NATIONAL SUPERANNUATION CONFERENCE

Transcription

1 NATIONAL SUPERANNUATION CONFERENCE Session 9B Written by: Lyn Formica Director McPhersons Stuart Forsyth Director McPhersons Presented by: Stuart Forsyth Director McPhersons National Division August 2016 Crown Conference Centre, Melbourne Lyn Formica & Stuart Forsyth, McPhersons 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

2 Lyn Formica & Stuart Forsyth Disclaimer This technical paper does not constitute financial product advice and is for general information only. It is written without taking into account any individual s personal objectives, situation or needs, and is not intended as professional advice. Any person acting upon such information without receiving specific advice, does so entirely at their own risk. The information contained within is based on our understanding of the relevant legislative provisions, APRA and ATO publications and policies and the continuation of the present law as at 19 July This technical paper has been prepared in summary form only and a detailed analysis of the law is not provided. There may have been changes to the relevant legislation since the date of preparation of this paper. Accordingly, the contents of this paper should be used as a practical reference only and no person should act on the basis of the information contained within it without further investigation and, if necessary, the taking of professional advice. McPherson Super Consulting Pty Ltd, its Directors and employees expressly disclaim any and all liability and responsibility to any person in respect of anything done or omitted to be done by any person in reliance wholly or partially on this publication. Authorisation under an Australian Financial Services Licence (AFSL) is not required in the provision of this technical paper. McPherson Super Consulting Pty Ltd is not acting in its capacity as an Authorised Representative of McPherson & Associates Pty Ltd (AFSL ) when providing this paper. Part IVA & Division 290 Although the ATO has issued rulings in respect of various strategies discussed within this paper, it should be noted that a combination of several strategies (each of which has been accepted by the ATO as not Part IVA) may, because of the combinations, be regarded as a Part IVA strategy when considered together. Further, such strategies should be considered in light of the promoter penalty laws in Division 290 of the Tax Administration Act. Copyright Strictly reserved. No part of these notes may be reproduced or copied in any form or by any means (graphic, electronic or mechanical, including photocopying, recording, taping, or information retrieval systems) without the written permission of McPherson Super Consulting Pty Ltd. Glossary of Abbreviations ABP Account Based Pension AFSL Australian Financial Services Licence APRA Australian Prudential Regulation Authority ATO Australian Taxation Office ATO ID ATO Interpretative Decision BDN Binding Death Benefit Nomination CGT Capital Gains Tax CSHC Commonwealth Seniors Health Card ITAA 1997 Income Tax Assessment Act 1997 ITAA Reg Income Tax Assessment Amendment Regulations 2007 PDS Product Disclosure Statement QC Quick Code (for referencing publications on ATO website) SIS Superannuation Industry (Supervision) Act 1993 SIS Reg Superannuation Industry (Supervision) Regulations 1994 SMSF Self Managed Superannuation Fund SMSFD Self Managed Superannuation Fund Determination TR Taxation Ruling TRIS Transition to Retirement Income Stream Lyn Formica & Stuart Forsyth, McPhersons

3 Lyn Formica & Stuart Forsyth CONTENTS 1 PENSION ISSUES Lifecycle of a Pension When Does a Pension Commence? When Does a Pension Cease? Failure to Satisfy Pension Standards Minimum Pension Underpaid Maximum Pension Limit Exceeded Commutation of the Pension Death of the Pensioner Fund Tax Exemption Contribution Notices Contribution Splitting Documentation Transition to Retirement Income Streams Conversion to Normal ABP Part Year Commencement Order of Cashing Consequences of Drawing More than 10% Payments which meet Minimum Payment Rules but are taxed as Lump Sums Additions to Pensions Age Pension/Centrelink Impact of Stop & Restart Age Pension Grandfathering Commonwealth Seniors Health Card Grandfathering Examples of Common Pension Addition Scenarios Stop and Restart on 1 July Effect of Small Contributions Timing of Contributions Ceasing/Commuting Pensions Reversionary Nominations Still Worthwhile? Nominating Post Pension Commencement Lyn Formica & Stuart Forsyth, McPhersons

4 1 PENSION ISSUES In preparing this material we are conscious that the detail in the paper covers existing issues, rather than the details of the Budget 2016 changes. There is a simple reason, the fact sheets released by Treasury on 3 May 2016 contain the currently available details. With a proposed start date of 1 July 2017, all of the existing pension issues apply at least for the current financial year. It is our view that existing arrangements should be reviewed so that advisers can prepare for 1 July The first step in preparing for these changes is to analyse what is already in place. Starting now will give your clients the best chance of maximising outcomes. In our work, we see pensions where the administrators have no paperwork, where trustees have treated a market linked pension as an account based pension or treated a transition to retirement pension (TRIS) as an account based pension. The proposed changes are unlikely to lessen the consequences of failure, there is a considerable risk that the consequences will increase. Of particular note are whether existing TRISs are in fact account based pensions and the existence of multiple pensions, especially from multiple funds, where the pensioner s account balance will exceed $1.6 million on 30 June We hope this material assists you in your review work. 1.1 Lifecycle of a Pension When Does a Pension Commence? In the ATO s view, in most cases, a pension cannot start until [TR 2013/5 paras 9 to 13]: all of the amounts which are to support the pension have been added to the member s interest in the fund, by way of contribution or rollover, and both the member and the trustee have agreed to the terms and conditions on which the pension will be paid. The pension will then be said to commence on the date specified as the pension s commencement date in the fund s trust deed, product disclosure statement (PDS) or the pension terms agreed between the member and trustee. Example 1 On 9 July 2016, Mary applied to receive an account based pension from the XYZ Superannuation Fund. The fund s trust deed specifies that a pension will commence on the first day of the month after the member s application is received. Therefore Mary s pension commenced on 1 August Lyn Formica & Stuart Forsyth, McPhersons

