The effect of the new superannuation legislation on transition-to-retirement income streams is more significant than first thought. Daniel Butler and Gary Chau analyse what the framework changes mean for these strategies.
A transition-to-retirement income stream (TRIS) provides an easy way to access superannuation savings.
Various TRIS strategies have developed in recent years, which may change following the super reforms that start on 1 July 2017. This article examines a number of popular strategies and considers the likely impact on TRISs on and after 1 July 2017.
For simplicity we refer to the term ‘pension’ in the Superannuation Industry (Supervision) Regulations 1994 (SISR) rather than the tax term ‘superannuation income stream benefit’.
What is a TRIS?
Before we discuss strategies, we will first examine what a TRIS is. It is based on the same regulations as an account-based pension, but comes with two extra restrictions on payment and commutation.These two restrictions are:
- A TRIS has a maximum pension payment in each financial year of 10 per cent of the account balance. This 10 per cent is generally determined on 1 July each year (or on the commencement date of the TRIS in the first financial year).
- A TRIS cannot generally be commuted to a lump sum and cashed outside of the superannuation environment unless the member can already access the amount as a lump sum (that is, to the extent the amount is an unrestricted non-preserved benefit which generally arises when a member has satisfied a condition of release with a nil cashing restriction such as retirement after attaining preservation age as defined in regulation 6.01(7) of the SISR).
However, a TRIS can be commuted back into the accumulation mode at any time.
A TRIS can be commenced on merely attaining preservation age; importantly, a member does not have to be retired to commence a TRIS. However, a member generally needs to be retired to commence an account-based pension.
If a TRIS does not meet the standards in the SISR in a financial year, both of the following apply according to the ATO in taxation ruling TR 2013/5:
- the SMSF trustee is taken not to have been paying a pension at any time during the financial year, and
- the TRIS ceases for income tax purposes.
In regards to the proportioning rule, the proportion of tax-free and taxable components is locked in at the commencement of a TRIS. This means any earnings and capital growth on assets supporting a pension occur in proportion to the locked-in tax-free component and the taxable component at the commencement of the TRIS. In comparison, earnings and capital growth add to the taxable component if the member remains in accumulation mode.
SMSF tax in respect of a TRIS
Before 1 July 2017
A fund is exempt from the usual 15 per cent income tax in respect of the earnings on assets supporting a pension, such as a TRIS.
From 1 July 2017
Earnings on assets supporting a TRIS will no longer be eligible for the exempt current pension income (ECPI) exemption. Only retirement-phrase pensions, such as account-based pensions, will be eligible for the ECPI exemption. A TRIS is expressly excluded from being in the retirement phase.
Member tax in respect of a TRIS
Before 1 July 2017
The taxable component of a TRIS is assessable income if the member is under 60. The member’s normal marginal tax rate plus applicable levies applies with a 15 per cent tax offset. Naturally the tax-free component of a TRIS is received tax free.
TRIS payments for a member aged 60 or over are not assessable income and not exempt income (this is normally referred to as tax free). Such payments do not even need to be declared in the member’s tax return.
For years now, many have crunched the numbers on the tax effectiveness of a TRIS. This has increased the attractiveness of salary sacrifice arrangements, where people see the potential tax savings that can arise from commencing a TRIS by reducing the salary they receive from their employer. This strategy was typically tied together with an arrangement where the person’s reduced salary, that is, sacrificed salary, is supplemented by TRIS payments so their overall cash flow was not reduced.
When a member turns 60, a TRIS becomes significantly more tax effective as TRIS payments received by the member become tax free.
From 1 July 2017
The tax treatment to a member does not change from 1 July 2017.However, the tax efficiency of a TRIS is less attractive given there will be a 15 per cent income tax applicable on the earnings on assets supporting a TRIS. However, for capital gains tax (CGT) assets held for more than 12 months, a 10 per cent tax applies (after applying the one-third CGT discount).
Employers and employees should also review salary sacrifice arrangements where salary has been sacrificed for additional employer superannuation contributions to ensure these arrangements are still appropriate.
Lump sum election
Before 1 July 2017
Broadly an election to convert a pension to a lump sum is available until 30 June 2017. This election has been used by those under 60 to access the lump sum low-rate cap (which is $195,000 for the 2017 financial year). This has proven to be a popular strategy for many who may otherwise never access their low-rate cap, for example, if they retire after 60.
