Monday 14 November 2016
The new super pension system: transfer balance accounts
The Government introduced a series of bills to Parliament on 9 November 2016 which cover a large portion its superannuation reform package. The proposed legislation provides a valuable insight into the intended operation of the new system for limiting the amount an individual will be able to hold in the tax exempt retirement phase of superannuation from 1 July 2017.
An understanding of the proposed system will be important for financial services professionals when providing advice to their clients in the lead up to 1 July 2017. In this article we provide an outline of the mechanics of the proposed system.
1. A ‘transfer balance account’ will be established
The starting point of the proposed system is the establishment of a transfer balance account when a client commences their first superannuation income stream (pension or annuity). Generally, the value of the superannuation income stream at commencement will be credited to the transfer balance account as at that date.
For those with existing superannuation income streams as at 30 June 2017, their transfer balance account will be established from 1 July 2017 based on the value of the superannuation income stream interests just prior to 1 July 2017.
2. Credits and debits
As mentioned above, the commencement of a superannuation income stream from 1 July 2017 will generally result in a transfer balance account credit based on the valuation of the income stream on the commencement date. Table 1 below describes the credits and debits most likely to appear in a client’s transfer balance account.
Table 1: Transfer balance account credits and debits
Value as at 30 June 2017 of existing superannuation income streams in the retirement phase
Value of new superannuation income streams in the retirement phase from 1 July 2017, including death benefit superannuation income streams
Reversionary superannuation income streams after 12 months from the date of death, valued at date of death
Notional earnings on excess transfer balance amounts, credited daily
Commutations (partial or full) from a superannuation income stream:
Personal injury contributions (court orders and settlements)
Certain ‘replenishment’ concessions:
Note that neither superannuation income stream regular pension or annuity payments nor investment earnings (positive or negative) result in a credit or a debit. There will be, therefore, an incentive to draw any additional funds needed in excess of the minimum pension amount for account-based pensions as a lump sum payment, as the commuted amount will result in a debit to the transfer balance account, increasing the scope to transfer further funds into the retirement phase.
3. Exceeding the transfer balance cap
The transfer balance account will record a client’s progress towards the general transfer balance cap of $1.6 million, which will be indexed with the consumer price index (CPI) in $100,000 increments. The difference between a client’s existing transfer balance account and the general transfer balance cap is referred to as their personal transfer balance cap.
Exceeding the cap will result in an excess transfer balance, and a requirement to remove that amount and certain notional earnings from the retirement phase. In addition, tax may be payable on the notional earnings.
Notional earnings will be based on the general interest charge (GIC) rate (8.76 per cent per annum in the December 2016 quarter) and will be credited to the client’s transfer balance account on a daily basis until the breach of the transfer balance cap is rectified or the Commissioner of Taxation (the Commissioner) issues a determination (see below).
A client will be able to self-rectify an excess transfer balance position, generally by commuting an appropriate amount (the excess including notional earnings) from a superannuation income stream, either back to accumulation phase or to cash out of superannuation completely.
If self-rectification hasn’t occurred, the Commissioner will issue a determination to the client. The determination will include the crystallised reduction amount, comprising:
- the excess amount
- notional earnings to the date of the determination.
This crystallised reduction amount must be removed from the retirement phase to bring the transfer balance account back within the transfer balance cap.
The determination will also include a default commutation authority which will set out:
- the superannuation income stream provider that the Commissioner will issue the commutation notice to; and
- the superannuation income stream to be commuted.
The client may, however, make an irrevocable election to commute a different superannuation income stream by notifying the Commissioner on the approved form within 60 days of the date of the determination.
If the client has not self-rectified the excess transfer balance, the Commissioner will send a commutation authority to the relevant provider (including the provider and income stream selected by the client in their election) after 60 days from the date of the original determination. The superannuation income stream provider will then have 60 days to make the commutation.
Excess transfer balance tax
Excess transfer balance tax will be based on a client’s total notional earnings.
Note that although the crystallised reduction amount quoted in the Commissioner’s determination includes notional earnings compounded daily to the date of the determination, for the purposes of the calculation of the excess transfer balance tax, notional earnings will continue to accrue on a simple interest basis from the date of determination until the excess is rectified.
Tax will be levied at 15 per cent on all notional earnings in the 2017-18 income year. The 15 per cent rate will also apply to a first time breach in a later year. After that, notional earnings will be taxed at 30 per cent, as a disincentive to deliberately exceeding the transfer balance cap. The Explanatory Memorandum to the bill warns against schemes designed to breach the transfer balance cap for the purpose of producing a tax benefit, as below:
…schemes designed to exceed an individual’s transfer balance cap for the purpose of producing a tax benefit are subject to the general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936. Part IVA may also apply to other schemes that seek to circumvent the transfer balance cap, for example washing assets through the retirement phase.
Transitional relief will apply where a transfer balance excess:
- occurs on 30 June 2017;
- is less than $100,000; and
- is self-rectified within 6 months.
If these criteria are met, the excess will not give rise to notional earnings or an excess transfer balance tax liability. This relief will help clients and advisers target the $1.6 million cap in the lead up to 1 July 2017 by reducing the fear of taxation penalties for small, inadvertent breaches.
Example – Amy
The following superannuation interests and transactions apply to Amy:
- 30 June 2017 – existing account-based pension (ABP no. 1), balance of $800,000
- 18 November 2017 – commences a new account based pension (ABP no. 2) with $700,000
- 2 February 2018 – commutes ABP no. 1 in full, commutation value $850,000
- 2 May 2018 – commences a new account based pension (ABP no. 3) with commutation value above, plus another $200,000 of existing accumulation phase funds – total purchase price $1.05 million
- 15 June 2018 – commutes $150,000 from ABP no. 3 back to accumulation phase
A graphic representation of Amy’s transfer balance account is shown in Diagram 1 below.
Diagram 1: Amy’s transfer balance account
Amy’s transfer balance account is opened on 1 July 2017 with an initial balance of $800,000 relating to ABP no. 1. The transfer balance account increases to $1.5 million on 18 November 2017 with the commencement of ABP no. 2.
The commutation of ABP no. 1 on 2 February 2018 causes a debit of $850,000 to Amy’s transfer balance account. These proceeds are combined with another $200,000 Amy was holding in the accumulation phase of superannuation and used to commence ABP no. 3 with $1.05 million on 2 May 2018.
At this time Amy’s transfer balance account exceeds her personal transfer balance cap ($950,000) by $100,000. Notional earnings will accrue and be credited to Amy’s transfer balance account until the excess is rectified, or the Commissioner issues a determination.
Amy realises the mistake and chooses to self-rectify by commuting $150,000 from ABP no. 3 on 15 June 2018. Notional earnings will be based on the excess of $100,000 over the period from 2 May 2018 to 15 June 2018.
If the GIC rate is 8.76 per cent per annum in this period (daily rate of 0.024 per cent) the notional earnings will be $1,061.47. Amy will be issued with a tax assessment for $159.22, based on this being a breach in 2017-18 attracting tax at 15 per cent.
The proposed legislation is yet to be passed by Parliament, so further changes may still occur. Nonetheless it may be helpful for financial services professionals to familiarise themselves with the progress to date, and begin to think about how the proposed system will impact their clients.
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