Pensions, Superannuation, Tax

Time to review pension payment rules

Pension payments must be paid in cash, so why does it feel like clients used to be able to transfer assets to meet their pension obligations?

In fact, it has always been a requirement of superannuation law that pension payments are made in cash. But there were changes from 1 July 2017 that altered which payments could be counted towards meeting a client’s minimum payment obligations for the year. These changes have confused the issue somewhat. As we turn our attention towards making sure clients meet their minimum pension obligations for this financial year, it makes sense to review the new rules.

There are two types of payment that can be taken from a super fund. The terms used in the Income Tax Assessment Act 1997 are “superannuation income stream benefit” (a pension payment) and “superannuation lump sum” (a lump sum).

The Superannuation Industry (Supervision) (SIS) Act 1993 and associated regulations set out how much must be drawn from a pension each year, what payments count for that purpose and how they can be paid.

SIS Regulation 6.01(2) specifically defines a lump sum as “includes an asset”, meaning a lump sum can be paid from a super fund either in cash or by transferring an asset to the recipient. There is no equivalent extended meaning for the term pension and hence the relevant regulators have concluded pensions must be paid in cash.

This was true both before and after 1 July 2017, so just to be clear, pension payments have always had to be paid in cash and only lump sums could be paid in specie by transferring assets.

But there has been a change from 1 July 2017 that is important here.

Before 1 July 2017, virtually any payment from an account-based pension (ABP) counted towards the minimum pension requirements – even payments that weren’t pensions at all, such as commutations. There were some exclusions. For example, amounts that were rolled over to another fund did not count. But the fact commutations paid out of the fund to the member were included meant an individual required to take $40,000 from their ABP could:

  • take $20,000 in normal pension payments – paid in cash,
  • elect to take a further $20,000 as a partial commutation (providing their pension allowed commutations), which is a lump sum for the purposes of super law,
  • have the commutation paid in specie, and
  • count both payments towards the $40,000 minimum.

This is why it might have felt like it was possible to pay pensions by transferring assets to the members. In fact, the member was exercising their right to draw a partial commutation and this was counting towards the minimum payment requirements.

Since 1 July 2017, those pensions that allow partial commutations are still legitimate and can still be paid in specie. They will just have to be paid in addition to the minimum payment required, $40,000 in the example above, which must be paid in cash to the member.

What about the rule that allowed people to choose whether or not a particular payment was a lump sum? Does that play a part somewhere?

This was a rule in our tax legislation, removed from 1 July 2017, that allowed individuals to say something like: “I’m about to take $20,000 from my pension account. I’m only 57 and I know that superannuation income stream benefits get taxed like normal income, but have a 15 per cent tax offset. I’d actually pay less tax if this was taxed as a superannuation lump sum. Therefore, trustee, could you please treat the payment I’m about to take as a superannuation lump sum for tax purposes?”

While confusingly the term lump sum pops up several times in here, individuals could make this election even if the payment wasn’t a commutation. In other words, it wasn’t a lump sum for super law purposes, just for tax purposes. That made it particularly useful in cases where the pension account wasn’t allowed to pay commutations to the member – most commonly a transition-to-retirement pension where the full account was preserved.

Even prior to 1 July 2017, if these payments weren’t also commutations, they still had to be paid in cash, because for super law purposes they were pension payments regardless of how they were taxed.

In a nutshell, don’t be surprised if you had assumed it should be possible to pay pensions in specie. The way the law worked pre-1 July 2017 made it feel that way. From 1 July 2017, however, all pensioners – no matter what sort of pension they have – should assume that at least the minimum payment must be paid in cash. Any excess over that amount can be paid in specie if it can be classified as a commutation – and remember, this is simply not possible for some pensions.

Meg Heffron is director at Heffron SMSF Solutions.

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