Superannuation Changes: $1.6 million pension cap

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1 2017 Superannuation Series Superannuation Changes: $1.6 million pension cap In the second instalment of our Superannuation Changes series, we put to rest the confusion and dispel some myths surrounding the $1.6 million Transfer Balance Cap and what it means for you. TRANSFER BALANCE CAPS & ACCOUNTS MORE JARGON FOR YOUR SUPER From 1 July 2017, the new $1.6 million pension balance limit (not to be confused with the $1.6 million account balance limit for contribution eligibility discussed in part 1 of this series) will come into effect. In short, the Government has concluded that a $1.6 million capital pool is sufficient to fund a modest lifestyle, and have accordingly capped the amount permitted to be retained in a tax-free pension account at that level. To add to the growing complexity of our superannuation system, we now have two new terms to get used to. The impact is that each member (i.e. each natural person) can only have a total of $1.6 million in pension mode as of 1 July 2017 across all funds. And no spreading your superannuation across multiple funds will not allow you to circumvent this new limit. For those with more than $1.6 million in pension mode currently, the excess must be commuted back into accumulation mode by 1 July 2017, whereupon future earnings on the excess will be taxed at the accumulation rate of 15%. TRANSFER BALANCE ACCOUNT You will have a transfer balance account as of 1 July 2017 if you already have a pension account. If you do not presently have a pension account, your transfer balance account will commence the day you commence a pension. TRANSFER BALANCE CAP Your transfer balance cap places a limit on the amount of capital that can be used to start a transfer balance account (essentially, a pension). This will be no more than $1.6 million as of 1 July Very importantly, if you have more than $1.6 million in pension mode currently, it does not mean the balance beyond $1.6 million must be withdrawn from superannuation it can be retained in your fund and the earnings on the excess will incur tax at up to 15% (which is still a concessional rate of tax). In summary, accumulated member savings can remain in the fund and benefit from the concessional tax environment of superannuation.

2 2017 SUPERANNUATION SERIES 2 TRANSFER BALANCE CAPS, TRANSFER BALANCE ACCOUNTS NO WONDER MEMBERS ARE CONFUSED! So how do these new concepts practically apply? Let s consider a pensioner couple, Beatrice and Barry. Case Study Beatrice Beatrice has a pension account balance of $2.5 million in an SMSF as at 30 June To comply with the new transfer balance cap, Beatrice will need to commute $900,000 of her current pension back to accumulation mode by 1 July The result will be: Account Composition at 30 June 2017 Account Composition at 1 July 2017 Pension balance at 30 June 2017 $2,500,000 Commuted to Accumulation ($900,000) Pension balance at 1 July 2017 $1,600,000 Accumulation balance at 1 July 2017 $900,000 Total balance at 1 July 2017 $2,500,000 $2,500,000 This is Beatrice s Transfer Balance Account $1,600,000 $900,000 Pension Mode (Transfer Balance Account) Accumulation Mode Outcome: the excess of $900,000 remains in the superannuation environment, but the earnings on that amount will be taxed at no more than 15% (possibly less if Beatrice is eligible for the capital gains discount). Case Study Barry Barry, Beatrice s husband, has a pension account balance of $1.1 million in the same SMSF as at 30 June As the balance is under $1.6 million, there is no excess to the transfer balance cap and no need to commute any amount back to accumulation mode. As Barry has not exhausted his full $1.6 million cap, he has the opportunity to commence a pension (or pensions) in the future up to an additional $500, JUNE 2017 Barry has a current pension of $1.1 million 1 JULY 2017 Barry s $1.1 million pension is added to his transfer balance account 30 JUNE 2018 Barry contributes $300,000 and commences an additional pension 30 JUNE 2021 Barry contributes $200,000 and commences an additional pension Outcome: Barry uses his full $1.6 million cap but does so over a number of years. The amount of the cap used only relates to the original pension commencement amounts and is not affected by investment gains or losses, or pension payment withdrawals. Transfer Balance Account Remaining Cap Available

3 2017 SUPERANNUATION SERIES 3 WHAT IF MY INVESTMENTS GROW IN VALUE ABOVE THE $1.6 MILLION? WHAT ABOUT IF THEY LOSE VALUE? Once a member commences a transfer balance account at 1 July 2017, any increase (or decrease) in the balance as a result of investment earnings (or losses) will not increase (or decrease) the initial cap. Investment gains and losses do not impact the transfer balance cap; gains above $1.6 million do not have to be commuted back and losses do not reduce the amount of the cap used. Case Study Beatrice & Barry Barry and Beatrice invest all their superannuation balances into a single speculative company which performs poorly and loses half its value in the 6 months from 30 June The investment loss does not impact any remaining transfer balance cap. 1,600,000 1,400,000 1,200,000 1,000, , , , ,000 BEATRICE Transfer Balance Account Remaining Cap Available Value of Investments 1,600,000 1,400,000 1,200,000 1,000, , , , ,000 BARRY Pension payment withdrawals, whilst they have the effect of lowering your pension balance, will not reduce your transfer balance account. Large withdrawals may therefore be best taken from an accumulation account going forward, subject to your individual age and tax circumstances Jun Dec Jun Dec-17 Outcome: So, even if Barry s original pension balance of $1.1 million falls to $550,000 by 31 December 2017 due to investment losses, he still only has a cap available of $500,000. Conversely, if the speculative investment instead doubled in value, Barry s original pension balance jumps to $2.2 million due to investment gains, he does not have to commute the excess above $1.6 million back to accumulation and he still has $500,000 left in his cap to add further funds.

