Contributed by Philip de Haan, Partner, and Aimee Riley, Lawyer, Thomson Geer
The purpose of this article is to discuss some tips and traps that relate to the new superannuation regime starting on 1 July 2017. It deals in particular with payments from self managed superannuation funds (SMSFs) after 30 June 2017, some interesting issues and recent developments in relation to transition to retirement income streams (TRISs).
Payments from an SMSF in pension mode under the current law
Currently, once a person triggers a relevant condition of release such as retirement or turning 65, he/she may commence to receive an income stream (called a pension in this article). The fund (eg SMSF) should be tax-free (at least in part), the pension income should be tax-free (assuming the person has turned 60), and there is no limit on the maximum pension that may be paid. A payment in commutation of the pension, in whole or part, should also be tax-free assuming the person has turned 60.
There is a fair degree of flexibility and the person may generally take out what they like at any time, subject to the minimum pension payment rules.
For example, assume John turned 65 and started an account-based pension from his SMSF before 1 July 2017. If he were the only member, the fund should be tax-free, and payments should be tax-free (whether they were pension payments or commutations). He would only need to ensure that he received the minimum pension payment. Assuming John had an account balance of $3m at 1 July 2016, and started the pension on or before then, the minimum pension payment for the year ended 30 June 2017 would be 5% of his account balance at 1 July 2016, ie $150,000.1
Say John wants $300,000 from the fund in the year ended 30 June 2017. He could simply take it out and most likely it would simply be treated as a pension payment. Nothing would turn on whether the amount above the minimum pension payment required were a pension payment or a lump sum resulting from a commutation. As the fund would be fully tax exempt, it would not matter how the trustee funded the payment, eg selling an asset and realising a capital gain. John probably would think it was so simple that he would not seek any advice about the payment. If John only needed the funds for a short time, he could recontribute all or part of the $300,000 by making non-concessional contributions over two years, provided he satisfied the work test.2
Payments from an SMSF in pension mode under the new law
The new law will have significant impacts on payments from SMSFs. These impacts relate to properly characterising and documenting what the payments are. If this is not done properly, there will be adverse consequences.
For example, assume that John has $3m in his SMSF at 30 June 2017. To comply with the new law, John commutes and internally rolls over $1.4m on 30 June 2017. So at 1 July 2017, John would have a pension account of $1.6m and an accumulation account of $1.4m.3
In accordance with the new law, he would have a transfer balance account at 1 July 2017.4 He would have a credit to his transfer balance account of $1.6m on 1 July 2017.5 This would not exceed his transfer balance cap, which would equal the general transfer balance cap of $1.6m.6 For the year ended 30 June 2018, the minimum pension payment would be 5% of $1.6m, ie $80,000.7
Say John wants $300,000 from the fund in the year ended 30 June 2018. Now he has to determine whether the payment will come from his pension account and/or his accumulation account. He has to take out a minimum pension payment of $80,000, so it would probably be best if he took the $300,000 as a pension payment of $80,000 and a payment from his accumulation account of $220,000. This would enable him to maximise the tax exemptions for the fund by keeping the pension account as high as possible.
The trustee of the fund would need to give more thought about how to fund the payment than would be required under the law before 1 July 2017. This is because the fund would not be fully exempt from tax, and it would not be able to use the segregated pension asset method to determine the exemption as John is receiving a pension and he has more than $1.6m in superannuation.8 The proportionate approach means that there will be some type of CGT liability when an asset is disposed of and gives rise to a capital gain (the CGT transitional rules could possibly give some relief). The tax-free proportion of the fund would likely be roughly about 53%, ie 1.6m/3m.
Interestingly, if the trustee funds the payment from, say, money at the bank so there is no CGT liability and the payment were from John’s accumulation account, it is likely that the exempt proportion of the fund in the year ended 30 June 2019 would be roughly about 56%, ie 1.52m/2.7m (assuming no income or capital growth).
This shows that if someone is going to take payments from an SMSF, payments from an accumulation account should lead to an increase in the proportion of the fund that is exempt. This may impact on the timing of the realisation of any assets subject to CGT.
Let us say that John took the $300,000 from his pension account (even though that would not be the best course of action), or that he only had a pension account. It would need to be determined whether the payment was a pension payment or a commutation payment, or a mix of both. If John took the whole payment as a pension payment, then this would have no impact on his transfer balance account, ie the payment would not give rise to a debit to his transfer balance account. As he has fully “used up” his transfer balance cap, this means that he would not be able to increase his pension account, eg start another pension with $220,000.
If, however, John took the $300,000 as a pension payment of $80,000 and a commutation of $220,000, he would receive a debit to his transfer balance account of $220,000.9 So, the balance in his transfer balance account would be $1,380,000. This means that he is able to start another pension in the future with a value of $220,000. This would give John greater flexibility for the future.
All this shows that the characterisation of a payment from a pension account will be very important under the new law as it will impact upon whether or not there will be a debit to a person’s transfer balance account, and whether or not the person will be able to start a new pension in the future.
In this example, John would not be able to recontribute all or part of the $300,000 as a non-concessional contribution, even if he satisfied the work test. This is because after 30 June 2017 a person must have a total superannuation balance at 30 June of the previous financial year of less than the general transfer balance cap in the relevant year ($1.6m for the year ended 30 June 2018) to be eligible to make non-concessional contributions.10
Documentation requirements under the new law
Documentation will be more important under the new law as it will be relevant to:
- • if the person has a pension and accumulation account, where the payment comes from, and
- • if the payment is from the pension account and above the minimum pension payment, whether the excess is a pension payment or a commutation lump sum.
