Tuesday 27 June 2017
A sneak peek at the year ahead
On 1 July 2017 the financial services advice industry will heave a collective sigh of relief. The Super Reform measures have placed unprecedented pressure on financial services professionals’ workloads over the six or seven months leading up to 30 June, and some release of that pressure will be welcomed immensely.
Having ensured that clients have complied with the $1.6 million transfer balance cap and maximised their opportunity to make super contributions, it is timely then to sit back and contemplate what’s ahead in the 2017/18 income year.
Many clients will still have decisions to make regarding their TTR pensions, possible CGT relief elections and super death benefit arrangements, including child pension nominations. These issues are explored below for the benefit of financial services professionals.
Many clients will still have decisions to make regarding their TTR pensions, possible CGT relief elections and super death benefit arrangements
Important legislative amendments were passed by Parliament on 15 June 2017. A TTR pension will become a retirement phase income stream where the recipient meets one of the following conditions of release (CORs):
- permanent incapacity
- terminal medical condition
- attaining age 65
When it becomes a retirement phase income stream, a TTR pension will be exempt from tax on the income from supporting assets and will be assessed against the client’s transfer balance cap - similar to an ordinary account-based pension. This treatment will apply from either:
- the day the super fund trustee is notified that the COR has been met
- the client’s 65th birthday, or
- 1 July 2017 if either of the above has already occurred.
Where a COR has not been met and the income from assets supporting the TTR pension becomes taxable from 1 July 2017, it may be preferable not to commute the TTR pension prior to 1 July 2017 to ensure any managed fund (and other trust) distributions declared on 30 June 2017 are exempt from tax.
The legislative amendments also ensure that capital gains tax (CGT) relief will be available to all TTR pensions, regardless of whether they are commuted prior to 1 July 2017 or continue to run. So there is no longer an incentive to commute a TTR pension prior to 1 July 2017 to secure access to the CGT relief.
Where the client does not require the pension payment cash flow, one action item in the new income year may be to commute those TTR pensions that become subject to tax on 1 July 2017. The later the commutation is, the greater the pro-rated minimum pension payment will be for the 2017/18 year, so it may be in the client’s best interest to ensure the commutation occurs as soon as possible in the new year.
2017/18 action items:
Commute TTR pensions which are not required, early in the income year.
CGT relief elections
The Australian Taxation Office (ATO) has confirmed (refer ATO QC 51875) that the election to apply the CGT relief to specific assets must be notified in the CGT schedule of the super fund’s 2016/17 annual return. For many self managed superannuation funds (SMSFs) the lodgement deadline is 15 May 2018.
The trustee will notify:
- which assets the CGT relief is being applied to
- how much assessable income results from the CGT election with regard to that asset
- whether that assessable income is to be deferred to a later income year
The decision to apply the CGT relief may not be straightforward in some cases, and may differ from asset to asset.
One important factor for those SMSFs using the proportionate method to calculate exempt current pension income (ECPI) in 2016/17 is the fund’s current ECPI percentage and whether it is likely to increase or decrease in the future. Bringing assessable to account when the fund’s ECPI is higher is in the best interest of fund members.
Furthermore application of the CGT relief to assets in a capital loss position is beginning to attract more consideration by some in the industry.
Macquarie Technical Services will cover the CGT relief election in greater detail later in the 2017/18 income year.
2017/18 action items:
Ensure SMSFs lodge their CGT relief elections with their 2016/17 annual return.
Super death benefit arrangements
A number of the Super Reform measures will impact on the superannuation death benefit arrangements of many clients. The measures include:
- the introduction of the $1.6 million transfer balance cap
- the differences in transfer balance cap assessment and timing of reversionary and non-reversionary superannuation death benefit pensions
- the modified transfer balance cap rules for superannuation death benefit pensions paid to children
- the removal of anti-detriment payments
- allowing superannuation death benefit pensions to be rolled over regardless of the recipient
- requiring superannuation death benefit pensions to be quarantined from other superannuation pensions
- the removal of the 6 month / 3 month rule impacting on the status of a superannuation benefit upon commutation of a superannuation death benefit pension (note that the ATO’s view in PCG 2017/6 is this rule wasn’t ever technically applicable to the commutation of a superannuation death benefit pension).
