By Monica Rule

In Bulletin 508, I explained how the $1.6 million Transfer Balance Cap affects Self Managed Superannuation Funds (SMSFs).  In this article I will explain the things that SMSF members must consider, prior to 30 June 2017, in order to comply with the $1.6 million Transfer Balance Cap.

$1.6 million limit on retirement pensions

The $1.6 million limit is on pension accounts in the retirement phase. This is the total amount a superannuation fund member can have across all their superannuation funds.  So if an SMSF member is accessing an account based pension from their SMSF as well as accessing a pension from another superannuation fund, it is the total of all their retirement pensions added together that must not exceed the $1.6 million limit. 

In addition to this, from 1 July 2017, a Transition to Retirement Income Stream (TRIS) is no longer treated as a pension in the retirement phase as earnings from assets supporting a TRIS are no longer exempt from income tax but will be taxed concessionally at a maximum of 15%.

Things to consider

• Members with multiple pensions will need to choose which pension to commute if the total of their pensions exceeds $1.6 million.  Members under the age of 60 may prefer to commute the pension with the higher taxable component to minimise the tax payable on their pension income.  This is because members, who have reached their preservation age but are under the age of 60, pay tax on the taxable component of their pension at their marginal tax rate with a 15% tax offset.

• Members need to check if their pension commenced prior to 1 January 2015 so as to preserve any entitlements to the age pension and the Commonwealth Seniors Health Care card.  This is because, if the pension commenced prior to 1 January 2015, the pension was assessed under the old income test rule – which is based on a life expectancy formula that determines how much of the pension is assessed.  The formula works out the “deductible amount” which is the return of a member’s own contributions to fund the pension that is excluded from the income test.  Pensions commenced from 1 January 2015 are assessed under the new deeming rules.

• Members that are withdrawing the excess amount from their SMSF need to weigh up the benefit of the $18,200 tax free income threshold and their marginal tax rate compared to the 15% superannuation tax rate.

• Members need to consider the reduced $25,000 annual concessional contributions cap and the annual $100,000 non-concessional contributions cap and their ability to make further contributions into their SMSF.

• Even though the investment earnings of TRIS will be taxable from 1 July 2017, a TRIS can still be an effective way to access a member’s superannuation tax free (members aged 60 and over) if the member is working part time.  Also, as TRIS is not counted towards the $1.6 million transfer balance cap, there is no limit on how much a member can have in their TRIS.

Exceeding the $1.6 million Transfer Balance Cap

If on 1 July 2017, a member’s retirement pension exceeds the $1.6million limit, they can either remove the excess amount from their SMSF by paying a lump sum superannuation benefit or transfer the excess to their accumulation account.  Any excess of up to $100,000 will be disregarded by the Tax Office provided the member removes the excess from their SMSF by 31 December 2017.  This means, the member will be treated as not having an excess and the excess transfer balance tax will not be imposed on the notional earnings of the excess amount.

If a member does have an excess of up to $100,000, they should consider reducing their pension account to $1.6 million but not any lower.  This is because the member will never be entitled to any indexed increase in the transfer balance cap if they have either reached $1.6 million or exceeded the $1.6 million limit.

Things to consider

• Spouses with uneven superannuation balances may consider withdrawing money from their SMSF and giving it to their spouse so that their spouse can top up their superannuation balance.  A member who has reached the age of 65 can access their superannuation savings from their SMSF regardless of whether they are working or not. Members aged 65 will need to satisfy the part time work test (i.e. 40 hours over 30 consecutive days) to be eligible to contribute into their SMSF; and members aged 75 or over cannot make personal contributions into their SMSF.

• Couples that are accessing TRIS may also consider withdrawing the maximum 10% of their TRIS account and giving it to their spouse to top up their superannuation balance.  The spouse will need to satisfy the eligibility rules (as above) to make contributions into their SMSF.

• Couples can also consider splitting their concessional contributions.  This is where an SMSF member can split his 85% of concessional contributions with his spouse.  To be eligible, the spouse must not have reached their preservation age or, if they have, they need to be under the age of 65 and not retired from the workforce.  Members cannot split their non-concessional contributions.

• Members may wish to take advantage of the current non-concessional contributions limit of $180,000 per annum or the $540,000 using the two year bring forward rules while they still can.  The annual cap will be reduced to $100,000 and the transitional bring forward non-concessional cap reduced to $480,000 or $380,000 depending on when the member triggered the bring forward cap.

Commutation of pensions

In Bulletin 508, I outlined the various items that count as a debit towards a member’s transfer balance account. One I mentioned is an amount commuted out of the pension account.  The term “commutation” is used when an income stream (i.e. pension) is converted to a lump sum.  Once it is converted to a lump sum, it can be used to pay out a lump sum superannuation benefit, rolled over to another superannuation fund, or added to the member’s accumulation account. 

Considering a member can only have up to $1.6 million in their retirement pension account, it is more important than ever to use the correct terms when a member is accessing money from their retirement pension account.  This is because a pension withdrawal does not create a “debit” to the member’s transfer balance cap where a commutation does.  Reducing the member’s transfer balance cap will allow the member to access more pension in the future.

