The use of complying pensions within a SMSFs seem to be somewhat of a distant memory, but some do still exist with defined benefit pensions options for both lifetime and life expectancy being used with existing fund members.
Given the legacy nature of these income streams, one of the interesting things that I’ve come across in recent times is that these a range of life expectancy pensions that were set up in the late 1990’s and early 2000’s until the legislation effectively outlawed the use of defined benefit pensions for new funds from 12 May 2004. What we are now seeing is that some of these life expectancy pensions or fixed term complying pensions, as they are also commonly known, are now coming to their expiration.
Over the course of the past few years, we have seen long overdue guidance finally arrive from the ATO in respect to the commutation of complying pensions within a SMSF. Originally issued as ATOID 2012/84 (now withdrawn), the Commissioner’s views are reflected in ATOID 2015/22. There is some level of disagreement within the SMSF community with the Commissioner’s view in this ruling, predominantly in the context of the type of income stream that the pension reserves can be transferred across to start of new income stream without the amount being caught as a concessional contribution.
Following the introduction of the Simpler Super reforms from 1 July 2007, we saw many members undertake a commutation of their defined benefit pensions. The main reason being that the RBL compression previously achieved through these complying pensions was no longer required. As mentioned, ATOID 2015/22 addresses the issues of commuting such pensions, giving consideration to the outcomes of all assets being used to support the defined benefit pension. Where effectively all the assets (both commuted value and the pension reserve) is used to support another complying income stream – that is, a market-linked income stream in accordance with SIS Regulation 1.06(8), then the requirements of Reg. 292-25.01(4)(b)(i) of the ITAR 1997 will be satisfied. What the regulation confirms is that an allocation from the reserve does not count towards the concessional contribution cap as it is being used to support another complying income stream. Should the member decide to start an account based pension with the amount in the pension reserve the Commissioner concludes that the amount would count as a concessional contribution.
But ATOID 2015/22 only talks about is what happens in the event of a commutation. What is not covered is what happens at the expiration of a life expectancy pension?
NB. I suspect that there may be a few non-complying pensions or flexi pensions (that were previously assessed against the lump sum RBL) that may have expiry terms approaching.
What happens at the expiry of a life expectancy pension?
The complying pensions that continue to operate today do so primarily for fact that they provide 100% asset test exemption (ATE) for age pension purposes.
When we look at what happens at the expiry of a life expectancy pension, we not only need to consider the various tax rules and superannuation laws around the treatment of any surplus reserve amounts, but also need to consider the Centrelink impacts as well. With the member no longer receiving an income stream, any asset-test exemption any remaining amounts (if used to support another pension) is gone.
In considering the Centrelink requirements, the section 126.96.36.199 of Chapter 4 in the Guide to Social Security Law (‘Guide’) provides guidance around the general provisions for assessing income streams within a self-managed fund. What the guidance outlines is the way that Centrelink will treat any unallocated reserves within a self-managed super fund, which is important in the context of surplus amounts and the expiration of such defined benefit pensions.
The Guide references ‘unallocated reserves’ as excess reserves where an actuary has determined that some of the reserves backing income stream are excessive to those required to meet the future liabilities and may advise the trustee to transfer any of that excess as unallocated reserves. What the guidance is telling us here is that if there are unallocated reserves sitting inside the self-managed fund, those reserve amounts, whether they are allocated to the member or unallocated reserves will actually count on a proportion of basis to the calculation of assets in determining a member (or couples) entitlement to the age pension.
What options are available at the expiration of the income stream?
The first decision that needs to be made here is – when the pension ceases, what does the trustee intend on doing with any surplus amount within the reserve account? Remember, the reserve is surplus amounts within the fund, having been created through investment outperformance over the life of the defined benefit. The amount does not belong to the member and their income stream had no residual capital value.