5 Example 2 On 1 July 2016, Robert requested in writing the commencement of an account based pension from his self managed fund. On the same day, Robert (as sole director of the corporate trustee of the fund) agreed to that request. The fund s trust deed states that a pension commences when the beneficiary and trustee agree. Therefore Robert s pension commenced on 1 July Pension commencement documentation which specifically includes both a request by the member for the commencement of a pension, and a subsequent trustee resolution agreeing to that request is recommended. The ATO s ruling on pensions also emphasises the important role a PDS can play in the commencement of a pension [TR 2013/5 para 76]. Many advisers choose to not issue a PDS to members who commence a pension from a SMSF as such funds are offered an exemption from the PDS requirements of the Corporations Act However, the PDS is an important document in explaining how a pension will operate and is critical in cases where the pension provisions in the fund s trust deed are not overly prescriptive (as is the trend these days to avoid regular amendments to the deed). Note, if the only evidence is payment, there is a risk that the first date of pension payment will be the commencement date When Does a Pension Cease? In the ATO s view, a pension will cease when there is no longer a member who is entitled, or a beneficiary of a member who is automatically entitled, to be paid payments from the pension account [TR 2013/5 para 14]. The ruling covers a number of common situations in which the ATO believes a pension will cease, some of which are detailed below Failure to Satisfy Pension Standards Whilst payments from account based pensions are not fixed, the payments must meet certain minimum levels [SIS Reg 1.06(9A(a)]. These limits are recalculated on commencement of the pension and on each 1 July thereafter as a percentage of the pensioner s balance at that time. It is the ATO s view that a pension will cease for income tax purposes if the fund fails to pay to the pensioner the required minimum annual payment [TR 2013/5 para 18, paras 96 to 101]. Further, the pension is considered to have ceased at the beginning of the relevant income year with the following tax consequences: the fund loses its claim for exempt pension income in respect of that pension account for the entire income year, any payments actually taken from the pension account in that year are treated as lump sum withdrawals, and if the minimum pension requirement is satisfied in the following income year, a new pension is said to have commenced from the start of that following year. Example 3 Bill is a member of the JKL Superannuation Fund (a SMSF) and has commenced an account based pension. The minimum annual payments were made to Bill during the first two income years in which the pension was payable. Lyn Formica & Stuart Forsyth, McPhersons

6 At the start of the third income year the trustee for the JKL Superannuation Fund calculates that the minimum annual payment they will be required to make under clause 1 of Schedule 7 of SIS is $1,000. During the third income year, the trustee of the JKL Superannuation Fund makes a single payment to Bill of $50. As this is less than the minimum annual payment required, the pension has not met the requirements of SIS for the third income year. The pension ceases for tax purposes at the beginning of this income year, and the $50 payment to Bill is a superannuation lump sum. If the minimum payment requirements are again met in the fourth income year, this will result in the commencement of a new pension for Bill MINIMUM PENSION UNDERPAID One of the questions which resulted from this publication of the ATO s view concerned those funds where the minimum amount had been short-paid by only a small amount. Could/would the ATO exercise discretion to overlook the shortfall? In response to industry requests, the ATO has issued guidance for trustees in this situation. Specifically, the ATO will exercise their powers of general administration and ignore a situation where the full minimum amount has not been paid where [QC 39769, QC 26864]: the full minimum amount was not paid due to either an honest mistake by the trustees resulting in a small underpayment, or matters outside the control of the trustee, the trustee met all the requirements for claiming exempt pension income other than the requirement to pay the minimum amount, the trustee makes a catch-up payment as soon as practicable in the following income year, if the trustee had made the catch-up payment in the prior year, the minimum payment rule would have been met, and the trustee treats the catch-up payment as having been made in the prior income year (eg accrues the amount in the fund s prior year accounts). If all the above conditions are satisfied: the pension will be taken as having continued, the fund can continue to claim exempt pension income in respect of that pension account, and any payments made will be treated as pension payments (ie not lump sum withdrawals). What is a small underpayment? To qualify as a small underpayment, the shortfall must not exceed one-twelfth of the minimum payment amount for the year. For pensions that commence part-way through a year, the shortfall is again calculated by reference to the minimum annual payment amount not the prorated amount [QC 39769]. Lyn Formica & Stuart Forsyth, McPhersons

