The treatment of account-based pension partial commutations in relation to prescribed yearly minimum income stream payments is an area advisers should revisit in light of the new superannuation legislation, write Daniel Butler and William Fettes.
Many advisers are broadly aware of there being significant changes on the horizon from 1 July 2017 that will impact on lump sum payments arising from the partial commutation of pensions. However, very few people are aware the federal government’s super reforms have already modified the tax treatment of lump sum benefit payments arising from the partial commutation of a pension and this change was effective from 1 January 2017.
This article explains the current state of the law and outlines some of the other issues advisers need to be aware of in relation to this important topic, such as the impact on minimum pension payments and the $1.6 million transfer balance cap (TBC) measure.
Background
Prior to 1 January 2017, a benefit payment arising from the partial commutation of an account-based pension was broadly considered a lump sum for superannuation purposes. A member could, however, also elect under regulation 9951.03 of the Income Tax Assessment Regulations 1997 (ITAR) to treat the payment as a lump sum for tax purposes. However, if a member did not elect, the payment arising from the partial commutation would constitute a superannuation income stream benefit for tax purposes.This analysis is consistent with the ATO’s view in Tax Ruling TR 2013/5 ([28] and [120]).
The general position in relation to the prescribed pension minimums under schedule 7 of the Superannuation Industry (Supervision) (SIS) Regulations 1994 is simpler. The ATO broadly considers that a lump sum payment arising from a partial commutation counts toward the required minimum pension payments. As a reference, Self Managed Super Fund Determination SMSFD 2013/2 and SMSFD 2014/1 outline the ATO’s view on this subject in relation to account-based pensions (ABP) and transition-to-retirement income streams (TRIS) comprising unrestricted non-preserved benefits.
However, the situation is somewhat less clear where an election under ITAR regulation 9951.03 is made. This is because the explanatory statement that accompanied the introduction of that regulation states that if such an election is made, the payment will not count toward the minimum pension payment requirements.
It is important to note though that an explanatory statement is not law, and the regulation, as a tax provision in respect of a member benefit payment, should arguably have no impact on the superannuation law pension requirements at the fund level. Additionally, we are aware the ATO has issued a number of private binding rulings in relation to numerous regulation 9951.03 elections that have been made, which lend support to the view that the election does not preclude a relevant payment from counting toward the minimum pension payments required each financial year.
Super reform changes
Tax treatment
The law has now changed to align the tax law treatment and superannuation classification of such a partially commutated amount paid as a lump sum. We now have section 307-65(2) of the Income Tax Assessment Act 1997 (ITAA), which provides:
“Treat a lump sum payment arising from a partial commutation of a superannuation income stream as a superannuation lump sum for the purposes of this Act (other than Subdivision 295-F).”
This new provision was effective from 1 January 2017 following royal assent of the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (TLAA), which occurred on 29 November 2016.Accordingly, from 1 January 2017 any benefit payment arising from the partial commutation of a pension will be treated as a lump sum for tax purposes, and thereby provide access to the low-rate cap, if the member is under 60 years of age without using the election under regulation 9951.03 of the ITAR.
Minimum pension payments
The explanatory memorandum to the TLAA states the federal government intends to change the law so that a lump sum payment arising from the partial commutation of a pension will no longer count towards the required minimum pension payments. More specifically, the explanatory memorandum provides the following commentary ([3.109]):“Partial commutations and minimum draw-down requirements3.109: To facilitate the ability for individuals to make partial commutations and receive a debit for the full value of that commutation against their transfer balance account, consequential amendments will be made to the SISR 1994 … These amendments will ensure that partial commutations cannot be counted towards the minimum annual payment requirement for superannuation income streams.”However, the relevant draft regulations to implement this change have not yet been finalised. Thus, the existing state of affairs as discussed above appears to be unchanged for the time being, consistent with the ATO’s view in SMSFD 2013/2 and SMSFD 2014/1.
However, in recognition of there being some uncertainty about the precise timing of the anticipated change, advisers may consider it prudent to caution their clients that a minimum (ordinary) pension payment may be required to satisfy the required minimum pension payments under the SIS Regulations if the only payment being made for the current financial year is a lump sum payment arising from the partial commutation of a pension, including an ABP or TRIS.
Hopefully Treasury will finalise the relevant draft regulations to address this uncertainty in the near future.
Regulation 9951.03 elections
In summary, the election under regulation 9951.03 of the ITAR remains in force for the time being. It is anticipated this election will be repealed on 1 July 2017 or possibly sooner depending on when the relevant draft regulation is finalised and registered.Accordingly there is still some time remaining for a member under 60 in receipt of a TRIS comprising entirely of preserved benefits to make an election in respect of a pension payment up to their 10 per cent per financial year maximum limit and thereby access their low-rate cap.
Clients who have already implemented an ITAR regulation 9951.03 election in respect of a TRIS comprising preserved benefits with a favourable ATO private binding ruling have a measure of protection.
Those taxpayers without a private binding ruling from the ATO hopefully have a reasonably arguable position documented that outlines relevant supporting arguments based on the law.
The transfer balance cap
Partial commutation strategies where the amount commuted is paid out as a lump sum benefit will also take on greater importance in light of the $1.6 million TBC measure.This is because an individual’s TBC will be tracked through a system of debits and credits in respect of a member’s transfer balance account, and debits to restore a member’s TBC will be available for commuted amounts (but not ordinary pension payments).
This means fund members who generally take more than their prescribed minimum pension payment as an ordinary pension payment will generally want to take any additional drawdowns in the form of a lump sum benefit payment arising from a partial commutation from 1 July 2017 to maximise their unused TBC. If they do not take this course of action, the additional pension payments they receive will reduce their pension capital without a corresponding reduction in their transfer balance account.
Conclusion
The tax and superannuation treatment of a lump sum arising from the partial commutation of a pension is now broadly aligned as a result of the federal government’s major package of super reforms.That is, a partially commuted amount that is paid out as a lump sum is now treated as a lump sum for both SIS Regulations and tax purposes. This change was effective from 1 January 2017. For the time being, such amounts will count towards the minimum pension payments required under the SIS Regulations, and the announced draft regulation to change this has not yet been finalised.
An election under regulation 9951.03 of the ITAA is no longer required where a member under age 60 wishes to partially commute their ABP or TRIS comprising unrestricted non-preserved benefits and pay the commuted amount as a lump sum to access their low-rate cap. One might argue that making the election in this context does no harm.
However, the election will be repealed in due course soon when the relevant draft regulation is finalised and registered. Thus there is only limited time remaining to elect to treat an ordinary TRIS payment as a lump sum for tax purposes in relation to a TRIS comprising preserved benefits. Expert advice should be obtained before using this strategy.
