The ATO has released Practical Compliance Guideline PCG 2017/5, which outlines the circumstances where the ATO will not conduct compliance reviews for pension commutation requests made before 1 July 2017 by a member of a self managed superannuation fund (an SMSF) to avoid exceeding the $1.6 million pension transfer balance cap.
Rolling back excess pension balances before 1 July 2017
The Guideline notes that SMSF members may need to take action before 1 July 2017 to ensure they do not exceed the $1. 6 million transfer balance cap. They can do this by requesting that the trustee of the SMSF commute some or all their income streams, to be rolled over as an accumulation interest within the SMSF or withdrawn from the SMSF as a lump sum.
The ATO acknowledges that SMSF members may not be in a position on 30 June 2017 to know precisely the value of the superannuation interests that support their superannuation income streams. This is especially the case for SMSFs that need to wait a few months after year-end to receive tax statements from managed funds to finalise their accounts. Other small funds tend not to finalise their accounts until much closer to the time that their tax return is due under their tax agent's lodgment program.
Therefore, PCG 2017/5 accepts that it is a valid strategy for the member to make a request, which is subsequently accepted by the trustee of the SMSF, to commute their income streams by the amount that exceeds $1.6 million on 30 June. Whether and at what time a valid commutation takes effect is a question of fact. It must be clear that some or all of the member's right under the trust deed to receive future income stream benefits has been exchanged for a right to receive a lump sum.
Requirements for commutation requests
The ATO will not conduct a compliance review in relation to such a strategy where the commutation request and acceptance:
- are both made in writing before 1 July 2017 – the agreement by the trustee may be documented as a trustee resolution;
- specify a methodology that allows the precise quantum of the amount commuted to be calculated (although the amount may be ascertained at a later time);
- specify the superannuation income stream that will be subject to the commutation; and
- do not conflict with a similar agreement to commute that the member has agreed to with a trustee of a different super fund. However, the ATO accepts that entering into an agreement with the trustee of one fund in conjunction with the commutation of a specific amount from another fund does not in itself cause a conflict.
A request to commute the excess amount must be made in writing before 1 July 2017 and cannot be revoked. The amount of the commutation must also be reflected in the SMSF's financial accounts for the year ended 30 June 2017, no later than the due date of the SMSF's annual return.
The Guideline states that the concessional ATO compliance approach will not apply where:
- the request is dependent on the later exercise of a discretion by either the member or trustee of the SMSF with respect to the amount or income stream that will be commuted;
- the request and/or whether the amount is to be commuted are subject to certain actions occurring after the date the SMSF trustee accepts the request;
- the request does not provide sufficient certainty to identify the income streams it concerns; and
- the request and/or the amount to be commuted depend on a decision or an exercise of discretion by a different fund's trustee. For example, where the member specifies the amount to be commuted is the excess amount over the member's $1.6 million pension transfer balance cap, taking into account all income streams the member has in multiple funds, and the member provides a similar request to commute to a trustee of a different fund. In this situation, the ATO says that neither request specifies a methodology that allows precise calculation of the commutation amount.
On 1 May 2017, Jim has the following three superannuation interests supporting superannuation income streams in his SMSF:
- income stream A, valued at $100,000;
- income stream B, valued at $1,200,000, and
- income stream C, valued at $600,000.
Jim requests in writing that the trustee of his SMSF commute amounts on 30 June 2017 in excess of $1.6 million, based on the value of the interests supporting his income streams valued at 30 June 2017. The trustee accepts the documented request. The trustee works out the amount of the commutation and ensures it is reflected in the SMSF's financial accounts for the year ended 30 June 2017 by the date that the SMSF's annual return is due.
In such a case the ATO says it will not review the commutation, provided that the commutation request specifies the income streams subject to the agreement to commute and the order in which the income streams will be commuted.
Law Companion Guideline LCG 2017/1 deals with how defined benefit income cap rules will apply to non-commutable life expectancy pensions and market-linked products as part of the super reforms legislation.
Capped defined benefit income streams
As with other types of superannuation income streams, the value of "capped defined benefit income streams" will count towards an individual's pension transfer balance cap of $1.6 million from 1 July 2017. However, capped defined benefit income streams cannot, of themselves, result in an excess transfer balance for an individual. This is because capped defined benefit income streams generally cannot be commuted and cashed as a lump sum. The modified rules apply to achieve an equivalent tax outcome for defined benefits.
Special value for MLIS and life expectancy pensions
If a pension or annuity from a life expectancy or market-linked income stream (MLIS) product is payable to an individual, a credit arises in their transfer balance account equal to the "special value" of the superannuation interest that supports the income stream.
