The introduction of a transfer balance cap represents one of the most significant changes to this country’s superannuation framework in recent history. Jordan George and Peter Hogan detail how the new cap will work.
Late last year, the federal government legislated wide-ranging changes to superannuation. One such change is that from 1 July 2017 superannuation fund members will be subject to a $1.6 million transfer balance limiting the tax exemption for assets funding superannuation pensions.
Amounts in excess of the lifetime cap will not attract the tax exemption for earnings from assets in retirement phase and will be required to be held in the accumulation phase and taxed at 15 per cent.
Given its significance for members of SMSFs, the SMSF Association prepared a briefing paper for its members on the issue. What follows is an edited version of that member communication.
Credits and debits for the cap
- Superannuation income streams, the total value of an individual’s superannuation interests supporting income streams at 30 June 2017 will count towards their $1.6 million transfer balance cap.
- For people with existing superannuation income streams, the total value of an individual’s superannuation interests supporting income streams at 30 June 2017 will count towards their $1.6 million transfer balance cap.
- The cap operates on the basis of credits counting to the cap and debits removing value from the cap.
i. Credits will be created by:
a. the value of super interest supporting income streams on 30 June 2017,
b. commencement of new superannuation income streams from 1 July 2017 onwards,
c. the value of reversionary income streams when an individual becomes entitled to them, and
d. notional earnings accruing to excess transfer balance amounts.
ii. Debits will be created by:
a. commutations of superannuation income streams,
b. structured settle payments contributed to superannuation, and
c. certain payments arising from family law splits, fraudulent or void transactions.
- Partial commutations will not count towards a person’s minimum drawdown requirements under the new rules.
- Investment gains and losses do not alter the transfer balance cap. Income stream payments do not change the transfer balance cap either.
- Reversionary pensions will count towards the cap, but taxpayers will have a 12-month period to deal with the reversionary pension before a credit arises and counts towards their cap. This deferral also applies to individuals who are receiving a reversionary pension on 30 June 2017.
- Non-reversionary pensions count towards the beneficiary’s cap on the date that they begin being paid to the beneficiary.
Exceeding the cap
- Breaches of the cap will require the excess amounts to be removed, which will most likely necessitate partial commutation of the relevant income stream that has exceeded the cap. The ATO will issue a notice that the transfer balance cap has been exceeded and that identifies the excess.
- If the excess is rectified, then the taxpayer only needs to notify the ATO corrective action has occurred. If not, the ATO will provide 60 days to reduce the transfer balance cap by the excess amount.
- After 60 days, the commissioner of taxation will issue a commutation notice to the trustee of the fund, setting out the amount by which an income stream must be reduced. A fund has 60 days to comply with the commutation notice.
- If the commutation notice is not complied with, then the entire income stream will not be eligible for the tax exemption for earnings from assets supporting an income stream.
- Excess amounts will also attract notional earnings that count towards the transfer balance cap. Notional earnings are charged at the 90-day bank accepted bill rate plus 7 per cent.
- An excess transfer balance tax of 15 per cent applies to the notional earnings. After receiving one excess transfer tax determination, a tax rate of 30 per cent applies to any excess transfer balance tax assessments the individual receives in a subsequent financial year.
Indexation of the cap
- The transfer balance cap will be indexed in line with the consumer price index and increased in $100,000 tranches.
- Individuals will only be able to access a proportion of the newly indexed amount consistent with the unused proportion of their transfer balance cap rather than the full $100,000 increase when it is available.
Child death benefit pensions
A child receiving a superannuation death benefit income stream will have a modified transfer balance cap that is linked to their deceased parent’s cap.
i. If a child is receiving superannuation income streams as a child recipient when these amendments begin to apply, the child’s transfer balance cap is $1.6 million.
ii. If the deceased parent did not have a transfer balance account at the time of their death, that is, they had not yet entered retirement phase, and they died on or after 1 July 2017, the child’s cap is their proportionate share of the deceased’s superannuation interests multiplied by the $1.6 million transfer balance cap.
iii. If the deceased person did have a transfer balance account, the child beneficiary’s transfer balance cap is equal to the portion of the deceased’s superannuation interests that was in the retirement phase that they are entitled to.
Non-commutable income streams
- Capped defined benefit income streams have special rules for the transfer balance cap recognising their non-commutable nature. These modifications apply to lifetime pensions/annuities, life expectancy pensions/annuities and market-linked pensions/annuities.Lifetime pensions and annuities have a transfer cap credit value determined by multiplying the annual entitlement by a factor of 16.
