The super reforms have changed the treatment of transition-to-retirement income streams. Tim Miller looks at the potential positive and negative effects of the new rules.
Transition-to-retirement income streams (TRIS) have for a long time been a very popular strategy among wannabe retirees, particularly within the SMSF sector. There are numerous reasons why these pensions have been popular and from 1 July 2017 most of these reasons remain. In reality it’s only the elements that many deemed too good to be true that have vanished, but they shouldn’t be reason enough to give these legitimate early-access schemes the cold shoulder.
A chequered past
Some within the superannuation industry have predicted the demise of TRIS year in year out for the best part of the past decade. The odds are one day they may be right, but the reality is these pensions have survived two of the most significant superannuation reform packages, albeit with a few cuts and abrasions, and for those using them for their intended purpose, there appears no reason why they shouldn’t continue to be around to fight their way through the next round of super reforms.Given that too much wealth accumulation is one of the supposed problems with superannuation, controlled withdrawals of superannuation proceeds should continue to be encouraged. However, there is no doubt prior to the 2016/17 federal budget, the ATO created a rod for its own back by allowing the lump sum election strategy to creep into transition-to-retirement pensions, effectively rendering the Superannuation Industry (Supervision) (SIS) Act as useless with regards to practical pension administration, and something had to give if the integrity of the system was to remain. That Treasury determined the appropriate course of action was to remove this tax strategy and deem transition-to-retirement pensions form part of the accumulation phase of superannuation rather than the retirement phase is, perhaps, one of the most logical policies we have seen in some time.
No doubt many will find the loss of the pension earnings tax exemption a tough pill to swallow, but it makes sense these pensions are in the accumulation phase given individuals can only access them with cashing restrictions attached.
Moving beyond 1 July
So from 1 July, an individual can continue to receive their existing transition-to-retirement pension and it, the pension, will continue to be taxed concessionally in the hands of the recipient. Then when the individual satisfies a condition of release without restriction, that is, reaching retirement or turning 65, they will have the opportunity to transfer the pension into the retirement phase, up to the transfer balance cap, which will not only provide the member with tax concessional income, but also means the SMSF will receive its entitlement to exempt pension income.
It is this point that has created a certain level of anxiety within the industry and resulted in a legislative amendment. Transition-to-retirement pensions are traditionally one of those legislative quirks whereby the industry took a practical approach to members meeting a condition of release, with nil cashing restriction, by effectively removing the 10 per cent maximum limit as was allowed under the SIS Regulations, but often with no other accompanying action on the pension, so by virtue they were still considered to be a transition-to-retirement pension, albeit without any lump sum or maximum restrictions. In some instances, member statements still reflected these pensions as transition-to-retirement long after a member had turned 65.There is possibly a divide in the industry between those taking the view these pensions were still considered a transition-to-retirement pension and those taking the view these pensions were always account-based pensions that effectively had a payment restriction on them until a nil cash restriction condition of release had occurred. Given that prior to 1 July 2017 these pensions were entitled to the exempt pension income deduction, this difference of opinion had little consequence. In effect, perhaps these pensions should have been commuted and account-based pensions commenced, but the practical approach seemed logical and, as stated, this was supported by the SIS Regulations that defined transition-to-retirement pensions, that is, the 10 per cent removal upon satisfying the condition of release.This leads us to the changes legislated just prior to 30 June 2017 that will theoretically see a transition-to-retirement pension convert from the accumulation phase to the retirement phase upon satisfaction of a condition of release, thereby entitling the fund to the exempt current pension income treatment. One of the reasons this appears to have been introduced was to cut down the administrative work associated with stopping the existing pension that was not entitled to the tax exemption and then commencing a new pension that is. That’s all well and good, but there is more than meets the eye and the administration work could end up being more rather than less and in most cases is likely to be no different.
