On 23 November 2016, the Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 and the Superannuation (Excess Transfer Balance Tax) Imposition Bill 2016 were passed by both houses of Parliament. Among the many measures was the introduction of the transfer balance cap. This originated from part of the government’s superannuation reform package announced in the 2016/17 budget. This new cap is the imposition of a $1.6 million cap on the amount of capital that can be transferred to the tax-free earnings retirement phase of superannuation. Hence, it limits the amount of earnings that are exempt from taxation.
There are many components to the cap, but one of the more complex elements is how indexation will be applied in future years. This will be detailed later, but first an overview of the new rules.
The government’s intention behind the cap is to “limit the extent to which the tax-free benefits of retirement phase accounts can be used by high wealth individuals”.Each person will have their own transfer balance cap. It works much the same way as the old accounting general ledger in which debits and credits to the account will need to be tracked. What will be interesting is how the ATO administers this. It does not, however, include earnings, losses or pension drawdowns.
The transfer balance cap for the 2018 financial year is $1.6 million. This amount is subject to indexation on an annual basis in line with the consumer price index. An individual’s personal transfer balance cap equals the cap amount in the financial year in which they first have a transfer account. It is important to note if a person has used up part of their cap, they are only entitled to any future indexation on a proportional basis based on their unused cap percentage. This is calculated by finding the individual’s highest transfer balance, comparing it to their personal transfer balance cap on that day and expressing the unused cap space as a percentage. Once a proportion of cap space is used, it is not subject to indexation, even if the individual subsequently removes capital from their retirement phase.
Example 1.3 of the explanatory memorandum provides a great example of how the proportional indexation works.
Example: Proportional indexation and the highest balance
On 1 October 2017, Nina commences a superannuation income stream of $1.2 million. On 1 January 2018, Nina partially commutes her superannuation income stream by $400,000 to buy an investment property. Nina’s transfer balance account on 1 October 2017 was $1.2 million and, on 1 January 2018, it is $800,000 (Nina’s account is debited in respect of the $400,000 partial commutation.)
In 2020/21, the general transfer cap is indexed to $1.7 million. To work out the amount by which her personal cap is indexed, Nina identifies the highest balance in her transfer balance account ($1.2 million), the day on which she first started to have this balance (1 October 2017), and her personal cap on that date ($1.6 million). Therefore, Nina’s unused cap percentage on 1 October 2017 is 25 per cent.
To work out how much her personal cap is indexed, Nina applies her unused cap percentage to the amount by which the general cap has indexed $100,000 (the indexation increase). Therefore, Nina’s personal transfer balance cap in 2020/21 is $1.625 million.
In 2022/23, the general transfer balance cap is indexed to $1.8 million. As Nina hasn’t transferred any further amount into retirement phase, her unused cap percentage remains 25 per cent. Her personal transfer balance cap is now $1.65 million (25 per cent of the indexation increase of $100,000).
In this year, Nina decides to transfer the maximum amount she can into the retirement phase. This will be her personal cap for 2022/23 ($1.65 million) less her transfer balance account of $800,000. This means Nina can transfer another $850,000 into the retirement phase without exceeding her transfer balance cap.
Aside from indexing, the new transfer balance cap has many other complexities. As such it will be essential over the coming months to start reviewing your clients who may be affected by this new cap and start putting in place any relevant necessary measures.