Contributed by Joseph Cheung, Lawyer and Bryce Figot, Special Counsel, DBA Lawyers
Payments above the account-based pension (ABP) minimum annual payment have the potential to become a trap. The June 2017 SMSF Benchmark Report by Class Super states that “the average SMSF pensioner withdraws about $74,000 annually on their pension over a series of 12 transactions and overdraws $24,000 above their minimum”. This means that the average pensioner is withdrawing more than 32% above their relevant ABP minimum and could miss out on significant opportunities unless timely action is undertaken! This article summarises the trap and examines the main reasons to prospectively document a strategy as soon as possible.
What is the trap?
For pensioners who receive payments above the ABP minimum for their ABP(s), the capital supporting the ABP(s) is reduced by the amount of pension payment(s). However, there is no corresponding debit to the pensioner’s transfer balance account (TBA)!
Where the pensioner had “maxed out” their transfer balance cap, they cannot add any further capital to start a new pension that is in the retirement phase (ie a pension that will obtain a pension exemption). Therefore, drawing more than the minimum payment will exhaust the capital supporting the ABP(s) significantly faster than would otherwise be the case. Where the pensioner had not “maxed out” their transfer balance cap, there will be limited capacity to add further capital to commence a new ABP.
What is a strategy to avoid this trap?
The authors understand that many advisers in the SMSF industry have been contemplating various strategies to avoid this trap. A common theme in the strategies involves partially commuting some or all of the amounts above the relevant ABP minimum(s). The following is an example of one of the strategies:
Pay all amounts above the relevant ABP minimum(s) as a lump sum payment from the pensioner’s accumulation interest.
Where there is no accumulation superannuation interest or the accumulation superannuation interest is insufficient to pay the amounts in excess of the relevant minimum ABP amount(s), these excess amounts are to be paid as a partial commutation of the relevant ABP.
What are the main reasons to prospectively documenting a strategy as soon as possible?
Compliance with the ATO’s view
In relation to the partial commutation of pensions, the ATO’s view (as expressed in SMSFD 2013/2 and TR 2013/5) is that the pensioner must consciously exercise their right to exchange something less than their full entitlement to receive future pension payments for an entitlement to be paid a lump sum. Where no documentation exists either before or at the time of payment, it is hard to prove that the pensioner consciously exercised their right. The ATO could decide that there was no partial commutation and that the amount was just paid as a pension payment in excess of the relevant ABP minimum(s).
Similarly, where the payments are allocated and the strategy documented “after the fact”, the ATO might take the view that the payments did not come from an accumulation superannuation interest as it could not be proven that this was the parties’ intention at the time of payment, and it was not a valid partial commutation. Accordingly, a conservative approach is to have relevant documentation completed and signed before the payment of the amounts in excess of the ABP minimum payment.
The onus of proof rests with the taxpayer. Also, the ATO may allege false and misleading disclosure and, in addition to winding back any tax benefit from the “fabrication” of any documents that did not exist before the relevant commutation, may impose penalties of up to 75% plus the general interest charge.
Achieving administrative efficiency and certainty under ATO reporting requirements — Transfer Balance Account Report (TBAR)
The new ATO reporting regime associated with the transfer balance cap applies from 1 October 2017. Broadly, the TBAR regime involves a need to report on an events basis regarding events since 1 July 2017 that have an impact on the pensioner’s TBA. TBAR also extends to reporting where further information is required to calculate a member’s total super balance or concessional contributions averaging amount from 1 July 2018. For example, all ABP commutations must be reported. Reporting is required whenever there are events that result in a debit or credit to the pensioner’s TBA. SMSFs will not be required to report until 1 July 2018 due to an administrative concession. However, it is best practice for SMSFs to start reporting from 1 October 2017.
The ATO’s rationale for the introduction of TBAR is to enhance visibility of each pensioner’s TBA. There are time limits for reporting events. TBAR is relevant for strategies to avoid the trap described above. Amounts that are paid directly from a pensioner’s accumulation interest will not need to be reported. However, amounts that are paid as a partial commutation of the pensioner’s relevant pension must be reported.
To the extent that pensioners (and their advisers/SMSF trustees) are not aware of their TBA, the TBAR regime could exacerbate this trap. For example, a late lodgment penalty may be imposed by the ATO if a pensioner’s partial commutation in relation to the amount above the relevant ABP minimum is not reported on time.
The introduction of the TBAR regime is also likely to increase the administrative costs for SMSFs. If a strategy was not prospectively documented for all future payments above ABP minimums, the adviser/SMSF trustee may have to liaise with the pensioner prior to each payment regarding the treatment of any amount above ABP minimums. For example, they would have to decide on which pension account the payment is to come from, and whether the amount above the ABP minimum was to be treated as coming from the pensioner’s accumulation interest or as a partial commutation. After making this decision, the SMSF trustee would then have to document each decision. The more payments there are during the year that are in excess of the relevant ABP minimums, the greater the frequency of the attendances and liaising required. Where an adviser is assisting the pensioner with the TBAR reporting, the extra attendances and liaising may translate to increased costs for the SMSF. The pensioner may also feel burdened by the extra amount of time needed to liaise with the adviser.
Moreover, advisers need to ensure their advice and services comply with the Australian financial services licence (AFSL) regime. Where a strategy was not prospectively documented for all future payments above ABP minimums, advisers without an AFSL would be at further risk of attending on multiple occasions a “restructure” of the pensioner’s payments. We would generally recommend that pensioners be provided advice from a licensed adviser prior to the commencement or commutation of an ABP.
One way to achieve administrative efficiency is to prospectively document a detailed strategy for all future payments above ABP minimums. Less documents are involved provided that the strategy is applied consistently to all future pension payments. Less attendances are required from advisers — this should hopefully translate to reduced costs for the SMSF and more time and resources for advisers to perform other tasks. Prospectively documenting a strategy also adds certainty to the treatment of future payments. The adviser/SMSF trustee could then follow the documented strategy when reporting under the TBAR regime.
Unless SMSF pensioners take timely action and prospectively record a strategy for payments above ABP minimums, they may be at risk of falling into an inescapable trap. Naturally, developing a strategy to cover all future payments above ABP minimums is no easy task!
To learn more about this topic, why not register for our webinars on Ongoing Management of Valuations in SMSFs under the Transfer Balance Cap Regime or Aged Care Advice.