7 When is as soon as practicable? If the underpayment is due to an honest trustee error, the ATO considers as soon as practicable to be within 28 days of the trustee becoming aware of the underpayment. If the underpayment is due to matters outside the trustee s control, as soon as practicable is considered to be within 28 days of the trustee being in a position to be aware of the underpayment. Can a Trustee self-assess? Yes, the ATO will allow a trustee to self-assess their entitlement for an exercise of the Commissioner s powers of general administration. To qualify for self-assessment, the following conditions must be satisfied: the failure to meet the minimum pension requirement must be due to an honest mistake or circumstances outside the control of the trustee, the underpayment must qualify as small (ie no more than one-twelfth of the minimum annual amount), the trustee must meet all the requirements for claiming exempt pension income other than the requirement to pay the minimum amount, the trustee must make a catch-up payment as soon as practicable in the following income year of an amount sufficient to otherwise satisfy the minimum payment rule, the trustee must treat the catch-up payment as having been made in the prior income year, and the trustee must not have previously been granted the Commissioner s concession for failing to meet the minimum payment requirement. What if the Fund does not Qualify to Self-assess? Where the above self-assessment criteria are not satisfied, the Commissioner s powers of general administration may still be exercised but the fund must make written application to the ATO. Each case would be considered on its merits, however the ATO has provided the following examples: Where the trustee of the fund had a serious ongoing medical condition that was supported by documented medical certificates, the fund is likely to be granted the concession. However, if the circumstance which prevented the payment being made was experienced by one but not all the trustees, the concession is not likely to be granted as the unaffected trustee was able to carry out the necessary administration of the fund. A fund which failed to make the minimum requisite payment due to a dishonoured cheque is unlikely to be granted the concession. Where the amount of the underpayment is not small, the trustee must be able to demonstrate that matters outside their control affected their ability to make the requirement payment (eg proven and documented bank error). Note, relying on incorrect advice received from the fund s accountant would not normally be considered a matter outside the trustees control. Lyn Formica & Stuart Forsyth, McPhersons

8 Trustees can make such application by lodging a Request for SMSF Specific Advice [NAT 72441]. The application form can be downloaded from and the address for lodgement is detailed in that form. From What Date does this Rule Apply? The Commissioner s policy in relation to using its powers of general administration to overlook a shortfall in minimum pension, as stated above, has application from 1 July What Types of Pensions are Covered? The Commissioner s policy in relation to using its powers of general administration to overlook a shortfall in minimum pension, as stated above, has application to account based and allocated pensions only (including transition to retirement income streams). Market linked and defined benefit pensions are not covered MAXIMUM PENSION LIMIT EXCEEDED In the ATO s view, a pension will also cease for income tax purposes when the particular pension is a TRIS and the pensioner draws in excess of the 10% maximum pension limit [TR 2013/5 para 18, paras 96 to 101, QC 26864]. The consequences of exceeding the 10% maximum pension limit are the same as the consequences for underpaying the minimum. That is: the pension is considered to have ceased at the beginning of the relevant income year, the fund loses its claim for exempt pension income in respect of that pension account for the entire income year, the payments taken from the pension account in that year are treated as lump sum withdrawals which will result in a breach of the superannuation legislation unless the individual had sufficient unrestricted benefits in their account to cover the lump sum withdrawal, and if the pension rules are satisfied in the following income year, a new pension is said to have commenced from the start of that following year. However, importantly, the ATO will not use their powers of general administration to overlook a payment in excess of the 10% maximum pension limit [QC 39769] Commutation of the Pension In the ATO s view, a pension will cease when a request from a member to fully commute their pension takes effect [TR 2013/5 para 23]. When a request to fully commute a pension is said to take effect must be determined by reference to the fund s trust deed and the terms of the particular pension being paid [TR 2013/5 para 116]. It is important that advisers are aware of the tax implications of the full commutation of a pension, as follows: It is the ATO s view that any payment made as a result of the full commutation of the pension is to be treated as a lump sum for tax purposes [TR 2013/5 para 117]. This is because the pension will have ceased prior to the lump sum payment being made. Lyn Formica & Stuart Forsyth, McPhersons