4 2017 SUPERANNUATION SERIES 4 TAX WE ALL HAVE TO PAY SOME Pension withdrawals remain tax-free and there has been no change in the tax treatment of pension and accumulation balances: earnings from pension balances are not taxed and earnings within accumulation mode are taxed at 15%. The forced commutation of pension balances above $1.6 million will however have some tax impact on members from 1 July For example, take Peter and Jane, a couple with accumulated superannuation in pension mode. For a significant superannuation balance of $5 million per member, an effective tax rate of 10.2% on total earnings is still generally a better alternative to investing personally. MEMBER BALANCES EXAMPLE 1 EXAMPLE 2 EXAMPLE 3 EXAMPLE 4 EXAMPLE 5 Peter $ 1,600,000 $ 3,200,000 $ 2,500,000 $ 5,000,000 $ 3,000,000 Jane $ 1,600,000 $ $ 2,500,000 $ $ 3,000,000 Combined Superannuation $ 3,200,000 $ 3,200,000 $ 5,000,000 $ 5,000,000 $ 6,000,000 Earnings, say, at 6% pa $ 192,000 $ 192,000 $ 300,000 $ 300,000 $ 360,000 Comprised of: Earnings (Pension) $ 192,000 $ 96,000 $ 192,000 $ 96,000 $ 192,000 Earnings (Accumulation) $ $ 96,000 $ 108,000 $ 204,000 $ 168,000 Tax on Earnings $ $ 14,400 $ 16,200 $ 30,600 $ 25,200 Effective Tax Rate on Total Earnings 0.0% 7.5% 5.4% 10.2% 7.0% EXCESS AMOUNTS & EXCESSIVE ENFORCEMENT The ATO has indicated that they will be taking a harsh view on pension accounts which have a balance greater than $1.6 million by applying an excess transfer balance tax to notional earnings on the amount above $1.6 million left in pension mode beyond 30 June 2017 (though there is a grace period where transitional arrangements will apply if the excess is less than $100,000). It is therefore important to get these arrangements right in time.

5 2017 SUPERANNUATION SERIES 5 ARE YOU PREPARED FOR THE CHANGE? These new pension rules are complex and have flow on effects on investment strategy, account operation and retirement drawings. They will give rise to a number of questions that trustees and members alike will need to consider in combination, such as: How will my minimum pension payments be effected from 1 July 2017? Should withdrawals come from my pension account or accumulation account going forward? I have multiple pension funds which total more than $1.6 million. Which is the best fund to commute back to accumulation mode? At what point does investing outside of superannuation become more tax effective? What are the implications of the transfer balance account on the future payment of my balance to my beneficiaries? There is no one size fits all answer to these questions and each member s account will need to be considered relative to their specific circumstances. For instance, minimum pension drawings (currently set as a percentage of the total pension balance based upon the age of the member) will now only apply to a maximum account balance of $1.6 million. For some, this is good news if you do not have a need to draw down on your pension account as it will allow you to retain more funds within a favourable tax environment. For others who require more than the minimum pension, it will require a reorganisation of your drawing arrangements as some of the cash flow required will need to come from the accumulation account. The planning implication is that trustees and members must start preparing for these changes now to ensure their pension balances comply with the new caps by 1 July Administratively, the transfer balance caps and accounts will be a nightmare for the ATO to monitor and notwithstanding we are only a few months away from the looming deadline, we are still awaiting firm and final guidance from the ATO as to the specific compliance requirements that will apply to trustees in order to calculate member balances as at 1 July. At a minimum, trustees should expect that they will be required to document members transfer balances and any necessary commutations before 1 July For members, you should turn your attention to the impact of these changes on your affairs, particularly if you have a current pension balance greater than $1.6 million, and start making arrangements now for the new regime such that the operation of your superannuation account continues undisrupted. Beyond what is discussed in this part of our series, the $1.6 million cap will also have implications on estate planning, which we will discuss in a later instalment. NEXT STEPS For clients of Cameron Harrison, we will be contacting you shortly to discuss what action you need to take ahead of 30 June If you would like to discuss any of the above further and how they might apply to your circumstances, please do not hesitate to contact any member of your Client Service Team or Anne-Marie Tassoni, Director Private Wealth Management, on or am.tassoni@cameronharrison.com.au. Cameron Harrison Level 3, 90 Collins Street, Melbourne, Victoria 3000 GPO Box 1559 Melbourne, Victoria cameronharrison.com.au Disclaimer: This document is provided for information purposes only. While every effort has been made to ensure the accuracy of the information in this document, its accuracy, reliability and completeness is not guaranteed. Past performance should not be relied on as a guarantee of future performance. Except for liability that cannot be excluded by law, Cameron Harrison Private, its directors and employees disclaim all liability for any error or inaccuracy in, misstatement or omission from, the information contained in this document or any loss or damage suffered, directly or indirectly by the reader or any other person as a consequence of relying on this information. Cameron Harrison Private, its directors and employees may have holdings in securities named in this article; however, Cameron Harrison Private does not consider these holdings to be sufficiently material to compromise the recommendations or advice. Performance is based on a model which is representative of the equity holdings and should not be relied upon to make any investment decision Cameron Harrison Private Pty Ltd ABN AFSL