Emerging strategy with certain legacy pensions
Recent regulations introduced aimed at addressing the perpetual excess transfer balance issue for certain legacy pensions may provide a new strategic opportunity.
In this article we detail the preliminary ‘ins and outs’ of the strategic opportunity provided under the new laws.
Is this opportunity to do with last year’s Budget announcement?
No. This opportunity does not stem from last year’s Federal Budget announcement.
How does the opportunity work?
Who is covered?
Firstly, the opportunity applies to:
- complying lifetime pensions (ie, pensions paid pursuant to reg 1.06(2) of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR));
- life expectancy pensions (ie, pensions paid pursuant to reg 1.06(7) of the SISR); and
- market linked pensions, also known as term allocated pensions (ie, pensions paid pursuant to reg 1.06(8) of the SISR);
that were in existence before 1 July 2017. These are called ‘capped defined benefit income streams’ (CDBISs).
Why is a large market linked pension (term allocated pension) such an issue?
Predominantly, a market linked pension rarely suits the needs of an SMSF member anymore. They are inflexible and usually relate to legacy planning under long since repealed laws.
Many market linked pension recipients would rather exchange at least some of that pension for an accumulation account where they can withdraw lump sums as needed.
In addition, there are also tax issues.
Consider an SMSF market linked pension that is funded by $10 million of assets. Presumably this market linked pension was in existence before 1 July 2017 (ie, it is a CDBIS). If the pensioner is now 80 years old it is possible that in the current year the pensioner must receive at least $316,678.40 of pension payments. And, if it weren’t for the current 50% COVID19 pension draw down relief, the pension minimum would be $633,356.79!
Even if the market linked pension is funded 100% by the tax free component, this will lead to a significant amount of personal assessable income for the pensioner. In the current year presumably it will lead to $105,214.20 of assessable income (calculated as 50% x [$316,678.40 less the pensioner’s defined benefit income cap, which presumably is $106,250]). Further, in years when the current 50% COVID19 pension draw down relief does not apply, it will probably lead to $263,553.40 of assessable income (or realistically even more since the pensioner will be older by then and thus the minimum pension payment will be higher).
Accordingly, a large market linked pension causes a significant personally income tax liability.
Why are ‘reserves’ such an issue?
Much like a market linked pension, a CDBIS with reserves (eg, a complying lifetime or a life expectancy) rarely satisfies the needs of the pensioner anymore. Rather, such a pensioner would also typically much rather exchange at least some of that pension for an accumulation account.
Further, the personal income tax referred to above would also occur for a large complying lifetime pension or a life expectancy pensions too.
Also, there is a significant succession planning issue.
Consider an SMSF that is currently paying a (CDBIS) complying lifetime pension to member. The assets supporting the pension including associated ‘reserves’ are valued at $3 million.
Naturally, the ‘reserves’ pose a significant issue. In Self Managed Superannuation Fund Regulator’s Bulletin 2018/2 the ATO say that the amounts supporting that pension are reserves for taxation law purposes however they are not reserves for superannuation law purposes (see paragraphs 24 and 25 respectively).
If this ATO view is correct, the implications of this presumably would cause a massive succession planning issue. If taken to its logical conclusion, this means that upon pensioner’s death:
- the $3 million in the SMSF that was supporting the former complying lifetime pension must be cashed ‘as soon as practicable’ (ie, because this amount is not a general reserve for superannuation law purposes) but
- there are presumably $3 million of concessional contributions and thus the deceased estate presumably has at least $2,972,500 of assessable income … and other negative implications too.
The mechanisms of the opportunity
On Monday 4 April 2022 the Government registered the Treasury Laws Amendment (Allowing Commutation of Certain Income Streams) Regulations 2022 (Cth). The exact mechanisms of the new provisions that the regulations introduction are somewhat complex.
However, at their core, they operate as for follows. Consider a $10 million CDBIS that is now (ie, after 4 April 2022) converted into a $10 million market linked pension. The regulations then allow typically $8.4 million of that market linked pension to then be converted into, among other things, an accumulation account after certain restructuring and other steps are taken.
Is it really that simple?
No. The conversion from the original CDBIS referred to above will first trigger an excess transfer balance (broadly pursuant to the CDBIS pension being converted into a non-CDBIS pension as a preliminary step). Moreover, before any relief is available, the Commissioner will need to provide a excess transfer balance determination and other steps need to be taken in response to this determination. Naturally, the excess transfer balance regime has its own implications that must be considered and managed.
Of course, one way to help address this aspect would involve seeking to implementing the conversation within very strategic timelines.
Furthermore, there are other considerations, including:
- Other taxation laws
- Succession planning
- Social security and
- Other laws (eg, navigating the AFSL regime).
Subject to these above aspects, the opportunity provided under the new law could result in the member potentially having:
- No further assessments in respect of pension income above the defined benefit income cap; and
- Flexibility regarding the $8.4 million being retained in super or paid outside the superannuation environment.
For more details
We will cover this opportunity in great detail in a webinar to be held on Thursday 28 April 2022.
By Bryce Figot, special counsel and William Fettes, senior associate, DBA Lawyers