A pension can be either fully or partially commuted. However, the amount of the commutation can only be withdrawn from superannuation where the benefits are ‘unrestricted non-preserved’ (URNP). The most common scenario for superannuation benefits to become URNP is when a person ‘retires’. If a transition to retirement income stream (TRIS) commences, access to the preserved component can be obtained prior to permanently retiring.
From 1 July 2017 it will no longer be possible to receive a payment from a TRIS and elect to have the amount taxed as a lump sum. This begs the question - can you take a lump sum from a pension at all after 30 June 2017? Or, in other word, can a member continue to wholly or partially commute their Account Based Pension (ABP) to a lump sum? Our understanding is that it will still be possible to fully or partly commute pensions to lump sums in cash or in specie. However, any amount received or the value of the assets transferred from the commutation will not count against the minimum pension payment.
Currently, a partial commutation of a pension counts towards the minimum pension amount and is beneficial, for two reasons:
1. Less tax on the benefit payment
For a member under the age of 60, a whole or part commutation of a pension to a lump sum benefit is taxed on its taxable component. However, no tax is payable on the first $195,000 of the taxable component of any lump sums withdrawn from super between ages 56 and 60. If the same amount was made as a pension payment, the taxable component would be subject to tax at the member’s marginal tax rate, plus applicable levies, less a tax offset equal to 15% of the taxable amount of the pension. In many scenarios commuting all or part of the pension to a lump sum benefit will result in a more favourable tax outcome for the individual.
For example, Mary, aged 58, has retired and started an account based pension. Her pension balance at 1 July 2016 is $780,000 and is split into 80% taxable and 20% tax free components. Her minimum pension for 2016/17 is $31,200, with $24,960 being the taxable component. She decides to receive a pension of $31,200. The taxable component of the pension is taxed at her personal rate of 32.5%, plus 2% Medicare levy. Applying the 15% pension tax offset, the tax on Mary’s pension payment would be $4,867.20 or 19.5%.
Rather than taking the payment as a pension, if Mary commuted it partially to a lump sum the amount received would be counted towards her minimum pension payment. Consequently, as the taxable component of $24,960 would be under her low rate cap of $195,000 (assuming no previous lump sum benefit payments), effectively the payment would be received by Mary tax free, saving her $4,867.20 in tax. In addition, Mary’s pension has satisfied the minimum pension requirement.
2. Receiving a lump sum as a transfer of investments
The Regulator’s view is that the super legislation requires pension payments to be made only in cash. However, a lump sum can be paid as a full or partial commutation of the pension as an in specie transfer of a fund investment. SMSF Determination 2013/2 published by the ATO says that a partial commutation counts towards the minimum pension amount. In Mary’s example previously, if she took the payment of $31,200 as an in specie transfer of fund assets, she would have the same tax outcome, that is, no tax on the lump sum she receives and the fund would satisfy the minimum pension payment rule.
Changes from 1 July 2017
It will still be possible to partially commute the pension to a lump sum and receive the payment as an in specie transfer of investments from 1 July 2017. The value of the investments transferred will be subject to lump sum tax rules including access to the low rate cap amount. So far, as you can see, there is no change from the current rules.
However, from 1 July 2017 a partial commutation will not count towards the fund satisfying the requirement to pay the minimum pension. In Mary’s situation, partial commutation of $31,200 would not count towards her minimum pension if taken after 30 June 2017. Consequently, she would need to take a further pension payment of at least $31,200 to satisfy her minimum pension payment (assuming $31,200 was her minimum pension payment for 2017/18). Using the same marginal tax rate, the amount of tax levied on the pension payment would be $4,867.20.
As partial commutations of a pension will not count towards the minimum pension requirements from 1 July 2017, SMSFs will need to ensure they have sufficient available cash to pay the required pension minimum. With the Regulator’s view that pension payments can only be made as cash payments, the option to make last minute pension payments as in specie transfers of fund investments will not be possible.
To summarise, from 1 July 2017, both cash flow of the SMSF and the personal tax situation of the member will need to be reviewed in light of these changes.