9 The fund s income tax exemption in respect of earnings on that pension account will cease as soon as the request for full commutation takes effect. This means care should be exercised where a fund would otherwise have taxable income in the year of the commutation. Where fund assets are realised after the commutation date, any capital gains will not be exempt from tax. This is particularly the case where the commutation is made as an in-specie transfer of assets rather than in cash. Importantly, it is also the ATO s view that a partial commutation of a pension does not cause the pension to cease [TR 2013/5 para 27]. For this reason, depending on the fund s circumstances, it may be preferable to ensure any in-specie asset transfers represent only a partial commutation of a pension Death of the Pensioner The ATO s draft ruling TR 2011/D3 confirmed the view first released by the ATO in 2004 that a pension would cease as soon as the member died unless a dependent beneficiary of the deceased was automatically entitled under the fund s deed, or the rules of the pension, to receive an income stream on the death of the member [ATO ID 2004/688, TR 2011/D3 para 24]. The provisions of the fund s trust deed and the rules of the particular pension being paid would determine whether an automatic entitlement existed. This would usually be the case where: the pensioner had nominated a reversionary beneficiary on commencement of the pension and that nomination was binding on the trustee, or the pensioner had a binding nomination in place which bound both the recipient and the form of the benefit as a pension. TR 2013/5 expresses the same view regarding death [TR 2013/5 para 29]. We expect most advisers would be aware of the tax implications of this view. Specifically, if the pensioner s account balance was said to rollback to accumulation phase on date of death for fund tax purposes, the fund would only be exempt from tax on the earnings attributable to the pension assets up to the date of death. Where fund assets were sold after the death of a pensioner (eg to finance a lump sum death benefit), capital gains tax (CGT) may apply to the sale. In addition, the asset s cost base would be based on the original purchase price with no concession for the intervening pension phase. For some funds this could have resulted in substantial CGT liabilities. However legislative change has now been made to address these adverse consequences as detailed below FUND TAX EXEMPTION Effective from 1 July 2012, the legislation was amended to allow the tax exemption for earnings on assets supporting superannuation pensions to continue post the death of a fund member in pension phase. The exemption continues for a period only, being from the date of death of the pensioner until as soon as it was practicable to pay the lump sum death benefit or commence a new income stream [ITAA Reg definition of superannuation income stream benefit ]. Whether this as soon as practicable test has been met will depend on each fund s particular circumstances. Lyn Formica & Stuart Forsyth, McPhersons

10 Importantly, the tax exemption is reduced where the pensioner s superannuation interest is added to on or after death by amounts other than investment earnings. This means the tax exemption is reduced where the pensioner s balance is increased post death by insurance proceeds or an anti-detriment benefit. This is achieved by excluding the amount of the insurance proceeds or anti-detriment benefit from the pensioner s balance for the purposes of the tax exemption calculations. This change means funds will generally retain their tax exemption in respect of earnings on pension accounts for an extended period and asset sales post a pensioner s death will generally not give rise to CGT issues. Note, where a pension account automatically reverts on death, the fund s tax exemption will automatically continue as the pension automatically continues. Proposed Changes As part of the 2016/17 Federal Budget, the Government proposed introducing a $1.6 million balance cap on the total amount of accumulated superannuation a member can transfer into pension phase effective from 1 July It is proposed that members will remain able to accumulate amounts in excess of $1.6 million in superannuation but those excess amounts must remain in accumulation phase, where the earnings will be taxed at 15%. This change has not yet been legislated but, if enacted as proposed, it will become more common for members to be holding both accumulation and pension balances on their death. Further, it is not yet clear how death benefit pensions (reversionary or otherwise) will interact with the $1.6m pension balance cap. For example, David and Helen each have $1.6 million in pension and David dies. David and Helen had intended that, on their passing, the surviving spouse would continue to receive the deceased s benefits in the form of a pension. However, Helen has already used her $1.6 million balance cap. Would this mean that David s death benefit must be paid to Helen in lump sum form or will there be an exemption from the balance cap for death benefit pensions? 1.2 Contribution Notices If the member has made personal contributions for which a tax deduction is to be claimed in the period immediately prior to the pension commencing, ensure the relevant section notice is signed and dated prior to the pension commencement date. If this is not done, the member s personal income tax deduction for the contribution will be denied [ITAA 1997 s (2)]. Further, the section notice is unable to be varied once a pension has been commenced with the monies. 1.3 Contribution Splitting Documentation If the member is to split contributions to their spouse, or receive splittable contributions, ensure the necessary documents and adjustments have been made prior to the pension commencement [ITAA 1997 s (2)(d)]. Note, contribution splitting is not always offered by superannuation funds. Generally it can only be done after the year of contribution and applies only to what are treated as concessional contributions. Lyn Formica & Stuart Forsyth, McPhersons

