Prior to September 2004 the government allowed retirees to purchase a complying lifetime or fixed-term pension with the intention that if the pension was not commutable, the pension attracted special assets test exempt status for Centrelink treatment. These rules encouraged a lot of retirees, concerned to attract the full age pension or at least part age pension, to buy these products and many were set up within an SMSF environment because they provided an opportunity for the underlying capital to pass to a beneficiary on death. By comparison, complying pensions provided by institutional companies typically had no surrender value on the death of the member beyond a 10-year guarantee period.
With the aging population there is a growing number of retirees who set up these complying pensions within an SMSF who are now aged in their 80s. They are now facing the prospect of having to move into aged care due to ill health, and they need to access the assets forming the complying pension in order to fund the accommodation cost of aged care.
In some cases, clients have used up all of their other balances within their SMSF but still have significant assets held in the complying pension account. This usually occurs if the member’s account balance comprises shares when the annual actuarial certificates have nominated a conservative earning rate well below the share growth rate.
Commuting a complying pension income stream carries a number of significant risks and issues that need to be carefully navigated, including a detailed understanding of the rules of the fund, Centrelink guidelines and taxation regulations.
Subject to the rules of the fund, the conversion of a complying pension constitutes a breach of the pension payment standards set out in regulation 6.17C of the Superannuation Industry Supervision Regulations unless it is permitted under regulation 1.06. These regulations are complex and when read with Section 31 of the SIS Act restricts a complying pension income stream from being converted other than in limited circumstances. Failure to meet the tests under the regulations constitutes an administrative penalty breach of $3,600.
Further, the commutation of a complying pension for Centrelink purposes, unless it is a permitted commutation, gives rise to a Centrelink debt since Centrelink will recalculate the complying pension as if it did not have assets test exempt status for a period of up to five years. The assets test exempt status of the complying pension will be lost for age pension purposes, and for people moving into age care this could significantly impact the means-tested fee that is required to be paid by each resident in an aged care facility. The current maximum annual means-tested fee payable is $25,731 per resident.
Pre-2004 complying pensions were typically set up as either a life expectancy or term complying pension. If the term expired prior to the death of the pensioner any surplus funds within the member’s account balance were treated as an ‘unallocated reserve’ and in respect of these funds, treated as a superannuation account balance and subject to means testing and deeming.
Further, as a result of a recent ATOID 2015 /22 it is possible that the capital forming the complying pension if it is converted into, say, an accounts-based pension or simply cashed out of the fund to be treated as a concessional contribution and taxed at a member’s marginal tax rate for amounts paid in excess of the concessional contribution limit.
Converting a complying pension therefore requires consideration of the ITAA and, in particular, the operation of ITAA Regulation 292.25.01, and Sections 9A, or 9B of the Social Security Act and Centrelink policy regarding permissible commutation of the complying pension income stream. The rules are complex and differ for pensions commenced before 20 September 2004 and those between this date and 20 September 2007, when the government reduced the assets test exemption by 50 per cent. Essentially, for Centrelink and aged care purposes, commuting a complying pension without triggering a Centrelink debt is permitted if the funds are rolled over to another complying pension income stream unless there is a payment split under a divorce. Other exemptions include the payment of a superannuation surcharge, payment to a reversionary beneficiary on the death of the primary beneficiary, payment of a ‘hardship amount’ and closure of the fund due to administrative burden by reason of the age or incapacity of the member
There are, however, a number of strategies that can be employed to mitigate potentially adverse tax and administrative penalties as well helping to prevent a member losing the important assets test exempt status of the complying pension for Centrelink and aged care purposes. If the members are elderly and facing the imminent cost of aged care, it is possible to close the fund due to the ‘administrative burden’ exemption by reason of their age and rolling the funds into a retail complying pension, which would reset the ‘deductible amount’. This would not only retain the 100 per cent assets test exempt status of the pension for a period of time but because of the member’s reduced life expectancy, would result in the cashing out of the pension over a short period of time. Such a strategy might fit with a person wishing to pay an accommodation deposit in an aged care facility either as a lump sum refundable accommodation deposit (RAD) or as a daily accommodation payment (DAP) and RAD combination. As the annual means-tested fee is determined on the basis of the member’s financial investments at the time of entry into an aged care facility, retaining the assets test exempt status of the fund, at least until this point in time, could save thousands of dollars in the annual means-tested fee payable.
Chris Hill, principal, Hill Legal Lawyers