Superannuation: Issues for Reversionary Pensions
Budget announcements on 3 May this year presaged a plethora of changes to the Australian superannuation system more significant than any since May 2006. Five months later we have an Exposure Draft of the proposed legislation.
These changes are some of the most complex yet. They introduce a whole range of new concepts and definitions with significant and far reaching consequences for many. This article deals with one major change; the introduction of the ‘Transfer Balance Cap’ and ‘Transfer Balance Account’ which includes all amounts transferred into a retirement income stream account. The Transfer Balance Cap is set at $1,600,000 as previously announced. There is provision for indexation to CPI but only in $100,000 lots. Given $100,000 is 6.25% of the initial cap we are unlikely to see any increase for at least three years.
Indexation relates only to portions of the cap which have never been used. For example:* in July 2017 Helen decides to retire and start a pension with $1,200,000 of her superannuation savings. Helen has used ¾ of her Transfer Balance Cap. Even if she later changes her mind, returns to work and commutes the pension back to accumulation for five years she will never receive any indexation on that first $1,200,000. In July 2022 Helen retires and wishes to start a pension with as much of her superannuation savings as possible. In the intervening five years the transfer balance cap has been increased by $100,000. Helen cannot use $1,700,000 of her savings to fund a pension. She can recontribute the $1,200,000 which she commuted. The remaining ¼ of her Transfer Balance Cap that was never previously used to fund a retirement pension is indexed to $425,000 giving Helen a Transfer Balance Cap of $1,625,000. Clearly, Helen would have been better off if she had never started and stopped the pension in 2017.
This lost indexation does not only apply to people who change their minds but also where: a cash lump sum is needed from the retirement income stream, an amount is lost through fraud or dishonesty of another person, an amount has to be paid out in accordance with the Bankruptcy Act 1966 or is split to a spouse.
Problems may arise for those with reversionary pension arrangements in place. The Transfer Balance Cap includes a pension that reverts to a person from their spouse. This means pensioners with well under $1,600,000 in superannuation may be caught when their partner dies. For example:* Carmen and Robert are domestic partners and each have $1 million in superannuation which they each use to start to start a pension when they retire in 2017. Each pension reverts to the other on its terms. When Robert passes away in 2019 his retirement income stream has a value of $900,000. Carmen has used $1 million of her Transfer Balance Cap to start her own pension but the reversion of Robert’s pension takes her over the $1,600,000 limit and she will be required to commute at least part of this pension. The Explanatory Memorandum seems to indicate that Carmen has to take the amount commuted as a lump sum rather than simply keep it in accumulation phase in the superannuation fund. She has a six month window in which to do this. However, if Carmen wishes to retain both amounts in the superannuation environment she could commute part of her own pension back to accumulation as she cannot commute Robert’s pension other than as a lump sum.
Where a child receives an income stream on a person’s death the child is subject to the Deceased’s Transfer Balance Cap, their own is not affected. Concessions allow that child to effectively restart with a Transfer Balance Cap of zero when he or she becomes an adult and that reversionary pension has ceased.
While it is hoped that the Exposure Draft will be amended to ameliorate at least some of these issues before becoming law there is little time until July 2017 when this legislation is expected to commence. It is important that members of superannuation funds and their advisors consider the impact of the legislation on existing plans and whether those plans may need modification sooner rather than later.
* Based on examples in Explanatory Memorandum.