11 1.4 Transition to Retirement Income Streams As discussed earlier, a non-commutable account based pension, often referred to as a transition to retirement income stream or TRIS, is simply an account based pension from which lump sum commutations may not be taken unless [SIS Reg 6.01(2) definition of transition to retirement income stream ]: prior to the commutation, the pensioner has satisfied a condition of release which has nil cashing restrictions (eg retirement), or an unrestricted benefit is being cashed, or the commutation is to pay a superannuation contributions surcharge liability, or the commutation is to allow for a family law payment split, or the commutation is to allow for payment of an excess contributions tax assessment/determination or Division 293 assessment via a release authority. In addition, in respect of a TRIS, a 10% maximum drawdown limit applies in each year. Proposed Changes As part of the 2016/17 Federal Budget, the Government has proposed removing the tax exempt status of the income from assets supporting TRISs with effect from 1 July Whilst TRISs can remain in place, it is proposed that from 1 July 2017, earnings from assets supporting TRISs will be taxed at 15%. This change is proposed to apply irrespective of when the TRIS commenced. This change has not yet been legislated, but if enacted as proposed, we expect most members drawing TRISs will elect to roll back their TRIS balance to accumulation phase effective on or before 1 July Conversion to Normal ABP Once a member satisfies a condition of release with nil cashing restrictions (eg retirement, reaching age 65), a TRIS automatically becomes a normal account based pension. This means lump sum commutations are permitted and the 10% maximum draw down requirement no longer applies, effective from the date of retirement, reaching 65 etc. No documentation is required in respect of this change however a trustee resolution acknowledging the situation is recommended Part Year Commencement In calculating the maximum pension for a TRIS, there is no proportioning for part periods nor is the maximum pension rounded to the nearest $10. Example 4 Malcolm commenced a TRIS on 1 June 2016 with all of his benefits of $500,000. Malcolm s maximum pension limit for the period to 30 June 2016 was $50,000. Lyn Formica & Stuart Forsyth, McPhersons

12 1.4.3 Order of Cashing Typically a TRIS is commenced where a member has only preserved benefits. However for various reasons, some members may also have restricted or unrestricted benefits. Where a TRIS is commenced from a combination of preserved, restricted and unrestricted benefits, payments must be deducted in the following order [SIS Reg 6.22A]: firstly from unrestricted benefits, then restricted benefits, then preserved benefits. This means the member s unrestricted benefits, which would otherwise be fully accessible in lump sum form, are eaten up by the TRIS payments. This outcome can be avoided by leaving the unrestricted benefits in accumulation phase or by commencing a separate account based pension with the unrestricted benefits. Example 5 Harry had a termination of employment after his 60 th birthday. This resulted in all of his superannuation benefits of $500,000 becoming unrestricted on that date. Harry continued in other employment and at 1 July 2016, his benefits consisted of: Preserved $100,000 Unrestricted $500,000 If Harry were to commence a TRIS on 1 July 2016 with his total benefits of $600,000, all of his pension payments would be deducted from the unrestricted balance until it was exhausted. However, if Harry were to commence a TRIS with his preserved benefits of $100,000 and an account based pension with his $500,000 of unrestricted benefits, the payments from the TRIS would be deducted from his preserved balance Consequences of Drawing More than 10% One of the conditions of a TRIS is that the total payments in each financial year must not exceed 10% of the pension s starting account balance (or the 1 July balance if not a new pension). If the 10% limit is exceeded, the fund will be in breach of SIS Regulation 6.18 as the fund has not adhered to the cashing restrictions which apply to a TRIS. Further the fund will be considered to have failed the pension standards and thus the pension will be considered to have ceased at the start of the income year. The payments taken will be considered lump sums and in breach of the rules. This may result in non-compliance status and the trustees being penalised. As in all cases of non-compliance, we would recommend repayment of the monies drawn and lodgement of a request for the Commissioner to exercise his discretion and overlook the payment. Arguably, the amount taken would also need to be included in the recipient s assessable income and be taxed at marginal rates, without any tax offsets [ITAA 1997 s ]. However, the legislation allows for the payment to not be taxed if the Commissioner considers it unreasonable to do so. Presumably if the monies are repaid, the Commissioner would consider it unreasonable to also tax the person on the payment. Lyn Formica & Stuart Forsyth, McPhersons

13 1.5 Payments which meet Minimum Payment Rules but are taxed as Lump Sums Can a payment from a superannuation fund satisfy an individual s minimum pension requirement in SIS but also be taxed as a lump sum for income tax purposes? In short, yes. When an individual commences an account based pension, they are required to withdraw from the fund a minimum amount each year [SIS Reg 1.06(9A), SIS Reg Schedule 7]. This minimum is calculated by reference to the individual s pension account balance and their age, and is commonly referred to as the individual s minimum pension amount. However, to avoid confusion, it is more correct to refer to the amount as the individual s minimum payment amount. Most payments taken from an individual s pension account can count towards the individual s minimum payment requirement, including lump sums. For individuals aged between preservation age and age 59 (inclusive), treating a payment from a pension account as a lump sum for income tax purposes can offer significant tax benefits. This is because pension payments are taxed at the individual s marginal tax rate less a 15% tax offset (ignoring any tax free component). By comparison, if the individual has not yet used their low rate cap ($195,000 in the 2016/2017 year), the lump sum would be tax free. Alternatively, where the low rate cap is not available, lump sums are taxed at maximum of 17%. Consider the following example. Example 6 Joe is age 56, retired and has a taxable income of $87,000. He is already fully utilising his concessional contribution cap and so has no avenue to reduce his taxable income through additional superannuation contributions. Joe has $500,000 in superannuation, all taxable component. Joe has not previously withdrawn monies from superannuation. If Joe were to commence a pension from his balance, the minimum payment amount would be $20,000 (ie $500,000 x 4%). The tax payable on a $20,000 pension payment would be $4,800 (ie $20,000 x 39% - 15%). If the fund was not paying more than $4,800 in tax on its income, there would be no tax benefit in Joe converting to pension phase. However, if Joe were to convert his benefits to pension, request a $20,000 payment from the fund and elect for the payment to be treated as a lump sum for tax purposes, it would satisfy his minimum payment requirement but would also be effectively tax free to him (via an offset, as it is within his low rate cap). The fund would receive the tax benefits of being in pension phase as the minimum payment requirements would have been met. Traditionally, the situations in which this strategy have been of most use include: pensioners aged between their preservation age and age 59 (inclusive) with unrestricted benefits (usually retirees) who would pay tax on a pension payment (but little or no tax on a lump sum payment) Lyn Formica & Stuart Forsyth, McPhersons

