Advisers told to take action on legacy pensions to prevent ‘nasty’ taxes
With many of the SMSF clients that hold legacy pensions getting older or reaching the end of their pension term, an actuarial firm has urged SMSF professionals to address these pensions now to prevent their clients from being hit with significant taxes.
Speaking to SMSF Adviser, Accurium general manager Doug McBirnie said that while there are probably only one or two thousand SMSFs left with defined benefit pensions, they’re presenting a lot of difficulties due to all the changes to laws and regulations over the years.
“It hasn’t been possible to actually start a defined benefit pension in an SMSF since 2005, so many of them are either at the end of their term or the members are at the point where estate planning is becoming a really salient issue,” Mr McBirnie said.
“However, when these pensions expire, that’s when we start to see all the real problems. The problem with these pensions is that when they were started, I don’t think many people realised that they were exchanging their capital for the right to an income stream, but when the pension ends, they no longer had any right to that capital.”
Clients that hold these pensions might believe that when they pass away, their beneficiaries will have access to the capital backing the pension, he said.
“However, if you take lifetime complying pensions, for example, they don’t provide a death benefit when the pensioner passes away, so any capital that is leftover, and often there’s a lot, remains in a reserve in an SMSF,” he warned.
“Getting access to the capital in that reserve poses a whole lot of problems, and that poses some nasty tax consequences as well.”
For clients stuck in this situation, they have to first allocate it to a member interest, and allocations from reserves to member interests generally count towards the member’s concessional contribution cap, he explained.
“If you exceed that cap then you’re left paying excess concessional contribution charges or you may even go above the non-concessional cap, which incurs even more penal charges,” he cautioned.
“In some of the cases we’ve seen, the amount paid to the estate is only around half of the capital because of all the tax that they’ve had to pay.”
Mr McBirnie said that there are some strategies that SMSF professionals can put in place to help eliminate some of the issues with these pensions.
“These complying defined benefit pensions are called non-commutable, but you are allowed to commute them in order to start another type of complying pension,” he said.
“There are a couple of complying pensions that you can still start as a market-linked pension or a complying annuity. While both of those are more restrictive than account-based pensions, the real benefit is that they have no capital left when they expire, they’re both term pensions or income streams and they both pay death benefits out.”
Whichever product they choose to go with, Mr McBirnie said that this removes all the issues with reserves being leftover when the pension expires.
“So, if we look at commuting now and starting with these new income streams, we can get rid of a lot of the problems that can arise before the pension expires,” he said.
“You may not be able to get rid of all the reserves because there are limits on how much you can commute for certain types of pensions, but you can certainly reduce the impact.”
Advisers who have clients with these pensions should be taking a look at them now, he said.
“It can be complicated, especially if there’s asset test exemptions involved, so make sure you speak to an expert or an actuary who knows what they’re talking about in relation to this topic.”