Naturally a member seeking to access their low-rate cap must still comply with the annual 10 per cent payment limit that applies to a TRIS that is discussed above.
This strategy has given rise to some uncertainty in recent times and numerous members have applied to the ATO for SMSF specific advice and private binding rulings to minimise risk, especially if the SMSF claims ECPI using the segregated method. Alternatively expert tax and SMSF advice should be obtained. As an aside, many large superannuation funds will not offer this election due to the uncertainty that has existed on this topic.
From 1 July 2017
The election to treat a TRIS payment as a lump sum is deleted. Thus, the strategy to access preserved benefits from a TRIS ceases and therefore members under 60 will generally no longer be able to access their low-rate cap from a TRIS.
Transfer balance cap
Before 1 July 2017
Not applicable as the transfer balance cap and transfer balance account measures commence from 1 July 2017.
From 1 July 2017
A transfer balance cap of $1.6 million limits the total amount of superannuation assets that a member can transfer to the retirement phase that will qualify for the ECPI exemption from 1 July 2017 (that is, the tax-free pension phase). This $1.6 million transfer balance cap limit will be indexed in future years.Since a TRIS account is not in retirement phase, it will have no transfer balance cap impact. However, when a TRIS converts into an account-based pension, then transfer balance cap measures apply.
CGT cost base election
Before 1 July 2017
Broadly, the object of the CGT cost base election is encapsulated in section 294-100 of the Income Tax (Transitional Provisions) Act 1997, which provides that the CGT cost base election is to provide temporary relief in respect of members complying with the introduction of the transfer balance cap and the loss of the ECPI exemption in respect of assets supporting a TRIS.
From 1 July 2017
The CGT election is temporary and relates to the reset that applies before 1 July 2017. The election, which applies on an asset-by-asset basis, for cost base reset must be lodged prior to the SMSF trustee’s 2017 tax return.
Succession planning
Before 1 July 2017
On the death of a member, a reversionary pension, including a TRIS with the appropriate documentation, can be paid to that member’s dependant. This is subject to the dependant beneficiary being automatically entitled under the SMSF deed and the rules governing the pension. The ATO in TR 2013/5 provides that both the SMSF deed and the rules governing the pension must specify the person to whom the benefit will become payable and that it will be paid in the form of a reversionary pension.
From 1 July 2017
For SMSF succession planning, it was stated in the explanatory memorandum to the new super reforms that the government intends to amend legislation so that a TRIS can no longer be transferred to a reversionary beneficiary on the death of a member, and only other pensions such as account-based pensions can continue to be paid to a reversionary beneficiary. Many members with a TRIS that have planned to revert their TRIS on their death to their surviving spouse will therefore need to revise their SMSF estate planning.On death of a member who is only in receipt of a TRIS, they would have met a full condition of release and thus a new account-based pension can be commenced as a death benefit for the deceased member’s dependant/s. With the new transfer balance cap, this will also mean the deceased member’s death benefit used to commence an account-based pension for say the surviving spouse will count as a credit towards the dependant’s transfer balance account.
Conversion of a TRIS to an account-based pension
Before 1 July 2017
Members in receipt of a TRIS who satisfy the relevant full, or nil, condition of release (for example, the member has reached their preservation age and retired) will generally be interested in converting their TRIS to an account-based pension to obtain a pension exemption after 1 July 2017. The SMSF trustee needs to carefully review the SMSF deed and pension documents to see if the TRIS can be converted to an account-based pension. Some document suppliers unfortunately draft their documents in a way that requires a TRIS to be commuted before an account-based pension can commence.
From 1 July 2017
The ATO will be on the lookout for people who seek to manufacture their cessation of gainful employment to obtain the ECPI exemption in respect of a conversion of their TRIS to an account-based pension.It is also worthwhile seeking a quality supplier of documentation to minimise the paperwork and steps involved in this conversion process. It is generally best to consider a TRIS supplier that offers automatic conversion to an account-based pension as soon as a condition of release with a nil cashing restriction applies, for example, retirement after preservation age or attaining age 65.
Conclusions
The reform measures impacting TRIS strategies are much more far reaching than initially thought. A major rethink is needed on the appropriateness of each TRIS strategy moving forward. We recommend every member with a TRIS be approached and members who are eligible who do not have a TRIS should also be reviewed to see if they should have one. Naturally, the right documentation and quality advice should be obtained to ensure the best strategies are implemented.