14 pensioners aged between their preservation age and age 59 (inclusive) who are drawing a TRIS but their account includes some unrestricted benefits, who would pay tax on a pension payment but little or no tax on a lump sum payment (note, in this case the amount of the lump sum payments must not exceed their unrestricted balance) children receiving pensions due to the death of a parent who would pay tax on a pension payment but no tax on a lump sum payment This is because, traditionally, the pensioner would request a lump sum commutation from their fund which is only available where the pensioner has unrestricted benefits. The ATO confirmed the validity of this concept in SMSFD 2013/2. However a modified version of this strategy is also available for individuals who are: between their preservation age and age 59, currently receiving a TRIS or could commence one, whose benefits in the TRIS are all preserved (as is usually the case with individuals drawing a TRIS), and whose benefits include sizeable taxable component. An example is provided below: Example 7 Carl is aged 58 and works full-time earning $180,000 per annum. He has superannuation benefits of $1m, all taxable component and all preserved. Carl has not previously commenced to draw a pension from his fund because the tax payable on a pension payment of at least the minimum amount would outweigh the tax savings in the fund and he has no unrestricted benefits with which to utilise a partial commutation strategy. As an alternative strategy, Carl could commence to draw a TRIS from his fund, request the trustee make a payment to him of up to $100,000 and at the same time elect that the payment not be treated as an income stream benefit. Carl would simply be asking for a payment and not requesting a partial commutation from his pension. Such a payment would be permitted under the superannuation legislation and tax free up to Carl s low rate cap with the fund still receiving all of the benefits of being in pension phase. Important issues to be aware of include: By default, all payments from a pension account (prior to its cessation) are to be taxed as pension payments unless the individual specifically elects otherwise prior to the payment [ITAA 1997 s , ITAA Reg ]. This means the fund must be specifically advised of the lump sum request prior to the payment being made and the payment must be specifically documented as a lump sum. The amount paid under such a strategy will count towards the individual s minimum and maximum payment limits. This means the amount paid, together with any other payments in the current year (including amounts taxed as pension payments), must not exceed the individual s 10% maximum payment limit for the year. Lyn Formica & Stuart Forsyth, McPhersons

15 In the ATO s view, the payment must be taken in cash (ie the strategy may not be used with an in-specie payment). As the individual is electing for the payment to not be treated as a superannuation income stream benefit for tax purposes, it will be taxed as a lump sum. This means it will count towards the individual s low rate cap ($195,000 in 2016/2017) which is a lifetime limit. Amounts within the low rate cap are included in the individual s assessable income but are effectively tax free via a tax offset. Amounts in excess of the low rate cap are also included in the individual s assessable income but subject to a maximum tax rate of 17% via a tax offset. Because the taxable component of the payment is included in assessable income, individuals should be aware that their ability to claim concessions such as the low income tax offset may be affected. Tax losses may also be reduced. Thus the optimal strategy for each individual will be determined by their own circumstances. For Division 293 purposes, lump sum amounts up to the low rate cap only are excluded from income. This means lump sum amounts in excess of the low rate cap could result in the individual paying an additional 15% tax on their concessional contributions. Where the strategy is being employed for a client with no unrestricted benefits, it is important to recognise that the individual should not be requesting the partial commutation of their pension. A partial commutation is not permitted as the individual does not have unrestricted benefits. They are simply requesting a payment and then electing for that payment to not be treated as a superannuation income stream benefit. The strategy is generally only useful for members of unsegregated funds. In the ATO s view, where the election is made by a member of a fund with segregated pension assets including funds wholly in pension phase, the calculation of the fund s exempt current pension income may be impacted. Some large funds may not offer either strategy. The strategy is not available to individuals drawing allocated pensions [SIS Reg 1.06(4)]. Proposed Changes As part of the 2016/17 Federal Budget, the Government proposed removing the ability for members to elect to treat certain payments from pension accounts as lump sums for tax purposes. This change has not yet been legislated but is proposed to apply to payments made on or after 1 July It is not yet clear whether this change will apply to payments from all pension accounts or only payments from TRISs. 1.6 Additions to Pensions Pension accounts may not be added to (by way of contribution or rollover) once commenced [SIS Reg 1.06(1)(a)(ii)]. However, the following approaches are possible, where further contributions/rollovers are made to a self managed fund for a member who is already in pension phase: Lyn Formica & Stuart Forsyth, McPhersons

