Friday 14 July 2017
Another bump on the market linked pension road
Market linked pensions (MLPs), sometimes referred to as Term Allocated Pensions (TAPs), have travelled a bumpy road since their introduction in September 2004. They originally appealed to clients seeking social security assets test concessions or qualification for the higher pension reasonable benefit limit back in 2004. Those incentives were effectively removed in the last major super reform program in 2007, although the social security assets test concession continued for MLPs commenced prior to 20 September 2007. Being non-commutable, some clients found themselves locked into a pension product which had reduced appeal following the 2007 reforms.
A decade (and another round of super reforms) later, MLPs are again presenting challenges for financial services professionals
A decade (and another round of super reforms) later, MLPs are again presenting challenges for financial services professionals. MLPs in place just prior to 1 July 2017 were assessed against the client’s transfer balance cap based on a special value calculation. This valuation process is different to the valuation process for both account-based pensions and lifetime pensions. In many cases the 1 July 2017 special value was higher than the MLP’s account balance.
MLPs commenced from 1 July 2017 result in a transfer balance account credit based on the account balance at commencement. Where the difference between the special value assessment and the potential current account balance assessment is significant, some clients may consider commuting their existing MLP and commencing a new MLP in 2017/18 to create more capacity for other pension interests within the $1.6 million transfer balance cap. This article explores a number of issues that financial service professionals should consider in this process.
2017 super reform impact on MLPs
A MLP in place just prior to 1 July 2017 is a capped defined benefit income stream (‘capped DBIS’), in contrast to a MLP commenced on or after 1 July 2017 which is not a capped DBIS.
A capped DBIS attracts special treatment, highlighted in Table 1 below.
Table 1: Market linked pensions pre and post 1 July 2017
|MLP existing just prior to 1 July 2017||MLP commenced on or after 1 July 2017|
|Transfer balance cap assessment||Special value = annual entitlement * remaining term (rounded up)||Account balance as at commencement|
|Treatment of excess over $1.6 million||Ignored||
|Taxation of pension payments over $100,000||50 per cent of excess is assessable income, taxed at marginal tax rates||Entirely non-assessable non-exempt income (tax free)|
The implications of commuting a pre-1 July 2017 MLP and starting a new MLP may include:
- possible reduction in the transfer balance cap assessment amount
- loss of the exempt status of the amount of a MLP pension in excess of the $1.6 million cap
- removal of tax impact on capped DBIS pension payments in excess of $100,000.
Transfer balance cap assessment
The special value of a MLP is based on the annual entitlement and the remaining term (in years, rounded up to the next whole number). The annual entitlement is based on the first payment the client is entitled to receive in 2017/18, divided by the number of days to which the payment relates, and multiplying the result by 365.
Example – Eddie, age 76:
Eddie’s non-reversionary MLP was commenced with a term of 18 years on 1 February 2006 when he was age 65.
The account balance was $600,000 at 30 June 2017, and the remaining term was 6 years and 7 months. The payment factor for the 2017/18 income year is 6.11, therefore the standard pension payment is $600,000 / 6.11 = $98,200.
MLP payments for an income year must be in the range of plus or minus 10 per cent of the standard pension payment. So Eddie’s range of annual payments is $88,380 to $108,020 for the 2017/18 income year.
The special values on 1 July 2017 for Eddie’s MLP are shown in Table 2 below.
Table 2: Eddie’s MLP special value assessment amounts
|Standard annual pension||Annual pension range||Annual entitlement||Remaining term (rounded up)||Special value|
These special values are unfavourable when compared with the 30 June 2017 account balance of $600,000.
This outcome (that is, the special value being in excess of the account balance) is typical for most remaining terms, except in limited circumstances. Chart 1 below shows that only in cases where the remaining term is very short (less than four years) will the special value be less than the account balance, and then only if the minimum (90 per cent of the standard) pension is taken.
In many cases consideration may be given to commuting and commencing a new MLP on or after 1 July 2017 so the transfer balance account credit is based on the account balance at commencement rather than the special value calculation method.
Transfer balance account impact of transferring to a new MLP
Commutation of a MLP is allowable where the resulting lump sum is transferred directly to purchase another MLP or complying income stream.
A transfer balance account debit will occur following the commutation of a superannuation pension. For a MLP, the debit amount is the special value of the MLP at the time of commutation.
