Wednesday 17 May 2017
The good and not-so-good news for TTR pensions
Wednesday 17 May 2017
The changes to the taxation of transition to retirement (TTR) pensions from 1 July 2017 mean that many clients will be reassessing their need for these pensions. While some clients may prefer to keep their pension in place, others may look to commute the pension back to accumulation or convert it to a standard account based pension (ABP). A further consideration will be whether the capital gains tax (CGT) relief that is available to superannuation funds as a result of the changes to the tax treatment of these pensions can be, and should be, applied.
This article aims to help financial services professionals understand the key considerations for clients with TTR pensions in the lead up to the 1 July 2017 changes.
What is changing?
From 1 July 2017, only those pensions that are in the retirement phase will receive an earnings tax exemption. Certain income streams such as TTR pensions are specifically excluded from being in the retirement phase and will be subject to tax on earnings.
However, the Government has proposed to allow TTR pensions to enter the retirement phase where the account holder later satisfies a full condition of release (that is, one with a nil cashing restriction). If this measure becomes law, earnings on assets supporting a TTR pension would be exempt from tax once the account holder retires, attains age 65, develops a terminal medical condition or is permanently incapacitated.
Commute back to accumulation phase
Given the change to the taxation of earnings, some clients may consider fully commuting their TTR pensions back to the accumulation phase. This may be the case where the additional cash flow generated by the pension payments is not required.
The lower concessional contributions cap in 2017/18 may also impact those clients with a TTR pension/salary sacrifice strategy in place. From 1 July 2017, the concessional contributions cap will be reduced to $25,000 per annum for all individuals, meaning that some clients will need to reduce their annual concessional contributions by up to $10,000.
This may have flow on implications for the amount of income required from the client’s TTR pension to either fund the super contributions or supplement reduced employment income. In some cases, a partial commutation of an existing TTR pension may be considered prior to 1 July 2017 to reduce the minimum payment requirement in the 2017/18 income year.
Convert to an account based pension
Where a client has retired or met another full condition of release since starting their TTR pension, it may be important to notify their superannuation fund of this event. If the Government’s proposed changes are legislated, the TTR pension will be treated as being in the retirement phase and the earnings on assets supporting that pension will be exempt from tax. Commuting the TTR pension and using the proceeds to commence a standard ABP prior to 1 July will also ensure the earnings are tax exempt.
When a TTR pension enters the retirement phase, the balance of the pension account will be measured against the client’s $1.6 million transfer balance cap. If the client has other retirement phase income streams, such as defined benefit pensions or other ABPs, care should be taken to ensure that the transfer balance cap is not exceeded.
Continue the TTR pension
Some clients will have a genuine need for additional income and may prefer to continue their TTR pensions into the new financial year. This might be relevant for clients looking to supplement their employment income, or who require more income than that generated by their retirement phase pensions.
Trish is aged 60 and has a lifetime defined benefit pension of $100,000 per annum paid from an untaxed scheme. The special value of that pension, or the amount that counts towards Trish’s transfer balance cap, is $1.6 million. Trish also has $300,000 in an accumulation account.
Trish requires $95,000 per annum to meet her living expenses. The net income from her defined benefit pension is around $82,300, so she needs a further $12,700 per year after tax.
As the defined benefit pension uses up Trish’s entire transfer balance cap, she is unable to start an account based pension. Assuming Trish hasn’t retired, she could commence a TTR pension which won’t count towards her transfer balance cap. As she is age 60, the pension payments will be tax free, meaning she only needs to take pension payments of $12,700 to meet her cash flow requirements.
There may also be an estate planning benefit of keeping a TTR pension in place, particularly where a death benefit is ultimately paid to a beneficiary who is not a ‘dependant’ for tax purposes. As the tax components of a pension are fixed at commencement, earnings are allocated proportionately between the tax free and taxable component. This is in contrast to an accumulation interest, where the tax free component is generally a fixed dollar amount based on non-concessional contributions made, and fund earnings above that fixed dollar amount are allocated to the taxable component.
The potential estate planning benefits of a TTR pension are illustrated in the following example.
Terry is aged 57 and has a TTR pension of $300,000, which is all tax free component. His taxable income exceeds $180,000, so his marginal tax rate is 47 per cent. Terry doesn’t require the TTR pension payments for cash flow purposes.
Terry’s options are to continue the pension or commute the pension back to accumulation. If he continues the pension, the pension payments are assumed to be invested in his own name. His asset position after three years is shown in the Table 1 below.
Terry’s adult daughter Therese is the sole beneficiary of his estate. If he passes away at the end of the three year period, the net death benefit payable to Therese is approximately $8,400 more (in today’s dollars) if Terry retains his TTR pension.
Table 1: Retain or commute TTR pension
|Position after 3 years||Option 1: retain TTR||Option 2: commute TTR|
- tax free component
- taxable component (taxed)
TTR pension balance
- tax free component
- taxable component (taxed)
|Tax if paid to non-dependant||Nil||($9,895)|
|Net death benefit||$357,358||$348,312|
|Net death benefit (today’s dollars)||$332,253||$323,843|
Transitional CGT relief
Once a decision has been made to commute or continue a TTR pension, a further consideration is whether CGT relief should be applied to the assets supporting these pensions. The CGT relief allows superannuation funds to reset the cost base on certain assets that are either reallocated or reapportioned from the retirement phase back to accumulation as a result of either the new $1.6 million transfer balance cap or the changes to the taxation of TTR pensions.
In its final guidance (LCG 2016/8) on the application of the transitional CGT relief, the Australian Taxation Office confirmed the relief is intended to apply to TTR pensions regardless of whether the pension is retained or commuted back to accumulation. While the super reform legislation makes this position clear for funds using the proportionate method to calculate exempt current pension income (ECPI), it is less so for funds using the segregated method.
However, the Government has recently released draft legislation to amend the CGT relief provisions to ensure the relief is available to segregated funds with TTR pensions without needing to commute the pension back to accumulation.
Table 2 below outlines the application of the relief for funds with TTR pensions that use either the segregated or proportionate methods to calculate ECPI.
Table 2: Application of CGT relief to TTR pensions
|Fund’s ECPI based on:||TTR pension:||Application of CGT relief:|
|Segregated method throughout pre-commencement period (ie 9 November 2016 to 30 June 2017)||Commuted to accumulation prior to 1 July 2017||Assets transferred during pre-commencement period from exempt pool to taxed pool|
|Retained until at least 1 July 2017||Draft legislation extends relief to assets that cease to be in the exempt pool at the start of 1 July 2017|
|Segregated method, but switches to proportionate method prior to 1 July 2017||Retained or commuted to accumulation||Any or all assets in exempt pool|
|Proportionate method throughout pre-commencement period and 2016/17 ECPI > 0%||Retained or commuted to accumulation||Any or all assets of the fund (excluding any segregated assets)|
In deciding whether to commute or continue a TTR pension, consideration should be given to a range of factors including cash flow requirements, contribution capacity and estate planning objectives.
Regardless of whether the pension is commuted or continued, consideration should also be given as to whether CGT relief can be and should be applied to any of the assets supporting the pension.
However, now that it has been confirmed the relief is available without needing to commute the pension, no action needs to be taken prior to 1 July to be eligible for the CGT relief. This will be a welcome relief for many financial services professionals, as it will allow them to focus on other, more time critical, issues.
Macquarie article: Super reform transitional CGT relief – Part 1
Macquarie article: Super reform transitional CGT relief – Part 2
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