16 A. Add the contributions to a new accumulation account for the member and retain these monies in accumulation phase until the next 1 July, at which time a second pension could be commenced or the existing pension could be stopped and then restarted with the member s entire account balance. Advantages Disadvantages Costs Simplicity, particularly where numerous contributions are made throughout the year. As a combined accumulation/pension fund, unless the assets were segregated, the fund would generally require an actuarial certificate to determine the proportion of income which was exempt from tax. Actuarial Certificate Tax payable in fund Pension commencement / Stop and restart documents B. Add the contributions to a new accumulation account for the member and then immediately convert this amount to a new pension. On the next 1 July, this additional pension account could remain intact or the existing pension and the new pension could be stopped and a further pension restarted with the member s entire balance. Advantages Disadvantages Costs The fund would retain its status as a 100% pension fund and thus be completely tax exempt on its earnings for the period. Time consuming if there are numerous contributions throughout the year New pension documents x no. of contributions Stop and restart documents (if desired) C. Add the contributions to a new accumulation account for the member, commute the existing pension on the date of the contribution and then restart a new pension with the member s entire balance at that time. Advantages The fund would retain its status as a 100% pension fund and thus be completely tax exempt on its earnings for the period. Only possible if the member has drawn at least their pro rata minimum amount to the date of commutation. Disadvantages Extremely time consuming if there are numerous contributions throughout the year. Does not provide the flexibility which two or more pension accounts may provide (refer to section 7.9) Costs Preparation of interim accounts on pension commutation date Stop and restart documents Lyn Formica & Stuart Forsyth, McPhersons

17 If option B or C is the preference, trustees should ensure the number of contributions made in the year is kept to a minimum. Further, the timing of contributions will be important (refer to section ). Advisors should not assume that a stop and restart of the existing pension is always the best approach. For example, where benefits are to be paid to a combination of dependants and non-dependants, it may be appropriate to retain additions of non-concessional contributions as a separate pension which consists of 100% tax free component. Further, retaining tax free component in a separate pension could act as a hedge against legislative change. In addition, changes to the way in which income from account based pensions is deemed for Centrelink purposes effective 1 January 2015 may also impact on the appropriateness of a stop & restart strategy (refer to section 1.6.1) Age Pension/Centrelink Impact of Stop & Restart Age Pension Eligibility to the Age Pension is based on an income test and an assets test. Financial investments such as shares and bank accounts are subject to deeming. Non-financial assets are not subject to deeming and instead are either subject to special rules (as in the case of superannuation pensions) or ignored for the purpose of the income test (as is the case for a principal place of residence). In the case of account based pensions and the income test, prior to 1 January 2015 amounts drawn from an account based pension were reduced by a deductible amount and only the net amount was counted against the income test. This deductible amount was calculated based on the amount used to start the pension and the pensioner s life expectancy at that time. However, a new account based pension started on or after 1 January 2015 is considered a financial investment and included in the income test by way of deeming GRANDFATHERING Importantly, the pre 1 January 2015 rules continue to apply to a pension (ie the income test treatment of the pension is grandfathered ) provided: the individual was in receipt of the Age Pension immediately prior to 1 January 2015 and at all times post 1 January 2015, and the individual s account based pension was in place immediately prior to 1 January 2015 and the same pension remains in place post 1 January Note, this grandfathering will be lost where: a pre 1 January 2015 pension is stopped and restarted on or after 1 January 2015, a pre 1 January 2015 pension is transferred to another fund on or after 1 January 2015, an individual loses their entitlement to the Age Pension post 1 January 2015, or an individual holds a pre 1 January 2015 pension, they die on or after 1 January 2015 and the pension does not automatically revert to their spouse. Lyn Formica & Stuart Forsyth, McPhersons

18 It should also be remembered that eligibility for the Age Pension is determined by both an income test and an assets test. A person s Age Pension entitlement is first calculated under both tests and their actual entitlement is then taken to be the lower of the two. In many cases, it will be the assets test which determines an individual s Age Pension entitlement not the income test Commonwealth Seniors Health Card Similar changes also apply to the Commonwealth Seniors Health Card (CSHC). Eligibility for the CSHC (which provides subsidised prescriptions through the Pharmaceutical Benefits Scheme as well as other payments, concessions and discounts) is based on adjusted taxable income alone. Specifically, individuals with an adjusted taxable income of less than $52,273 ($83,636 combined for couples) (as at 20 September 2015) are eligible for the card (provided they were at least Age Pension age). Prior to 1 January 2015, payments from account based pensions to individuals age 60 or over were not included in adjusted taxable income. This meant clients could have substantial amounts invested in account based pensions and still be eligible for the CSHC. From 1 January 2015, the income test for the CSHC changed to include untaxed superannuation income. Importantly, it is not the actual amount drawn from the pension which is counted. Instead, a deemed amount is determined using the same rules which apply for Age Pension purposes post 1 January GRANDFATHERING As with the Age Pension changes noted above, the pre 1 January 2015 rules continue to apply to a pension (ie the pension is grandfathered ) provided: the individual was in receipt of a CSHC immediately prior to 1 January 2015 and at all times post 1 January 2015, and the individual s account based pension was in place immediately prior to 1 January 2015 and the same pension remains in place post 1 January Note, as with the Age Pension grandfathering rules, CSHC grandfathering will be lost where: a pre 1 January 2015 pension is stopped and restarted on or after 1 January 2015, a pre 1 January 2015 pension is transferred to another fund on or after 1 January 2015, an individual loses their entitlement to the CSHC post 1 January 2015 (even if this loss is only temporary eg unusually high income in a particular year), or an individual holds a pre 1 January 2015 pension, they die on or after 1 January 2015 and their pension does not automatically revert to their spouse. In summary, if a client is currently in receipt of an Age Pension or are a CSHC cardholder, it is imperative that you are aware of the social security consequences of starting, stopping or changing pensions post 1 January Lyn Formica & Stuart Forsyth, McPhersons