Take for example, on 1 July 2017 a member (aged 66) commences a pension from their SMSF with a net assets’ value of $1,200,000.  The $1.2 million will be recorded against their transfer balance account.   Then in December 2017, the member partially commutes their pension account by accessing a lump sum benefit of $45,000 in order to purchase a new car.  The commuted amount of $45,000 will be treated as a transfer balance debit and would reduce the member’s transfer balance account to $1,155,000 ($1,200,000 - $45,000).  This means, the member has the ability to commence another pension with $45,000.

If the member did not commute their pension by accessing a lump sum of $45,000, but instead accessed a larger pension of $105,000 (i.e. the minimum 5% pension payment of $60,000 + $45,000), the total pension of $105,000 would not create a debit to the member’s transfer balance account.

It is important to use the correct terminology when members are accessing money from their SMSF.  Otherwise, it can cause confusion for accountants and auditors, as well as members missing out on opportunities to put more money into their pension account.

SMSF members with more than $1.6 million superannuation balance

From 1 July 2017, SMSFs will no longer be permitted to apply the segregated method to determine their exempt pension income where a member has more than $1.6 million superannuation balance and the member is in the pension phase.  SMSFs that do not have any members who have exceeded the $1.6 million limit can continue to use the segregated method.

SMSF members may consider establishing a separate SMSF for their pension assets.  Although this still does not mean that the new SMSF can apply the segregated method, a similar result may occur from being unsegregated for an entire financial year where the SMSF is almost entirely in pension mode.

For example, a member that realises a significant capital gain on an asset in a separate SMSF may obtain a 100% exemption under the unsegregated method if the SMSF’s assets are wholly in pension phase.  However, having a separate SMSF may reduce the liquidity available to pay pensions from the SMSF as it is limited to its own assets.  Operating a separate SMSF may also give rise to additional operation costs.  You may also need to justify to the ATO that your reason for establishing a separate SMSF is not purely for tax minimisation purposes.

Transitional CGT Relief

The transfer balance cap measure includes transitional Capital Gains Tax (CGT) relief via a cost base reset.  Trustees can choose which assets they provide the relief to, provided the asset was held by the SMSF that is paying a pension prior to 9 November 2016 and the asset is held during the period 9 November 2016 to 30 June 2017. SMSF trustees can also decide to defer the payment of the tax until the asset is actually sold if they are applying the CGT relief under the unsegregated/proportionate method.  

Things to consider

• Members need to be careful in the case of a marriage split in that the deferred gains are not overlooked in valuing members’ superannuation savings. For example, if an SMSF has deferred notional gains on two assets under the transitional CGT relief, and those notional gains are realised in a financial year where the relevant assets are disposed of, then they need to be incorporated into the valuation of the member’s account. The problem is that, the deferred notional gain is related to the assets themselves and not related to the member of the SMSF at that time.  Therefore, if there is a marriage split, the SMSF’s accountant needs to take into account the notional gains sitting somewhere in the balance sheet of the SMSF.  By not taking it into consideration, a member’s superannuation interest could be overvalued.

• The decision to hold an asset in the pension account or the accumulation account should be based on the characteristics of the asset and should not be driven by the availability of the CGT relief. Maximising the amount in pension phase maximises the tax free returns that can be generated. Growth within a pension account is not counted towards the transfer balance cap.  Therefore, higher expected returns from growth assets will help sustain the level of pension income.   

  • Growth assets generally have the highest long term return expectations and therefore minimising the tax payable on these assets is more favourable by having the assets in the pension phase.  However, income may not be sufficient to meet the minimum pension payment.  Assets with higher expected returns also generally carry greater risk.

  • Assets that generate little or no income may be better in the accumulation account.  They will not affect the minimum pension payment cash flow requirement; whereas, assets with high cash flow income would be better in the pension phase to meet the minimum pension payment requirements.

  • Members must also consider when members in the accumulation phase are likely to commence retirement pensions and the likelihood of an asset being sold once the member is in pension phase.

 For Gold and Platinum members, please read on for examples of:

• How the indexation of the transfer balance cap is measured (Examples 1 & 2).
• How the excess transfer balance tax is imposed (Example 3).
• How the transfer balance cap is measured (Example 4).
• CGT relief and the segregated method (Examples 5, 6, 7, 8)
• CGT relief and unsegregated method (Examples 9 & 10).

Monica Rule is an SMSF Specialist and author or The Self Managed Super Handbook – Superannuation Law for SMSFs in plain English – www.monicarule.com.au

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

Related documents:

• Pension Pack for Self Managed Super
• SMSF - Deed Update
• Self Managed Superannuation Fund Deed
• Derivative Risk Statement for SMSF

Related webinars:

• Webinar Recording - Understanding The 2017 Superannuation Changes
• Webinar Recording - Tips And Traps For Property Investment In Your SMSF
• Webinar Recording - Pitfalls That SMSF Trustees Should Avoid
• Webinar Recording - Demise Of The Accountants’ Exemption - Walking The Line, Post 1 July 2016