At the expiration of the member’s life expectancy (or term), there is a zero dollar value left in the pensioner’s superannuation interest. Understanding the member’s intention at this time becomes important in determining any Centrelink, superannuation and tax law issues. For example, if the reserve is to be transferred to the member’s account to create an income stream for that member, then the interpretative decision, ATOID 2015/22 will come into play. That is, it is the Commissioner’s view that such amounts that were utilised to previously support a complying pension can only be transferred to support another complying pension without impacting the member’s concessional contributions for that income year. As it stands today, a market linked pension in accordance with SIS regulation 1.06(8) would need to be established.
Assuming therefore that the trustees actually transfer the amount from the pension reserve into a market linked pension, and this transfer occurred as soon as practicable following the expiration of the defined benefit pension, then the requirements of regulation Reg. 292-25.01(4)(b)(i) of the ITAR 1997 will have been met.
Alternatively, if such a decision isn’t made as soon as practicable, the question that follows is whether any such subsequent transfers would be allowed without impacting the concessional contribution caps?
In seeking further guidance here, a private ruling was issued by the Commissioner – authorisation number 1012474281784 for the year ending 30 June 2013. Whilst this is a private binding ruling and relates only to the taxpayer that completed the application, it does provide valuable guidance as the ruling relates to a defined benefit pension being paid in accordance with SIS regulation 1.06(7) – i.e. a fixed-term complying pensions.
The facts of the private ruling outline that the fund was paying a fixed term complying pension which had expired (in the 2011/12 income year). At the end of the term, there was a surplus amount left inside the fund that was being used to support that pension, i.e. an amount was held in the pension reserve to support the actuarial valuation for investment risk with the complying pension.
The question that was being asked within this private ruling application was whether the amount that was set aside to meet the ongoing obligations of that complying pension could be transferred across to commence an account based pension, applying subregulation 292-25.01(4)(b)(i).
The two issues the Commissioner considered here in his decision was:
- the timing of the request to transfer of the pension reserves to support another income stream – it was concluded that this was not done ‘as soon as practicable’; and
- whether the pension reserve can be transferred to support an account based pension – ATOID 2012/84 has previously concluded that such a transfer would result in a concessional contribution.
Therefore, it is important to note that where some period of time lapses between the expiry of the complying pension and any request to commence a new account based pension (i.e. not as soon as practicable) will impact on the potential application of the reserve transfer rules. Whilst ‘as soon as practicable’ is not defined within superannuation or tax laws, it is safe to assume that where a reasonable period of time passes from the expiry date of the complying pension, then the monies are genuinely unallocated reserve of the fund.
There is nothing that would prevent or preclude these unallocated reserve amounts staying as monies in reserve (would need to create a separate investment strategy). The trustees could look to employ a crediting strategy to undertake reserve transfers that benefit each of the fund members on a proportionate basis, fair and reasonably, and within the 5% threshold value of the member’s interest in the fund. From a Centrelink viewpoint, section 188.8.131.52 outlines that such unallocated reserve amounts would be attributed proportionately across all fund members – this may be advantageous in certain circumstance as it would lower the assets being tested for age pension entitlement.
NB. Reserve transfer amounts could be made disproportionately or above the 5% member interest threshold, which would count towards the member’s concessional contribution cap, but would really have little or no impact on their overall circumstances.
Plenty to consider…
As you can see from the above, there are several important steps in the lead up to the expiry of the life expectancy (or fixed-term) pension that need to be worked through. With the loss of the 100% ATE on any new pension, this will have a bearing on the way you may look to structure the potential income stream going forward.
The SMSF Academy has developed a range of precedent documents regarding the expiration of defined benefit pensions and where a member intends to commence a market-linked pension with the pension reserves of the fund. You can contact me via the blog should you wish to purchase a copy of these documents.
I suspect over the coming 4-5 years, we are going to see quite a number of these life expectancy complying pensions reach maturity. That’s why it is important to start identifying these issues now and develop the right approach to meeting the member’s future requirements.
As always, I’d love to hear your comments.