- Life expectancy pensions/annuities and market-linked pensions/annuities have their transfer cap credit value determined by multiplying the annual entitlement by the remaining term.
- Table 1 from the explanatory memorandum lists the different approaches for valuing these income streams for the transfer balance cap.
- Where the value of a capped defined benefit income stream exceeds the transfer balance cap, it will not give rise to excess transfer balance tax, but instead will attract additional income tax on the income stream.
- Additional income tax consequences are determined in reference to a taxpayer’s ‘defined benefit income cap’ that is worked out by dividing the current financial year’s general transfer balance cap by 16 (that is a cap of $100,000 in 2016/17).
i. Taxed element or tax-free defined benefit income that exceeds the defined benefit income cap – 50 per cent of the amount exceeding the defined benefit income cap is included in assessable income.
ii. Untaxed elements defined benefit income cap is not eligible for the 10 per cent tax offset and is assessable at the taxpayer’s full marginal rate.
- When applying the defined benefit income cap for taxpayers with multiple tax components, the following order applies to counting the components to the cap:
1. tax-free component
2. taxable component – taxed element
3. taxable component – untaxed element
- Draft regulations released by Treasury on 16 December 2016 allow for limited commutations of generally non-commutable annuities and pensions, such as market-linked pensions, to comply with the transfer balance cap and avoid extra income tax.
i. The partial commutation of these non-commutable annuities/pensions is limited to the amount required to be commuted to comply with the transfer balance cap.
- For fund members with retirement income streams at 1 July 2017, they can exceed the transfer balance cap by up to $100,000 without penalty if the excess is reduced within six months.
Removal of the segregated exempt current pension income (ECPI) method
- Taxpayers in excess of $1.6 million in superannuation will be required to use the unsegregated method to calculate the tax their fund must pay on earnings when they have assets in retirement phase and assets exceeding $1.6 million.
Roll over of death benefits
- The transfer balance cap amendments also introduce the ability to roll over death benefits from one super fund to another.This allows death benefit dependants, who are a recipient of a superannuation death benefit as an income stream, to transfer the death benefit to another superannuation fund that better suits their needs.
A consequence of this amendment is that the notion of the prescribed period for death benefit commutations being treated as a super death benefit is repealed.
- This change means all benefit withdrawals stemming from a death benefit income stream will be treated as a death benefit no matter when the withdrawal is made.
- This will also stop death benefit income streams being able to be commuted and rolled into accumulation phase or being combined with the recipient’s member benefits. These amounts will always remain as death benefits.
CGT relief arrangements for asset transfers
- The government has allowed capital gains tax (CGT) relief for assets that need to be transferred from retirement phase to accumulation phase due to the $1.6 million transfer cap and changes to transition-to-retirement income streams.
- The CGT relief arrangements will allow funds to reset the cost base on CGT assets that are moved or reapportioned from the retirement phase to the accumulation phase from 9 November 2016 until prior to 30 June 2017.
- This will ensure when the assets are sold, only tax is paid on capital gains accruing after 1 July 2017.
- For segregated current pension assets:
i. Assets transferred from retirement phase back to accumulation phase to comply with the $1.6 million cap will be taken to be disposed of and reacquired on the day of being transferred.
- This effectively washes out any capital gain accrued up to that point.
i. If a fund is required to change from the segregated to unsegregated method as it has a member with a total superannuation balance over $1.6 million, and a member in retirement phase, then all assets are deemed to have been disposed of and reacquired just before this change occurs.
ii Election for this treatment is made via the fund’s annual tax return.
- For unsegregated current pension assets:
i. For funds using the proportionate method to determine ECPI, they can choose to apply the transitional treatment to assets.
ii.mThe treatment for unsegregated assets deems an asset to be disposed of and reacquired just before 1 July 2017.
iii. As the fund’s assets are all 100 per cent tax-free if there is an accumulation component, a taxable capital gain will arise from the deemed disposal and acquisition. This capital gain can be deferred to a later time when the asset is sold.
iv. The net capital gain after applying the CGT discount and ECPI percentage for 2016/17 is deferred from being assessable income until the asset is sold. When the asset is sold the deferred gain will form part of the fund’s assessable income.
v. The deferred gain is not subject to the CGT discount and ECPI treatment in the year it is brought to account as those elements would already have been applied in 2016/17.