The introduction of the transfer balance cap is an issue top of mind with many SMSF advisers and trustees. Anne-Marie Esler provides an outline of how the cap works as well as some relevant strategies to allow SMSFs to operate within the newly imposed limits.
Most advisers are aware legislation introducing significant changes to superannuation has recently passed through Parliament. The Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 received royal assent on 29 November 2016 and for the most part will come into effect from 1 July 2017. The key changes in this legislation include:
- the introduction of a new transfer balance cap of $1.6 million,
- a reduction in the concessional contribution cap to $25,000 a year,
- a reduction in the non-concessional contribution cap to $100,000 a year,
- removal of the tax exemption for funds within the transition-to-retirement phase, and
- the removal of the anti-detriment payment, to name a few.
Due to the start date of 1 July for the majority of these changes, financial advisers should consider strategies that could be put into place in the coming months. In this article, we are going to concentrate on the new transfer balance cap and associated strategies.
Schedule 1 of the legislation imposes a $1.6 million cap (the transfer balance cap) from 1 July 2017 on the amount of money that can be transferred to the (tax-free) retirement phase of superannuation. The $1.6 million includes only net amounts used to start, or already within, a pension and does not include earnings, losses or drawdowns that occur once the pension has begun.
Each individual has a personal transfer balance cap reflecting the total amount they can transfer. In addition, individuals have a transfer balance account that the ATO uses to track the net amounts an individual has already used to commence a pension.
The transfer balance cap will begin at $1.6 million in 2017/18 and is designed to increase in $100,000 increments on an annual basis in line with the consumer price index thereafter.
The imposition of this legislation affects SMSF members in two categories:
- those with accumulation balances over $1.6 million looking to start an income stream after 1 July 2017, and
- those already in retirement phase with a balance over $1.6 million as at 30 June 2017.
Table 1: Super Duper Wrap account
Unfortunately, there is no reprieve for SMSF members already in retirement phase with a balance over $1.6 million as the cap also applies to these balances. However, for individuals in this second category, transitional arrangements have been introduced for members who have chosen to transfer or reallocate amounts from the retirement phase to the accumulation phase prior to 1 July 2017 in order to comply with the transfer balance cap. Complying superannuation funds, including SMSFs, are able to reset the cost base of assets, to their market value, reallocated in the period between 9 November 2016 (when the bill was first introduced to Parliament) and 1 July 2017. The relief is provided by deeming the superannuation fund to have sold and reacquired the relevant asset on the same day at the same price (market value), therefore resetting the cost base of the asset. Consequently, only gains made from this date on will apply to the relevant asset. This election is irrevocable and must be made on or before the day the trustee is required to lodge the fund’s 2016/17 income tax return.
Members with pension balances in excess of $1.6 million after 1 July 2017 will be required (and will be directed by the tax commissioner) to commute their pension by the amount of the excess to rectify the breach. The member will also be liable for a newly introduced excess transfer balance tax.
So what does all of this mean in practice?
Case study 1: Understanding the transfer balance cap
Jeff Johnson, 62 and single, is a television sports commentator who is planning on retiring at the end of the football season this year. Jeff currently has $1.44 million in his SMSF, the Footy Fund. In October, Jeff retires and commences an account-based pension from his SMSF. Jeff’s personal transfer balance cap is $1.6 million for the 2018 financial year and $1.44 million is credited to Jeff’s transfer balance account. At this time, Jeff has used 90 per cent of his transfer balance cap.After a couple of years, Jeff is enticed back to the commentary box with a lucrative salary package and commences working again. He continues to work throughout the 2019 and 2020 football seasons and then decides he has had enough. During his last two years of work, Jeff and his employer have been contributing to Jeff’s SMSF and combined with the significant returns generated in the high-risk fund Jeff was invested in, Jeff’s accumulation account has risen to $280,000.
By this time, the general transfer balance cap is indexed to $1.7 million. As Jeff has already used 90 per cent of his cap, he has 10 per cent ($160,000) remaining plus an additional 10 per cent ($10,000) of the indexed increase, a total of $170,000. Jeff commences a second account-based pension from his SMSF with $170,000 and retains the remaining balance of $110,000 in the accumulation phase. Jeff has now used 100 per cent of his personal transfer balance cap and therefore unless Jeff make a commutation in the future, he may not transfer any further funds to the retirement phase.