Trustees of SMSFs will need to ensure that they have appropriate documents to deal with the above. Such documents would include minutes and application forms. The terms of the pensions would also be important.
The timing of when documentation should be prepared will also be important. The ATO may not accept that documentation may be prepared, and payments characterised, when the financial statements for the fund are being prepared, which would often be about nine months after the end of the relevant financial year.
In Law Companion Guideline LCG 2016/911, the ATO states that a commutation occurs when the member consciously and validly exercises their right to exchange some or all of their entitlement to receive future income stream benefits for an entitlement to be paid a superannuation lump sum.12 The ATO also refers to Taxation Ruling TR 2013/5 dealing with when a superannuation income stream commences and ceases in which the same view was expressed by the ATO.13 TR 2013/5 seems to indicate that the ATO expects the request to be before the commutation.14
It seems that it will clearly be best if documentation were signed in advance of payments being made, particularly payments above the minimum pension payments required, and especially if the person has an accumulation and a pension account. Perhaps documents could be entered into which indicate that any payments from the fund above the minimum pension payments are payments from the person’s accumulation account, or if from the pension account, are commutations.
We expect that the timing and quality of documentation will be a focus of ATO reviews in the future.
Transition to retirement income streams and CGT transitional rules
TRISs are not treated as superannuation income streams in the retirement phase.15 Accordingly, the transfer balance cap rules do not apply to them, whether they commence after 30 June 2017 or are payable before then and continue after 30 June 2017. Of course, the exemption from tax for a fund paying a TRIS will not apply after 30 June 2017.16
There are CGT transitional rules that apply to funds paying pensions prior to 30 June 2017. The precise rules depend upon whether the fund is using the segregated assets or proportionate method to determine the exemptions prior to 1 July 2017. These rules are beyond the scope of this article. This article will only deal with whether they are capable of applying to a TRIS.
It seems clear from the relevant objects clause17 and the Explanatory Memorandum18 that the government’s intention is that a fund paying a TRIS could use the transitional CGT rules. However, for a fund using the segregated assets approach, one of the eligibility criteria is that at some time between 9 November 201619 and 30 June 2017, the asset must cease to be a segregated current pension asset of the fund.20But the trustee of a fund paying a TRIS does not have to do anything before 1 July 2017. This is because a TRIS may continue to be paid, irrespective of its value, after 30 June 2017 (and it is just that the fund would no longer be exempt from tax after 30 June 2017 in relation to the TRIS). So can it satisfy the CGT concessional rules that apply for segregated assets?
“In relation to TRISs, the transitional arrangements are intended to provide CGT relief by enabling complying superannuation funds to reset the cost base of assets to their market value where those assets are re-allocated or re-apportioned from the current pension phase to the accumulation phase in order to comply with the new law. It should be noted that members of funds using the segregated method may receive TRISs during the 2016–17 income year that continue past 1 July 2017 and the TRISs will not be in the retirement phase from that date. That is, the value of the interest supporting the TRIS will not necessarily be transferred to the accumulation phase before 1 July 2017. The Explanatory Memorandum states that the CGT relief is intended to apply to this situation and the Government is currently considering legislative options to clarify this. In view of this, it seems likely that this issue will be resolved by 30 June 2017 and funds paying TRISs and relying on the segregated assets approach for being exempt from tax should be eligible to use the CGT transitional rules.”
This problem does not arise for a fund using the proportionate approach for determining its exemption from tax. This is because the relevant provision does not require the trustee to do anything prior to 1 July 2017.21 The ATO accepts that under the new law a problem similar to the one for a fund using the segregated assets method for determining the exemption from tax does not arise.22
Accordingly, it seems that the CGT transitional rules will apply to SMSFs paying TRISs, but some further work needs to be done by the government to clarify this in relation to funds using the segregated assets method for determining the exemption for the year ended 30 June 2017.
Starting a pension after 9 November 2016 and the CGT transitional rules
If a pension started after 9 November 2016, the fund would not be able to use the transitional rules that apply to segregated assets, because at 9 November 2016 the assets would not be segregated.23 However, the wording of the transitional rules for funds using the proportionate method does not have a similar requirement, though the Explanatory Memorandum gives the impression that the fund needed to be subject to the proportionate method for the entire pre-commencement period, ie from 9 November 2016.24
“A particular question raised during consultation on the CGT relief provisions concerned the relevance of commencing a pension (including a TRIS) after 9 November 2016 to the availability of CGT relief under the proportionate method. Generally speaking, merely starting a pension during the pre-commencement period would not be of concern to the ATO from a Part IVA perspective. However, a commutation of the pension shortly after its commencement might be scrutinised more closely if the purpose of such action appeared consistent with obtaining a tax benefit.”
For pensions, including TRISs, that start after 9 November 2016, the following needs to be considered:
- • What type of pension will it be (eg account-based pension or TRIS)?
- • Will it need to be commuted, at least in part, before 1 July 2017 (eg an account-based pension that will have a value above $1.6m)?
- • If a TRIS, is there a financial need for the income to be paid to the member?
- • How much of the fund will be exempt in the year ended 30 June 2017, and will there actually be an advantage in using the CGT transitional rules? We consider that actuarial advice and modelling would need to be done now, to evaluate this if it were going to be recommended to clients.
- • How will Pt IVA of ITAA 1936 apply?
After 30 June 2017, it will be important to properly characterise and document payments from SMSFs in pension mode, particularly if the member has an accumulation and pension account. The timing of the documentation is also important.
SMSFs that start to pay a pension after 9 November 2016 should carefully consider whether there are any advantages in applying the CGT transitional rules, and if so, carefully consider the application of Pt IVA.