Speaking to SMSF Adviser, DBA Lawyers director Daniel Butler said in June this year the ATO uploaded some materials to its website in QC 51875, which states that the trustee of super fund can hold assets in reserve that support a flexi-pension which exceeds the maximum amount that can be regulation 1.06(6) of the Superannuation Industry Regulations 1994 (SISR).
“Where the flexi-pension has been commuted in full, the trustee may, subject to the deed, allocate the excess amount from the reserve to all the members of the fund in a reasonable manner, and any allocation above the five per cent amount is to be treated as a concessional contribution cap,” Mr Butler explained.
While there is no express materials from the ATO which explain its position in relation to lifetime pensions, based on recent discussions with the ATO, Mr Butler said the ATO will also take this position where a trustee commutes their lifetime pension or their flexi-pension.
“That means the reserve that’s left over can be applied to other members of the fund, subject to that five per cent rule,” he said.
There has been concern among SMSF practitioners and trustees, he said, that where one of these pensions has been commuted, it will result in a reserve amount becoming trapped because of the way the regulations operate.
“[However], the ATO has said that you can allocate that across to members in a fair and reasonable manner where it doesn’t exceed that five per cent amount, and it won’t count towards your concessional cap,” he explained.
“Given this clarity from the ATO, people with these pensions should really take stock and work out whether it’s the right time to move across to a more modern form of pension,” he said.
It may be best to deal with these pensions now he said for the estate planning implications.
“People with these pensions are getting older and if they do pass away, then what’s going to happen with their pension and their reserves if they have a defined benefit pension?”
In response to the last question in this article, a deceased person with a lifetime pension has zero value by definition (if no reversion). At all times prior to this, it has a prospective value based on both the person’s life expectancy and interest rates. However, the ATO’s definition of a cap or limit is by reference to a prevailing account balance. This is a retrospective approach and therein creates complication and confusion in the system. Prospective lifetime valuations are a relatively simple exercise for those trained in such methods, i.e. actuaries.
The problem is there may be no other members or other SMSF accounts to apply the 5% route for reserve usage to all accounts. The lifetime 1.06(2) can go to market linked will full monies backing the legacy pension. The 1.06(7) life expectancy with its commutation limit are problematic. The alternative use of allocation of grossed up amount subject to the $25,000 cap can be used – but not both the 5% to all accounts plus the grossed up allocation in tandem. I understand it does not need the work test – not regarded as a contribution (doesn’t increase size of fund) but still counts against contribution cap – unless the ATO have changed their approach again!!
The better process would be to transfer the surplus into a pension reserve for the pension member only rather than spread it around other members. This may breach the sole purpose test looking at the Commissioner’s guidance on reserves. In a pension reserve it may be allocated pursuant to the concessional contributions exemptions under Income Tax Assessment Regulation 291-25.01(4)(b).
The better process would be to transfer the surplus into a pension reserve for the pension member only rather than spread it around other members. This may breach the sole purpose test looking at the Commissioner’s guidance on reserves. In a pension reserve it may be allocated pursuant to the concessional contributions exemptions under Income Tax Assessment Regulation 291-25.01(4)(b).