The special value of a superannuation interest that supports a life expectancy or market-linked pension or annuity is calculated by multiplying the "annual entitlement" by the product's "remaining term"; that is, number of years remaining in the period that superannuation income stream benefits are payable under a product (rounded up to the next whole number).
If a life expectancy or market-linked pension or annuity is payable before 1 July 2017, the credit is equal to the special value of the superannuation interest that supports that income stream just before 1 July 2017. The credit arises in the individual's transfer balance account on 1 July 2017. This will be calculated based on the first superannuation income stream benefit the person is entitled to receive on or after 1 July 2017.
Just before 1 July 2017, Victoria has a market-linked pension. The first benefit she is entitled to receive from her pension just after that time is her fortnightly payment of $2,301.37, due on 4 July 2017. The remaining term in Victoria's pension just before 1 July 2017 is 9.75 years.
Victoria's "annual entitlement" just before 1 July 2017 is $60,000, which is worked out as the first payment amount divided by the number of days in the period, and multiplied by 365 = $2,301.37/14 x 365 = $60,000.
The remaining term in Victoria's pension just before 1 July 2017 is rounded up from 9.75 years to 10 years (the next whole number). The special value of Victoria's pension just before 1 July 2017 is $600,000 ($60,000 x 10 years). A credit arises in Victoria's transfer balance account on 1 July 2017 for this amount.
Additional income tax
The guideline also explains the additional income tax consequences for an individual with defined benefit pension income that exceeds the defined benefit income cap ($100,000 per annum) for a financial year. In a taxed fund, 50% of the excess capped defined benefit income stream payments will be included in the recipient's assessable income and taxed at the marginal rates to the extent they exceed $100,000 per annum. For untaxed defined benefit arrangements, the 10% tax offset will be limited to the first $100,000 per annum of defined benefit income the individual receives from 1 July 2017. Pay as you go (PAYG) withholding obligations will also apply to these amounts, which will be subject to taxation from 1 July 2017.
Law Companion Guideline LCG 2017/3 explains the tax and regulatory treatment of superannuation death benefit income streams under the $1.6 million pension transfer balance cap from 1 July 2017.
Where a deceased fund member's superannuation interest is cashed to a dependant beneficiary in the form of a death benefit income stream, a credit will arise in the dependant beneficiary's transfer balance account: s 294-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997). The amount and timing of a transfer balance credit arising for a death benefit income stream will depend upon whether the recipient is a reversionary or non-reversionary beneficiary.
Transfer balance credit: reversionary pension
For a reversionary death benefit income stream, a credit will arise in the reversionary beneficiary's transfer balance account 12 months from the date of the original superannuation member's death. If the reversionary income stream commenced before 1 July 2017, the credit will arise on the later of 1 July 2017 and 12 months from the date of the original member's death.
The credit that will arise in the reversionary beneficiary's transfer balance account is equal to the value of the superannuation interest on the starting day when it first becomes payable to the reversionary beneficiary (ie, at the date of the death), or just before 1 July 2017 if the income stream commenced before that time.
Larissa commences a pension on 1 October 2000. The rules of the pension allow for it to revert to a dependant beneficiary. Larissa dies on 1 January 2017. Brad is Larissa's spouse and is the reversionary beneficiary of her pension. As Brad is a reversionary beneficiary, Larissa's pension automatically becomes payable to Brad on the date of Larissa's death (1 January 2017). The value of the superannuation interest that supports the reversionary pension just before 1 July 2017 is $1 million.
A transfer balance credit arises in Brad's transfer balance account 12 months from the day that the reversionary income stream first became payable to Brad (1 January 2018). The transfer balance credit that arises is equal to the value of the superannuation interest that supports the reversionary pension just before 1 July 2017 ($1 million) and not the value of the superannuation interest when the transfer balance credit arises (1 January 2018).
Transfer balance credit: non-reversionary pension
For a non-reversionary death benefit income stream, a credit will arise in the recipient's transfer balance account on the later of 1 July 2017 and when the dependant beneficiary becomes entitled to be paid the income stream. The credit is the value of the superannuation interest at the time the dependant beneficiary becomes entitled to payment (or the value just before 1 July 2017, if it commenced before that time).
The ATO notes that this value for non-reversionary death benefit pensions may include any investment earnings that accrued to the deceased member's interest between the date of death and the date the dependant beneficiary becomes entitled to be paid the death benefit income stream. It may also include other amounts – for example from the deceased member's accumulation interest or an amount paid under a life insurance policy – if the trustee has made a decision to pay these amounts out as a death benefit income stream.
