The impact of the $1.6m pension transfer balance cap – The story of Albert and Anne
**Relevant information **
- Albert is 85 and Anne is 82.
They have an SMSF. Albert’s balance is $3m and Anne’s is $1.5m.
These benefits are held in the form of Account Based Pensions.
** The original plan **
When Albert and Anne retired, and commenced their Account Based Pensions, it was their intention to keep their benefits in their SMSF for as long as possible, both for the sake of simplicity and to capitalise on the inherent SMSF tax benefits.
Accordingly, Albert and Anne directed that their Pensions would revert to one another upon death. This means that, when either of them were to pass away, their pension would continue, with the pension payments being made to the surviving spouse. It would not be necessary for the benefits to be cashed out of the fund until the remaining spouse passes away.
** The $1.6m pension transfer balance cap **
From 1 July 2017, a limit will be imposed on the total amount that a person can transfer into a tax-free pension phase account. This limit is initially set at $1.6m, but will be subject to indexation.
Albert and Anne are keen to find out what this means for them.
If Anne’s balance doesn’t increase above $1.6m by 30 June 2017, no action is required to be taken for her to comply with the new rule. Albert, however, must reduce the amount of his pension to $1.6m or less to comply.
**What should Albert do? **
He could simply transfer a portion of his pension back to the accumulation phase (known as a partial commutation).
He could withdraw any amount over $1.6m as a lump sum payment from his super fund and retain the rest in his account based pension.
Considering their main objective, being to retain their benefits in super for as long as possible, it is likely that Albert will proceed with option 1. Even though the SMSF will pay tax on the income earned on the portion of the assets that are held in the accumulation phase, the level of tax is capped at 15%, which is highly concessional. Additionally, there is no need to transfer any cash or assets out of the fund just yet.
** But what happens when either of them dies? **
It is this that will have the biggest impact on their original plan.
Depending on the amount that they choose to retain in their Account Based Pension on 1 July 2017, all or most of the deceased spouse’s benefits would have to be paid out of the fund as a death benefit. It may also be possible for the surviving spouse to fully commute their own pension for them to be eligible to receive the reversionary pension. However, whether this could be done or not would depend on the balances at the time of death and the circumstances of the surviving spouse.
The death benefit itself, when paid to the spouse, would have no tax impact. However, all income earned from that point onwards, would be taxed at the surviving spouse’s marginal tax rate.
The above illustration is meant to clarify the impact of the $1.6m pension transfer cap on people with large superannuation balances, but it also highlights the impact it will have on the Estate Planning of those individuals. Furthermore, there are other matters to consider, such as the application of the CGT relief.
There has been a continuous shift away from generic strategic planning towards planning according to the relevant, unique and specific circumstances of individuals. It is also becoming clear that there is no longer such a thing as “set and forget”.
** My advice? **
Contact Cordner Advisory and obtain advice on how to address the forthcoming changes and its effect on your SMSF. Do not wait until after 30 June, because then it may well be too late.