Example – Eddie (continued):
Assume that Eddie was not aware of the transfer balance account impact of his choice of pension payment level, and elected to receive the standard pension payment of $8,183 per month in July 2017. As a result, Eddie’s transfer balance account credit on 1 July 2017 was $687,400.
If Eddie maintains the standard pension payment on a monthly basis and commutes his MLP, the following outcomes would result:
If commuted prior to the commencement anniversary on 1 February 2018:
- transfer balance account debit will be $98,200 * 7 = $687,400
This will entirely offset the original transfer balance credit relating to the MLP.
If the commutation occurs on or soon after 1 February 2018 when the remaining term reduces to 6 years (rounded up):
- transfer balance account debit will be $98,200 * 6 = $589,200
This will only partially offset the original transfer balance credit relating to the MLP, leaving a residual credit of $98,200.
So Eddie may prefer to commute his MLP, if at all, prior to 1 February 2018. Note also that if Eddie changed his monthly pension payment, the debit amount will change also.
The lump sum resulting from the commutation will be used to purchase another MLP. Assuming an after fees return of 6.72 per cent per annum and monthly pension payments of $8,183, Eddie’s account balance as at 31 January 2018 would be $565,617. This amount would be credited to Eddie’s transfer balance account upon commencement of the new MLP.
As a result of the commutation and commencement of a new MLP, Eddie’s transfer balance cap assessment will reduce by $121,783 from $687,400 to $565,617.
Transfer balance excess impact
Where a MLP pension exceeds the $1.6 million transfer balance cap, the excess is ignored if the MLP is a capped DBIS (that is, the MLP is existing just prior to 1 July 2017).
Transferring to a new MLP on or after 1 July 2017 will mean the excess is no longer ignored. Ordinarily any excess must be removed from the retirement phase, but as a MLP is non-commutable, the excess may not be able to be removed. Excess transfer balance tax will accrue until the excess is reduced, potentially indefinitely. The Australian Taxation Office notes in its online document Super changes – Frequently asked questions (QC 51875 – last modified: 07 Jul 2017):
It is therefore particularly important that you ensure that any income streams subject to commutation restrictions you start after 1 July 2017 will not exceed your transfer balance cap.
Defined benefit income cap
The defined benefit income cap of $100,000 per annum was introduced from 1 July 2017. Pension payments from all capped DBISs counts towards this cap, and if the cap is exceeded, additional tax may be payable on the excess amount.
Table 3: Taxation of capped DBIS pension payments
|Pension payments||Taxed super scheme||Untaxed super scheme|
|Up to $100k cap||Non-assessable non-exempt||Assessable, 10% tax offset on element untaxed|
|Above cap||50% assessable||Assessable, no 10% tax offset|
Table 3 shows that if a MLP (paid from a taxed super scheme) is the only capped DBIS a client holds, only 50 per cent of the amount of pension payments received in excess of $100,000 will be subject to tax at marginal tax rates. Given the effective tax fee threshold of $32,278 for most clients over age 65, if a client has no other sources of taxable income, no tax would be payable until their MLP payments exceed $164,556.
However, if a client has capped DBISs in both taxed and untaxed super schemes then, for the purposes of the defined benefit income cap, the pension payments from the taxed super scheme count towards the $100,000 threshold first. If the total payments from the taxed super scheme are less than or equal to $100,000, then any excess over $100,000 will be considered to be entirely from the untaxed super scheme. As a result, the excess will be fully assessable income with no 10 per cent tax offset on the portion of the income in excess of $100,000.
Commuting a MLP where a client’s total capped DBIS payments exceed $100,000 may be beneficial in reducing the excess over $100,000 and the tax consequences referred to above.
The pension payments from the new MLP will not count towards the defined benefit income cap and will be treated entirely as non-assessable non-exempt income (tax free).
Certain clients may benefit from commuting their existing MLPs and starting a new MLP, including:
- where the special value transfer balance cap assessment exceeds their account balance by a significant amount, or
- where their capped DBIS income exceeds $100,000.
However, those clients whose capped DBISs exceed $1.6 million, and are benefitting from the excess over the $1.6 million transfer balance cap being ignored, should exercise some caution before commuting their existing MLP to commence a new MLP.
Restricted to financial services professionals
This information on this website is provided for the use of financial services professionals only. In no circumstances is it to be used by a potential investor for the purposes of making a decision about a financial product or class of products.
In order to proceed, please confirm that you are a financial services professional by clicking 'I accept'.