Nathaniel commences a pension worth $1.4 million on 1 October 2017. The rules of the pension do not provide that it may revert to another person on Nathaniel's death. Nathaniel dies on 1 January 2018. At the time of Nathaniel's death, the value of the superannuation interest supporting the pension is $1.3 million. Nathaniel has no other super interests.
Malena is Nathaniel's spouse and the only beneficiary. On 15 June 2018 she becomes entitled to all of Nathaniel's remaining superannuation interest, to be paid as a death benefit income stream. During the period between Nathaniel's death (on 1 January 2018) and when Malena becomes entitled to be paid the death benefit income stream (on 15 June 2018), $1,000 of investment earnings accrued to the superannuation interest, bringing its value to $1,301,000. The value of the superannuation interest supporting the death benefit income stream on 15 June 2018 is $1,301,000. A transfer balance credit arises in Malena's transfer balance account on 15 June 2018 in respect of the death benefit income stream equal to the value of the superannuation interest that supports the death benefit income stream on 15 June 2018 ($1,301,000).
Reversionary versus non-reversionary pensions
A reversionary death benefit income stream is an income stream that reverts to the reversionary beneficiary automatically upon the fund member's death. That is, the income stream continues, with the entitlement to it passing from one person (the member) to another (the dependant beneficiary) pursuant to the rules of the fund.
According to the ATO, the superannuation income stream reverts in this manner because the governing rules or the agreement/standards under which it is provided expressly provide for reversion, as opposed to the trustee exercising a power or discretion to determine a benefit in the beneficiary's favour: see Taxation Ruling TR 2013/5. That is, the preconditions necessary for an income stream to revert must exist within the rules governing the superannuation income stream before the member's death. If this is not the case, then the ATO says that the income stream ceases on the member's death. However, the ATO accepts that administrative steps, such as confirming that the reversionary beneficiary is a dependant beneficiary and obtaining bank account details or other account information about the dependant beneficiary, do not preclude an income stream from being reversionary. Also, a binding death benefit nomination does not, by itself, make a superannuation income stream reversionary.
On the other hand, a non-reversionary death benefit income stream is a new superannuation income stream created and paid to a dependant beneficiary where the trustee has the power or discretion to determine:
- to whom the death benefit is paid;
- the form in which the death benefit will be paid (eg as a lump sum or income stream); or
- the value of the death benefit paid.
However, the ATO accepts that a death benefit income stream is not precluded from being reversionary if the rules under which the superannuation income stream is provided limit the value of the reversionary income stream to a set percentage (eg 75%) of the amount that was payable to the deceased member.
Commutation of excess transfer balance
To reduce an excess transfer balance so that it does not exceed the general transfer balance cap, an individual can choose to either commute (fully or partially):
- the death benefit income stream; or
- a superannuation income stream that the individual already has in retirement phase.
If an individual chooses to commute their own existing superannuation income stream, the commuted amount can remain within the superannuation system as an accumulation interest. However, if the individual chooses to commute the death benefit income stream, the commuted amount cannot be retained as an accumulation phase interest, but must be cashed out as a lump sum death benefit.
Rules for death benefits
The guideline notes that a deceased fund member's superannuation benefits must be "cashed" (ie paid out) by the fund trustee as soon as practicable after the death. While superannuation death benefits can be cashed in the form of a lump sum or pension/annuity, a death benefit income stream can only be paid to a dependant beneficiary of the deceased member. For this purpose, a dependant beneficiary includes a:
- child under 18 years;
- financially dependent child under 25;
- child with a prescribed disability (irrespective of their age); or
- person who was in an interdependency relationship with the deceased.
Where a deceased member's superannuation interest is paid to a dependant beneficiary as a death benefit income stream, the compulsory cashing requirement is met as long as the income stream continues to be in the "retirement phase" (which is subject to the recipient's pension transfer balance).
Roll-over of death benefits
From 1 July 2017, the definition of a "roll-over superannuation benefit" allows a superannuation lump sum death benefit for dependant beneficiaries to be rolled over. Only superannuation death benefits paid to dependant beneficiaries of the deceased member qualify as a roll-over superannuation benefit. The ATO says that qualifying as a roll-over superannuation benefit does not enable the amount to remain in an accumulation phase interest or be mixed with the dependant beneficiary's own superannuation interest. As the compulsory cashing rules still apply, the interest must be cashed as soon as practicable, either as a lump sum or death benefit income stream (where permitted).