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Knowing which pension to commute

A specialist superannuation lawyer has suggested advisers apply a rule of thumb to determine the correct pension to commute in cases where a client’s transfer balance cap is greater than $1.6 million and they have an income stream that consists entirely of a tax-free component and another comprised entirely of a taxable component.

The method DBA Lawyers special counsel Bryce Figot suggested involves a comparison between the amount an SMSF member has to draw down and the level of investment return generated by the supporting assets.

“If I had to boil it down, here’s a good rule of thumb – if the drawdown percentage is greater than the investment return percentage, commute the 100 per cent tax-free pension,” Figot said.

“And then the flipside is true – if the drawdown percentage is less than the investment return percentage, commute the 100 per cent taxable pension.

“That’s going to get you to the position where umpteen years down the track, if you tried to model both cases, where you’d be left with the greatest tax-free component in the fund.”

He admitted scenarios seldom involved a situation where the two account-based pensions were of $1.6 million value and one was 100 per cent taxable while the other was entirely tax-free, but insisted the rule of thumb would still apply even if this was not the case, that is, the pension with the highest tax-free component should be the one to fully or partially commute.

The adviser may, however, require the SMSF member to estimate what the investment return might be, he said.

However, if the SMSF member has no idea what the investment return on the pension assets might be, he suggested the default position should be to commute the pension with the least tax-free component percentage.

The reason for this is to ensure any tax-free components in the SMSF remain purely tax-free, he said.

“If you’ve got any money in accumulation, if you mix tax-free component with that money, the taxable component is going to mix together and be unable to ever be separated again,” he noted.

He pointed out it would mean no irreversible action would have been taken.

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