The transition to retirement income stream (‘TRIS’) entered a new era on 1 July 2017 where most members will want their TRIS to enter retirement phase as soon as possible to gain access to an earnings tax exemption. A new law has provided a roadmap for this TRIS reclassification, but tips and traps still exist. Additionally, the new law and supporting material appear to have cemented a somewhat surprising government and ATO position that a TRIS can be never actually become an account-based pension (‘ABP’), even when a person meets a condition of release with a nil cashing restriction. We discuss these points below.
Rationale for the TRIS
The rationale for initially introducing the TRIS was to provide people with some limited access to their superannuation monies (in the form of a pension) upon attaining their preservation age, without the person needing to retire. Prior to 1 July 2017, there were many who have sought to commence a TRIS on attaining preservation age. During this period, a fund was typically exempt from the usual 15 per cent income tax in respect of the earnings on assets supporting the TRIS. However, from 1 July 2017, earnings on assets supporting a TRIS are typically no longer eligible for the exempt current pension income exemption (pension exemption). Only retirement phase pensions, such as ABPs, will be eligible for the pension exemption. In particular, a TRIS is expressly excluded from being in the ‘retirement phase’ under s307-80(3) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’). In explaining these changes, the explanatory memorandum to the Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 (Cth) (the formal explanation that accompanied the 2016 law changes) states:
14.273 TRIS were intended to help older workers transition to retirement by allowing them to access their superannuation to supplement a reduction in their salary from working fewer hours. In practice these arrangements are used almost exclusively to reduce tax payable without a reduction in working hours, and to take advantage of the tax-free earnings in retirement phase.
14.274 Reducing the tax concessional nature of TRIS would ensure they are fit for purpose and not primarily accessed for tax minimisation purposes.
New law allows TRIS to enter retirement phase The Treasury Laws Amendment (2017 Measures No. 2) Bill 2017 (‘TLA No 2 Bill’) was passed on 15 June 2017 and received royal assent on 22 June 2017. The new law is premised on the assertion in the explanatory memorandum that a ‘superannuation income stream that is established as a TRIS will always retain its character as a TRIS [and a TRIS is prevented from being] in the retirement phase even after the holder later satisfies a condition of release with a nil cashing restriction’. However, the new law fixes this problem by allowing a TRIS to enter retirement phase (and gain the pension exemption at the fund level) when the member:
- Meets the condition of release ‘retirement’ and notifies the trustee;
- Meets the condition of release ‘terminal medical condition’ and notifies the trustee;
- Meets the condition of release ‘permanent incapacity’ and notifies the trustee; or
- Attains age 65 (with no need to notify the trustee).
The changes to the law relate to the ‘retirement phase’, but they do not change the definition of a TRIS or an ABP under superannuation law.
Entering the retirement phase brings the pension exemption but also brings the pension within the transfer balance cap regime. The fact that no notification is required when attaining age 65 means that careful planning ahead of time is a must, since attaining age 65 will give rise to an automatic credit to the transfer balance cap, without notice. This can give rise to an excess transfer balance tax assessment where a member’s TRIS account balance exceeds their $1.6 million personal transfer balance cap (as indexed in future years).
For the other conditions of release the ATO has confirmed that some form of written notice is required to be given to the trustee before a TRIS counts as being in the retirement phase. Constructive notice or knowledge is not considered sufficient for SMSFs. This is a hurdle to pass before the pension exemption can apply, but it also prevents transfer balance cap credits arising before the trustee is ready.
Under the new law and the ATO’s analysis, even though SMSF members will typically be the same people as the trustee or directors, TRIS recipients will need to notify the SMSF trustee in writing in order to get the pension exemption (other than those who turn 65). That is, simply meeting conditions of release is not enough to allow a TRIS to enter retirement phase. The law also requires notification. A legal personal representative of a member can also write to the trustee on the member’s behalf. This should ideally also be authorised by the SMSF deed.
For those with larger TRIS balances preparing to move into full retirement phase, careful planning and documents are needed when reducing TRIS balances in anticipation of the transfer balance cap. In particular, reducing TRIS balances early in anticipation may not be sufficient if later growth in TRIS assets causes an excess transfer balance when retirement phase is actually entered.
Does the 10 per cent TRIS maximum still apply?
The ATO takes the view that the commutation restrictions and 10 per cent maximum annual payment limit fall away automatically under the statutory definition of a TRIS (see the ATO web page ‘Super changes – Frequently asked questions’ (QC 51875)). However, under some pension documents, these restrictions remain hardwired into the rules for trust law and/or contract law purposes. The newly passed law only allows a TRIS to enter retirement phase for tax law purposes and does not vary the hard-wired requirements of certain deeds and TRIS documents (which can also prescribe TRIS rules). In order to not be in breach of one’s own documents, a deed of variation that removes the TRIS requirements is typically needed.
Does the TRIS become an ABP when it enters retirement phase?
While the ATO takes the view that the TRIS specific requirements can fall away automatically on meeting a full condition of release, the ATO does not accept that a TRIS can convert to an ABP. The ATO states on its web page ‘Super changes – Frequently asked questions’ (QC 51875):
Our view is that the current law does not facilitate an ‘auto conversion’ of a TRIS to a different or new pension or income stream. The same TRIS continues on and remains a TRIS until such time as it ‘ceases’.
The law currently provides that once a nil cashing restriction condition of release is met, the limitations of a 10 per cent annual maximum payment and commutation restrictions are no longer applied.