19 Proposed Changes As part of the 2016/17 Federal Budget, the Government proposed introducing a $1.6 million balance cap on the total amount of accumulated superannuation a member can transfer into pension phase effective from 1 July Subsequent earnings on these balances will not be restricted. Members already in pension phase with balances above $1.6 million will be required to roll back the excess to accumulation by 1 July Whilst this change has not yet been legislated, where the client has grandfathered Age Pension or CSHC pensions, care should be taken with any roll back to accumulation to ensure the pensions remain grandfathered and that any restructuring (eg moving monies outside superannuation) does not trigger a loss of concessions Examples of Common Pension Addition Scenarios Stop and Restart on 1 July Peter (age 60) commenced a TRIS in his SMSF on 1 July Peter continues to make personal undeducted contributions and also has employer contributions made on his behalf. The fund is unsegregated and will obtain an actuarial certificate specifying the proportion of the fund s income which will be exempt from tax in the 2016 financial year. To ensure the fund obtains the highest tax exempt percentage possible and to maximise the level of pension paid to Peter, Peter decided to adopt a strategy of: a) stopping the TRIS on 1 July 2016, b) rolling the proceeds into Peter s accumulation account on 1 July 2016 and c) commencing a new TRIS on 1 July 2016 with Peter s accumulation account balance on that date (ie a stop & restart ). How do I calculate the tax free and taxable components of the new TRIS? In essence, the following calculations are required: 1. Identify the tax free and taxable proportions (%) of Peter s original TRIS. These would have been calculated when Peter s TRIS commenced on 1 July Example 8 When Peter s original pension commenced on 1 July 2015 the tax free and taxable proportions were set at: Tax free proportion 20% Taxable proportion _80% Total 100% 2. Apply the proportions from step 1) above to the balance of Peter s original TRIS on 1 July 2016 (ie the date of commutation of the pension) to determine the tax free and taxable components ($) of this account. The balance of Peter s original TRIS is $500,000 on 1 July Therefore, the tax free and taxable components of this pension account at 1 July 2016 are: Lyn Formica & Stuart Forsyth, McPhersons

20 Tax free component 100,000 (ie 20% x $500,000) Taxable component 400,000 (ie 80% x $500,000) Total $500, Determine the tax free and taxable components of Peter s accumulation account on 30 June 2016, as follows: i. Identify any contributions which have not been taxed in the fund (eg personal undeducted contributions, Government co-contributions). ii. Deduct from the amount in step i) the amount of any tax free component taken in lump sum withdrawals during the year. iii. Identify Peter s accumulation account balance on 30 June iv. The lower of the answer at step ii) or step iii) is the member s tax free component at 30 June v. Take the member s 30 June 2016 accumulation balance and deduct the amount in step iv) above to determine the taxable component at 30 June The balance of Peter s accumulation account at 30 June 2016 is $150,000 (its opening balance on 1 July 2015 was nil). During the 2016 year, the movements in Peter s accumulation account were: Personal undeducted contributions 150,000 Employer contribution/rollover 50,000 Net earnings/(losses) & contribution taxes (50,000) Total $150,000 Accordingly, the tax free and taxable components of the accumulation account are: Tax free component 150,000 (ie the UDC) Taxable component nil ($150,000 - $150,000) Total $150,000 Note: any gain or loss in the accumulation account is effectively allocated to the taxable component until it is reduced to nil. 4. Calculate the tax free and taxable components of Peter s accumulation account on 1 July 2016 (ie after the rollback of the TRIS) by adding together the amounts from steps 2) and 3) above. Tax Free Component $ Taxable Component $ Total $ Pension 100, , ,000 Accumulation 150,000 Nil 150,000 Total 250, , , Now calculate the tax free and taxable proportions of Peter s new TRIS which commenced on 1 July 2016 with his total balance of $650,000. Tax free proportion 38.46% ($250,000/$650,000) Taxable proportion 61.54% ($400,000/$650,000) Lyn Formica & Stuart Forsyth, McPhersons