Are there limits to an amount that can be commuted?

“This ability to commute the pension is vital for management of a super balance when in pension phase,” Mr Hallinan said.

“It permits the pension to be rolled over to another superannuation entity to avoid being locked into a particular superannuation fund and can assist in estate planning in relation to super balances.”

The legislation governing account-based pensions imposes only one limitation on pension commutations to ensure that they cannot be used to bypass the pension drawdown rule.

For a pension that is partially commuted, the limitation is that the balance of the pension account must be sufficient to satisfy the minimum drawdown requirement.

This requirement considers any pension payments already made in the financial year before the partial commutation.

If a pension is fully commuted, the limitation is that sufficient pension payments must have been made at or before the full commutation to satisfy the minimum drawdown rule pro-rated to the date of commutation.

This regulation also takes into account any pension payments already made in the financial year before the full commutation.

Mr Hallinan illustrated how these limitations apply using a fictitious client Peter, who started an account-based pension on 1 July 2023 with a $300,000 balance. The minimum drawdown requirement is $15,000 given that the prescribed percentage is 5 per cent given Peter’s age at 1 July 2023.

“For a partial commutation the maximum Peter can commute is 95 per cent or $285,000,” Mr Hallinan said.

“This is because there must be at least $15,000 retained in the pension account to satisfy the minimum drawdown requirement.”

He added that if $6,000 in pension payment has been made before the partial commutation, the maximum commutation amount would be about 97 per cent of the account balance before commutation.

“The slight increase in the percentage amount arises because the pension account balance prior to the partial commutation is $294,000 as $6,000 had already been made,” he said.

“That means only $9,000 in pension payments needs to be made in respect to the balance of the financial year as these future pension payments, together with the pension payments already made, will equal $15,000.”

If Peter were to make a full commutation, he would have to consider the period from 1 July 2023 to the date of commutation compared to the entire financial year.

“If the commutation occurred on 30 September 2023, so the pension was payable for one-quarter of the financial year, the maximum commutation amount would be $296,250, or about 98.75 per cent of the pension account balance prior to the full commutation,” Mr Hallinan said.

The date of the full commutation is important because if a pension is fully commuted during a financial year, the minimum drawdown requirement is pro-rated for the number of days the pension was payable, which includes the date of commutation.

“So as the pension was payable for only 25 per cent of the financial year, the minimum drawdown requirement which applies is 25 per cent of the full year requirement which is $3,750,” he said.

Alternatively, if $3,500 in pension payments was made before 30 September 2023, then the maximum commutation amount to be paid would be $296,250 or about 99.91 per cent of the pension account balance immediately before the full commutation.

“Given the pro-rated drawdown requirement is $3,750 and already $3,500 of pension payments have been made, then only another $250 in pension payments need to be made to satisfy the (pro-rated) minimum drawdown requirement,” Mr Hallinan said.

“The slight increase in percentage is because only another $250 in pension payments has to be made given the pension account balance has been reduced by the previous pension payments.”