Further, the explanatory material to the law introducing the TRIS retirement phase rules states (explanatory memorandum to the TLA No 2 Bill):
1.131 As a superannuation income stream that is established as a TRIS will always retain its character as a TRIS, the restriction introduced as part of the Amending Act would always prevent TRISs from being in the retirement phase even after the holder later satisfies a condition of release with a nil cashing restriction.
Limitations for succession planning
The above strongly suggests that the somewhat surprising latest ATO and Treasury view is that a TRIS cannot be converted to an ABP. To our knowledge, this concept that ‘once an income stream is established as a TRIS will always retain its character as a TRIS’ was only first broached when changes were included in TLA No 2 Bill, which was introduced into Parliament on 24 May 2017 (or some may have had access to the exposure draft Bill and explanatory memorandum during the consultation process during April 2017).
This change in ATO and Treasury view, if it is correct, will have serious succession planning consequences. Take for example a person who is 65 and in receipt of a TRIS that is in retirement phase. This TRIS never effectively converted to an ABP (assume that this is indeed impossible). On the death of the recipient, the TRIS is automatically reversionary to a reversionary beneficiary. The reversionary beneficiary has not met any condition of release. Due to the specific drafting of the new retirement phase rules, the TRIS will automatically cease to be in retirement phase because the recipient has not met any condition of release. This will cause problems for the pension earnings tax exemption as well as for reg 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) which requires that death benefit pensions must be pensions in the retirement phase.
One alternative under this latest ATO and Treasury view to overcome potential regulatory issues is for the TRIS to be commuted during the member’s lifetime and a new ABP commenced that could be reverted for the survivor. If the survivor receives a reversionary ABP, there is no need to satisfy any condition of release as that condition was satisfied on the member’s death.
Thus, under this latest ATO and Treasury view the actual documents that are used will have a substantive difference on the outcome where the recipient has not satisfied a relevant condition or release (e.g. the recipient has not attained their preservation age). In summary:
- An ABP can revert and the recipient obtains a pension in retirement phase without having to satisfy any condition of release (with the fund obtaining the pension exemption).
- However, if the member does not undertake a commutation of their TRIS and commence a new ABP during their lifetime, the recipient who has not satisfied a relevant condition of release would not be able to receive a reversion of that TRIS. The fund could, however, commute that TRIS (or treat the TRIS as having ceased on the member’s death) and commence a new ABP for the recipient so that the recipient can be in retirement phase.
Under this latest ATO and Treasury view, there is considerably more work and fees for advisers as you can see the above scenario is quite onerous, typically quite costly and may come with other adverse consequences. It will also typically require the assistance of an adviser who has an Australian Financial Services Licence who can provide a statement of advice; another potential further cost.
Naturally, it would be far more efficient and simpler if the ATO accepted that a TRIS could convert to an ABP without ceasing as the law has been operating for many years. In particular:
- A TRIS by definition is actually an ABP with additional restrictions, accordingly it seems highly unusual that a TRIS should be prevented from becoming an ABP. As discussed above, the ATO accepts these restrictions fall away on a relevant condition of release being satisfied.
- If the governing rules of the fund and related pension documents provide for the rules of an ABP once a relevant condition of release with a nil cashing restriction is met, the income stream meets the definition of an ABP regardless of whether it commenced as a TRIS originally.
- There is no express provision in the legislation that precludes the conversion of a TRIS to an ABP. One would have expected express wording in the legislation if there was an intent to change long established industry practice that was initiated by the Explanatory Statement to the Superannuation Industry (Supervision) Amendment Regulations 2007 (No. 1). There have been no relevant changes to the definition of a TRIS or an ABP in the Superannuation Industry (Supervision) Regulations 1994 (Cth) that would support the conclusion that a TRIS cannot be converted to an ABP. In particular, our understanding is that TRISs have since 1 July 2007 been able to convert to an ABP and this has been undertaken on a widespread basis in the SMSF industry.
This conversion practice became quite popular following the super reforms that occurred in mid-2007 aimed at ‘crystallising’ a tax-free component in respect of a pension (broadly, the then pre-1983 component); which was typically then an allocated pension. Following the mid-2007 reforms, members were permitted to convert their allocated pension (which were phased out with no new allocated pensions being allowed to commence after 19 September 2007) to an ABP without the need to first commute their original allocated pension back to accumulation to commence a new ABP (and therefore be subject to the proportioning rule on the commencement of the new ABP). Instead, the member could convert straight across from their allocated pension to a new ABP. In this regard, the Explanatory Statement to the Superannuation Industry (Supervision) Amendment Regulations 2007 (No. 1) made the following comment:
The new minimum standards [being the payment rules for an ABP] will not be restricted to income streams which commence on or after 20 September 2007. This means that existing allocated pensions will be able to operate under the new minimum payment rules from 1 July 2007 without the need to commute and restart the pension.
While the new law gives a mechanism for TRISs to enter retirement phase, the ATO does not appear at this stage to accept that a TRIS can convert to an ABP. However, the points outlined above do support that a TRIS can convert to an ABP. Hopefully the ATO will eventually accept this view or legislative clarification will eventuate to clarify the uncertainty caused from the recent changes that passed as law in June 2017. We understand that a number of professional bodies are still seeking to clarify this point.
Daniel Butler, director and David Oon, senior associate, DBA Lawyers