Transfer balance cap
Moving a transition-to-retirement pension from the accumulation phase to the retirement phase to enable it to be entitled to the exempt pension income will mean it becomes subject to the transfer balance cap and, as such, there is a need for it to be revalued at the point the condition is met to determine where the valuation sits in line with the individual’s personal transfer balance cap. This is important given there is no restriction on the value of a transition-to-retirement pension post-1 July 2017, meaning it is conceivable some will be worth more than $1.6 million. Given an account-based pension is restricted to $1.6 million, there will in some instances be a requirement to commute the excess amount of the transition-to-retirement pension.So by enabling a smoother move to an exempt environment we may be inadvertently creating something that isn’t very smooth at all, and given it will take place after 1 July 2017, it is not going to be subject to any transitional six-month grace period for being over the cap. As such, for many members wanting to move from a transition-to-retirement pension to an account-based pension, a commutation of the transition-to-retirement pension may be a more appropriate course of action. Then an account-based pension can be commenced when the member is ready.
Access to accumulation interest
As the issue with transition to retirement now seems to be centred on what to do when a member satisfies a condition of release, it is important to recognise that from a withdrawal point of view, once a member satisfies a nil cashing restriction condition of release, such as retirement, they have access to lump sums from their accumulation interest as well. Therefore, in the event they were paying a transition-to-retirement pension, they can, upon satisfying the condition, commute the pension but still have access to a lump sum, which of course is likely to be non-assessable non-exempt income if the member is over 60 or subject to the low-rate cap on the taxable component from preservation age to 59. The low-rate cap for 2017/18 is $200,000.That, of course, leads to the inevitable question of whether there is still an opportunity to take a lump sum from a transition-to-retirement income stream.
Certain existing transition-to-retirement strategies remain
A partial commutation of a transition-to-retirement pension is still possible provided the member has unrestricted non-preserved benefits within the pension. This may be the case if the member has previously met a condition of release, but didn’t commence a pension and has had earnings and further contributions added to the fund. Due to the 1 July changes, the information previously provided by the tax commissioner in SMSFD 2014/1 will no longer be valid, that is, the lump sum will no longer count towards the minimum pension. The SIS law still recognises a lump sum via a commutation is possible.
How does this look in practice?
Jane is 58 and has an SMSF with $1 million, all taxable, with $600,000 preserved and $400,000 unrestricted non-preserved. She works full-time and is earning $100,000 a year.Jane commenced a transition-to-retirement pension for the full value of her account balance prior to 1 July 2017 and chose to retain the pension after that date. The pension factors require Jane to draw an income between $40,000 and $100,000.
Jane plans to draw down her minimum of $40,000. Prior to doing so she determines she needs a further $50,000 to replace her car and to pay off some additional debt. She has multiple options available to her, one being that she could elect to take the $50,000 as a partial commutation. Alternatively, she could take all of the benefit as an income stream as the total amount is below her maximum.
If all of Jane’s benefits were preserved, she would have to draw the full amount as income and the tax effect would be that she would be taxed at her marginal rate less a 15 per cent rebate. As Jane has unrestricted non-preserved benefits, she can take a partial commutation for the amount of $50,000 so long as she has either drawn her minimum prior to taking the lump sum or ensured there is sufficient balance remaining to take the minimum prior to the end of the year.
By taking the lump sum, the $50,000 is measured against the low-rate cap ($200,000), meaning no tax is payable.
Another strategy is the combined salary sacrifice or personal deductible contribution combined with a TRIS. The reduction in the concessional contribution caps plus the removal of the exempt pension income deduction will reduce the effectiveness of this strategy for those in the lower marginal tax brackets, however, it should not be discounted entirely as tax-effective investments will continue to provide SMSFs with a lower than 15 per cent tax rate, so savings, albeit smaller, are still achievable.
Don’t forget the CGT relief
As we all know, the government is providing SMSF trustees with transitional capital gains tax (CGT) relief to ensure that tax does not apply to unrealised capital gains that have accrued on assets that have been used to support transition-to-retirement pensions prior to the super reform measures taking effect from 1 July 2017. Applying the CGT relief does not require the pension to be commuted and given there is no $1.6 million cap for transition-to-retirement pensions, it could be very beneficial.This is a new beginning for transition-to-retirement pensions and an opportunity for them to be used for their intended purpose. Of course, that doesn’t mean we can’t obtain other benefits out of using them, but let’s consider those after we’ve secured our CGT relief.