News 06/07

Super Concepts e-SuperUpdate provides you with technical tips and updates on Self Managed Superannuation Fund topics of interest.

Commutation and Rollover of Benefits

In this e-SuperUpdate we look at the new super rules and whether it is worthwhile to rollover and start a new pension prior to reaching 60.  This would apply to those who have already commenced a pension prior to 1 July 2007.

What are the advantages?

Until you reach 60 any pension that you commence because of invalidity, retirement or as a transition to retirement pension is taxable.  However, if your pension commenced with non-deductible contributions then a part of your pension will be tax free.  The tax free amount is called your deductible amount and is calculated as your non-deductible contributions divided over your life expectancy or the term of your pension.

However, if you decide to commute your pension, that is, convert it to accumulation phase, and then commence a new pension from 1 July 2007 a new way of calculating the tax free amount applies.  In most cases we have seen, the result is a higher tax free amount.

What Makes up your Tax Free Component

Prior to 1 July 2007 your tax free component is the amount of your undeducted components/amount divided by your life expectancy or the term of the pension. 

However, from 1 July 2007 your tax free component/amount will be calculated as a proportion of your pension account balance.  If you are under 60 access to the new way of calculating the tax free amount can only be done if you commute your allocated pension and then commence a new account based pension.  After age 60 all of your pension is tax free.

How can it be done?

Let’s look at Beth who commenced an allocated pension on 1 July 2006 when she was age 56.  The balance of her account in her superannuation fund was $684,000 of which $290,000 were undeducted contributions.  At age 56 Beth’s life expectancy is 29 years.

As at 1 July 2006:

Beth’s maximum allocated pension is $684,000/11.4 = $60,000
Beth’s minimum allocated pension is $684,000/20.8 = $32,884
Beth’s tax free annual deductible amount is $290,000/29 = $10,000

Beth decided to take a maximum allocated pension of $60,000 which means that her taxable pension was $50,000 ($60,000 – $10,000).  That is, the amount of her allocated pension less the deductible amount.

As at 1 July 2007 the balance of Beth’s pension account, assuming 7% earnings, would be $667,680 and the balance of her undeducted contributions would be $280,000 ($290,000 - $10,000).

Starting an Account Based Pension from 1 July 2007

If Beth commuted her pension on 30 June 2007 and commenced an account based pension from 1 July 2007 then the tax free amount of her new account based pension, calculated as a percentage of the account balance, would be calculated as:

$280,000/$667,680 = 41.93%

If Beth withdrew a pension of $60,000 then 41.93% or $25,161 would be tax free.  This means the taxable amount of her pension would now be $34,839.
 
By commuting the allocated pension and commencing an account based pension the tax free amount of Beth’s pension increases from $10,000 to $25,161.

What are your options?

Option 1: Do Nothing

Simply continue to operate your existing income stream

Option 2: Elect to transfer

Under the simplified super system you can elect to transfer your existing pension to the new system.  This will remove the maximum and minimum calculations however it will require you to take a minimum of 4% (depending on your age) plus as much as you like of the rest.

Option 3: Commute to an Account Based Pension

On the 30th June 2007 you can commence an Account Based Pension which will need to be re-calculated based on the example of Beth above.  By commuting to an Account Based Pension you may be able to increase your exempt amount which could also benefit your estate planning on death.

We recommend you seek structural planning advice tailored to your own SMSF and personal situation to ensure that you make the most of the benefits available.