New regulations present planning opportunity for legacy pensions

The regulations allow the commutation of certain income streams for the purposes of meeting the superannuation transfer balance cap.

A joint article by DBA Lawyers special counsel Bryce Figot and senior associate William Fettes explained that following these regulations, there may be an opportunity for certain SMSF trustees with complying lifetime pensions, lifetime expectancy pensions, or market-linked pensions that were in existence before 1 July 2017.

These pensions are referred to as capped defined benefit income streams (CDBISs).

Mr Figot explained that market-linked pensions rarely suit the needs of an SMSF member anymore.

“They are inflexible and usually relate to legacy planning under long since repealed laws,” he stated.

“Many market linked pension recipients would rather exchange at least some of that pension for an accumulation account where they can withdraw lump sums as needed.

“In addition, there are also tax issues.”

Mr Fettes gave an example of an SMSF market-linked pension that is funded by $10 million of assets.

“Presumably this market linked pension was in existence before 1 July 2017 (i.e., it is a CDBIS). If the pensioner is now 80 years old it is possible that in the current year the pensioner must receive at least $316,678.40 of pension payments. If it weren’t for the current 50 per cent COVID19 pension draw down relief, the pension minimum would be $633,356.79,” he calculated.

“Even if the market linked pension is funded 100 per cent by the tax free component, this will lead to a significant amount of personal assessable income for the pensioner. In the current year presumably it will lead to $105,214.20 of assessable income (calculated as 50 per cent x [$316,678.40 less the pensioner’s defined benefit income cap, which presumably is $106,250]).

“Further, in years when the current 50 per cent COVID19 pension draw down relief does not apply, it will probably lead to $263,553.40 of assessable income (or realistically even more since the pensioner will be older by then and thus the minimum pension payment will be higher).”

A large market-linked pension causes a significant personal income tax liability, he warned.

However, Mr Figot explained that the way in which these new regulations operate might provide an opportunity to convert excess amounts into, among other things, an accumulation account once certain steps are taken.

He explained that if the client converts the $10 million capped defined benefit income stream into a $10 million market-linked pension, this will trigger an excess transfer balance, broadly pursuant to the CDBIS pension being converted into a non-CDBIS pension as a preliminary step.

“The Commissioner will need to provide an excess transfer balance determination and other steps need to be taken in response to this determination. Naturally, the excess transfer balance regime has its own implications that must be considered and managed,” he noted.

“The opportunity provided under the new law could result in the member potentially having no further assessments in respect of pension income above the defined benefit income cap and flexibility regarding the $8.4 million being retained in super or paid outside the superannuation environment.”

Mr Figot pointed out there are other important considerations, including social security, succession planning and other taxation laws.