Delaying pensions for TBC increase ‘not a given’ for all clients
While delaying pensions to access the full transfer balance cap indexation sounds attractive, mathematical modelling shows it’s not always the right answer, an actuary has explained.
Speaking at the SMSF Association National Conference, Heffron managing director Meg Heffron said with the general transfer balance cap set to index to $1.9 million from 1 July, many SMSF professionals have been grappling with the question of whether clients should delay starting their pension.
Ms Heffron explained if the client hasn’t started any pensions yet but are thinking about doing it now, SMSF professionals will be thinking about whether they should wait.
While the conventional wisdom is to wait, said Ms Heffron, some of the modelling with the numbers reveals it’s not that straightforward.
“If you wait and don’t start a pension now for a client, then they’re missing out on the opportunity to put $1.7 million into pension phase. The cost of that is that they could have had exempt current pension income this year and they won’t,” she explained.
“The amount of exempt current pension income really depends on how much of the year they’ve got left.”
She gave an example of a client with $2 million in super, who are the only member in the fund, and they start a pension with $1.7 million now.
The actuarial percentage for that client would be roughly around 30 per cent, she said.
“In terms of the exact size of the percentage, you would probably need to ask an actuary almost every time because it depends on the size of the fund and all those sorts of things.”
Using a very rough calculation, Ms Heffron explained that the $1.7 million is being converted into pension phase.
“Now let’s say the income component of the fund’s return is about five per cent. Income component [refers to] anything the fund will pay tax on so interest rates, dividends, franking credits, and capital gains that have been realised.”
“Putting the money into pension means you don’t pay tax on it so you say 15 per cent so you’d save $4,250. So that’s the cost of waiting versus the benefit of starting now.”
Ms Heffron noted this is not how the calculation would actually work but provides an approximation.
“The benefit of waiting of course, is slightly harder to determine. I know that conceptually the benefit is that I have a bigger pension so I get more ECPI in the future but it’s a really long range thing that we have to model out.”
Ms Heffron noted that while there is an immediate cost to not starting the pension straightaway, the benefit of waiting emerges over a longer period of time.
The number suggested that over time the client would be better waiting even with four months to do.
“However, the numbers are almost trivial so I’d almost say that it’s not crazy to stick with your original plans and start a pension now. Don’t assume that delaying is the right answer,” she stated.
She also noted that the numbers may be different if the fund had a very large capital gain, even well before the pension was started.
“So instead of having income over the year that was $100,000, it was $300,000 which makes the cost of delaying three times as big.”
“If you’ve made a large capital gain already, it may be absolutely worthwhile starting the pension now, even though the client’s not going to get any indexation.”
Ms Heffron said the key thing for SMSF professionals to be aware of is that delaying the pension isn’t necessarily a given in terms of getting the best outcome for the client.
“It’s conceptually attractive, wait and you’ll get a bigger pension but mathematically it’s not necessarily a given.”
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.