Julie Dolan Examines the transfer balance cap implications of market-linked pensions

16-Oct-2017

By Julie Dolan

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The TBC (transfer balance cap) is fast becoming a common acronym in the superannuation world. There are many twists and turns we are constantly needing to work through in the new world of superannuation post-30 June.

One such twist and turn is how a market-linked pension or term-allocated pension is treated in relation to the TBC. 

Market-linked pensions were introduced in September 2004 as a more flexible option to the older-style complying pensions. They allowed members to have greater control over their capital and commutation ability to their dependents on death, while still having favorable social security and reasonable benefit limit eligibility at the time. However, during the life of the recipient member, there are restrictions on the commutation ability. The main exception being the ability for the commutation amount to be applied to commence a new market-linked pension. 

In relation to the TBC, a market-linked pension is defined as a ‘capped defined benefit income stream’ under section 294.130 of the Income Tax Assessment Act 1997 (ITAA 1997) if it was in place just before 1 July 2017. As stated in Law Companion Guideline LCG 2017/1, the value of a capped defined benefit income stream counts towards an individual’s TBC, but with modifications. 

The modifications apply to where these capped defined benefit income streams cannot of themselves result in an excess transfer balance amount. Instead, modifications result in certain amounts of the pension payments being included in the personal assessable income of the member, with adjustments to the available tax offsets. 

As stated above, a market-linked pension is defined as a capped defined benefit income stream due to its restrictions on commutation. The credit value of a market-linked pension to an individual’s personal TBC is calculated under subsection 294.135(3) of the ITAA 1997. The special value is calculated as the annual entitlement multiplied by the remaining term. Close examination on the timing of when the special value is calculated under this subsection has raised some questions as to whether it just applies to market-linked pensions that were in existence prior to 1 July 2017 for the purpose of the TBC. The wording “that is, or was at any time” implies a prior time, especially when it is linked back to section 294.130 of the ITAA 1997 where this section refers to specific items on the table that are to be in retirement phase prior to 1 July 2017.

So what does this all mean?

On strict interpretation, it seems that market-linked pensions established after 1 July via a commutation of an existing market-linked pension would not be assessed under the special value rules, but rather it would be based on the capital of the pension. When calculating the special value, in most cases, this value can exceed by quite a margin the capital value of the pension. This is beneficial when the capital value of the pension exceeds $1.6 million such that the member receives the higher value as per the special value calculation and hence can benefit from more capital in the retirement phase and the tax benefits thereon. However, should the value not exceed the $1.6 million, it can be detrimental, especially when added to the credit value of existing account-based pensions.

Example

Sara has been in receipt of a market-linked pension for quite a number of years and it is non-reversionary. As at 1 July 2017, the market value of the pension is $1.4 million, with a remaining term of 18 years. Under Schedule 6 of the Superannuation Industry (Supervision) Regulations 1994, the payment factor is 13.19. Sara’s annual payment for the 2018 financial year is $106,141 (plus or minus 10 per cent). The special value for the credit item to her transfer balance cap is $106,141 x 18 = $1,910,538. Therefore, the special value for the TBC increases the capital value by $510,538. If it wasn’t a market-linked pension but an account-based pension, the member would still have a gap of $200,000 before exceeding the cap amount.

 However, should the member start a $200,000 account-based pension with her market-linked pension in place, an excess TBC issue would arise.

 This is where it gets interesting based on the strict interpretation of the law as per above.Should Sara commute her existing market-linked pension and start a new one after 1 July 2017, it could be argued the special value rules do not apply, but rather the credit value to her TBC is calculated based on the market value of the pension at the time. On commutation, a debit item of the special value would occur to negate the initial credit value. The new credit value based on the capital value of the pension would then be recorded. The result would be that her new market-linked pension would be under the TBC amount. She would have a surplus of at least $200,000 in her TBC for future account-based pensions and any excess over her $100,000 pension payment would not be brought to account at a personal level.

Julie Dolan is principal of SMSF Consulting.

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