Case study 2: Resetting the cost base of assets
Dr Helena Hand has recently retired from her own practice where she was a successful hand surgeon for many years. Dr Hand has an SMSF, the Handsome Fund, of which she is the sole director of the corporate trustee. Upon retirement on 31 December 2016, and at the age of 64, Helena commenced an account-based pension drawing $84,000 each year in order to meet her ongoing living expenses and pay for the extensive overseas trips she has planned.Helena’s existing pension portfolio consists of the assets held within the Super Duper Wrap account (see Table 1).
As Helena’s pension balance is over $1.6 million, she will be required to roll over the excess above $1.6 million ($500,140) into the accumulation phase within her SMSF prior to 1 July 2017.
Helena’s financial adviser has asked her to come to her office for a meeting, along with her accountant, who works with the financial adviser, to discuss the situation. Together they decide to segregate a portion of Helena’s Australian share portfolio into the accumulation phase. Unaware of the transitional provisions allowing super funds to reset the cost base of assets, the financial adviser and accountant choose the following shares in Table 2 to reallocate to Helena’s accumulation account:
If Helena made a lump sum withdrawal from her accumulation account at any time throughout her retirement, she would be subject to significant capital gains tax. This would also be the case if the shares remained in the accumulation phase until Helena’s death and were then sold to pay a death benefit to Helena’s children. As an example using just one of the above parcels of shares, assume Helena decides to sell down her Westpac shares in five years’ time and assume Westpac’s share price has grown to $37 per share. Helena would be subject to the following capital gains:
Purchase price $61,425 ($10.92 x 5625)
Sale price $208,125 ($37.00 x 5625)
Capital gain = $146,700
Using the discount method, the Handsome Fund would be liable for a capital gains tax bill of $14,670.
However, if Helena’s financial adviser and accountant were aware that if they made an irrevocable election on behalf of the Handsome Fund to redeem and reacquire the Westpac shares for the market value on the day the SMSF balance was calculated above, the cost base of the Westpac shares would be $34.15 instead of $10.92. The capital gains payable on redemption in five years’ time would therefore look like this:
Purchase price $192,094 ($34.15 x 5625)Sale price $208,125 ($37.00 x 5625)
Capital gain = $16,031
This time using the discount method, the Handsome Fund would be liable for a capital gains tax bill of only $1603.
It is important to note that resetting the cost base of an asset will also reset the 12-month period for the asset to be eligible for the CGT discount.
Case study 3: Strategies for couples with high income stream balances
Minnie and Mickey Mouse are directors of their corporate trustee, the Clubhouse Pty Ltd, which is trustee of their super fund, the Clubhouse SMSF. Minnie and Mickey have accumulated a significant amount of money in their SMSF, however, the majority of the money is in Mickey’s name as he was the main breadwinner during the couple’s working life. When Mickey retired at the age of 70 a few years ago, he commenced an account-based pension that currently has a balance of $2.5 million. Although several years younger than Mickey, Minnie commenced a pension at the same time and her balance is currently $650,000. Being astute trustees, Mickey and Minnie are aware of the new super changes and book an appointment with their financial adviser to discuss the implications of Mickey’s pension balance exceeding $1.6 million.
Their financial adviser discusses strategies with them for reallocating funds from Mickey’s to Minnie’s pension in order to remain below the transfer balance cap and to avoid excess transfer balance tax. As Minnie is only 61, she is able to make non-concessional contributions to super. Their financial adviser recommends Mickey make a lump sum withdrawal of $540,000 from his pension and contribute it back into the Clubhouse SMSF as a non-concessional contribution for Minnie. He also recommends Mickey roll over the remaining portion of his pension in excess of $1.6 million ($360,000) back into the accumulation phase of super. In three years’ time, and just before Minnie turns 65, Mickey can withdraw another lump sum, this time from his accumulation balance and make a further non-concessional contribution of $300,000 into Minnie’s account.
While this article only concentrated on the new transfer balance cap and associated strategies, financial planners should be across each of the new changes to ensure they do not have clients who are currently affected by the changes or may be at some time in the future.
Following each of these steps, Mickey will have used his full transfer balance cap of $1.6 million and Minnie will have $1.49 million in her transfer balance account.