Defined benefit calculation requires strategic thinking: expert
Calculating the tax payable on a defined benefit fund under the new proposed $3 million super tax will require more strategic thinking, according to an industry expert.
Meg Heffron, director of Heffron, said there are two reasons why determining the new Division 296 on defined benefits will be “tricky” – first, a defined benefit doesn’t have a “balance” associated with it, and second, when a defined benefit is still building up in accumulation phase, there might not be any contributions going in that are specifically related to that member.
“When a member has a defined benefit pension, for example, the trustee has promised to pay a particular income stream for a predetermined period which is often for life and the pension will stop when the period comes to an end,” she said.
“Even though we might show account balances for members with these pensions in their SMSF, that balance is technically irrelevant to them. Their benefit is purely based on the promise made by their fund.”
Heffron clarified that the balance referred to isn't utilised for calculating their total super balance, particularly in APRA funds offering defined benefits, where members don't have a specific balance reported to the ATO.
“Historically, the amount used for their total super balance has been the value for transfer balance cap purposes that was reported when their pension first started which was 16 times the next year’s annual pension payment for lifetime pensions,” she said.
“The new regulations needed to come up with a method to place a more realistic value on the pension for total super balance purposes.”
Heffron said that regarding a defined benefit in the accumulation phase, it should be able to pay the benefit when it becomes due if it is funded by an employer or the government.
“They might put in a lot of contributions in some years, and not much the next. It’s quite different to the more common style of super where an amount clearly gets added to a member’s super balance,” she said.
“So again, the government needed to come up with a way of calculating that for Division 296 purposes.”
Heffron added that the key impact of the regulations for defined benefit pensions is to start with the family law value or, how the pension would be valued if the member’s relationship had broken down and a value was needed for their super.
Alternatively, instead of relying on the default family law value, the fund's trustee can opt to engage an actuary to assess and certify the pension's value. However, this approach may have limitations, especially if the actuarial valuation is required to fall within a narrow range of 90–110 per cent of the family law value anyway.
“The family law value for a defined benefit interest is calculated using regulations to the Family Law Act which sets out both a methodology and a range of factors,” she said.
“For pensions, the concept is the same as the method used for transfer balance account purposes - annual payment multiplied by a factor, however, the factor is much more nuanced and is not 16 for everyone regardless of age and the features of the pension.”
She continued that for defined benefit super interests that are still accumulating, there may already be regulations in place to value these and in cases where there are none, larger interests will also default to the family law value.
“However, there is an extra test to weed out accumulating interests that aren’t worth much yet. Essentially if the ‘vested benefit’ is less than $1 million, it can be used instead of the family law value,” she said.
“The vested benefit is the amount the member would receive if they terminated their interest. Often, in a defined benefit fund, the vested benefit at a point in time is less than the ‘underlying’ value of the ultimate benefit.”