Two of these measures (items 5 and 6 above) may not necessarily prompt any actions in the 2017/18 income year. However, the remaining items warrant some consideration.
Current superannuation death benefit pensions
Although the anti-detriment benefit has been removed effective from 1 July 2017, a transitional rule allows superannuation funds to continue to pay anti-detriment benefits until 30 June 2019 in respect of deaths which occurred prior to 1 July 2017.
The ‘6 months from date of death or 3 months from grant of probate’ rule (6/3 month rule) was previously thought to result in a lump sum commuted from a superannuation death benefit pension outside this period being treated as an ordinary lump sum, not a death benefit lump sum. Removal of this rule, coupled with the anti-detriment transitional rule, means that commuting an existing, perhaps long running superannuation death benefit pension, may also attract an anti-detriment benefit, in contrast to commutation of the same income stream just prior to 1 July 2017. The anti-detriment benefit payment may be up to 17.6 per cent of the taxable component of the death benefit lump sum.
Contrast this outcome with the payment of the same superannuation death benefit income stream upon the death of the current recipient as a death benefit lump sum to an adult child – no anti-detriment payment would be payable, and tax at 17 per cent of the taxable component may be payable.
Jill is receiving pension payments from a death benefit account-based pension following the death of her husband in 2012. The current account balance is $400,000 and the taxable component is 50 per cent.
If Jill commutes this account based pension after 30 June 2017, but prior to 1 July 2019, and her super fund pays an anti-detriment benefit, she may receive $400,000 plus approximately $35,200, or $435,200 in total. No tax would be payable.
If Jill instead passed away and a lump sum death benefit payment was made to her adult daughter, then no anti-detriment benefit would be payable, and $34,000 (17 per cent of $200,000) of tax would be payable on the taxable component. Her daughter would receive a net benefit of $366,000.
This is $69,200 less than if Jill had commuted the benefit herself prior to passing away and left the proceeds to her daughter via her estate.
2017/18 action items:
Consider whether worthwhile to commute existing superannuation death benefit pensions prior to 1 July 2019.
Superannuation death benefits from 1 July 2017
Estate planning arrangements will be more complicated from 1 July 2017 for couples who have combined superannuation interests in excess of $1.6 million.
Prior to 1 July 2017, the simple estate planning solution for these clients was to pay death benefits to the surviving spouse as one or more superannuation death benefit pensions. The introduction of the $1.6m transfer balance cap upsets that simplicity, as the superannuation death benefit pensions will be assessed against the surviving spouse’s transfer balance cap.
The alternative to paying a benefit as a pension is payment as a lump sum payment, which cannot be rolled over and must be taken out of the superannuation environment. The ongoing tax impact may be significant, depending on the level of taxable income of the surviving spouse.
A single individual over age 65 will generally not pay any tax if their taxable income is $32,278 or less. But the effective marginal tax rate on taxable income in excess of this threshold is at least 31.5 per cent, and may be as high as 56.5 per cent.
In contrast, keeping the funds in the superannuation environment subject to tax at a maximum rate of 15 per cent is attractive.
An effective strategy for the surviving spouse is to commute his or her existing superannuation pensions back to the accumulation phase. Assuming the existing pensions are account-based pensions, a commutation will result in a transfer balance cap debit amount equal to the value of the pension commuted, effective from the date of the commutation.
The debit will reduce the balance in the surviving spouse’s transfer balance cap, potentially creating capacity for the transfer balance cap credit associated with the reversion or commencement of a non-reversionary superannuation death benefit pension within the $1.6 million cap.
Timing of the transfer balance cap debits and credits are important in terms of reducing the possible penalties associated with being in excess of the cap. If the transfer balance cap credit occurs before the debit, an excess position may result. Tax will be payable based on the notional earnings calculated on the excess amount at the ATO’s general interest charge rate (8.73 per cent per annum in the July-September 2017 quarter). The tax rate applicable will be either 15 per cent or 30 per cent for subsequent breaches.
Reversionary pensions are attractive as the transfer balance cap credit does not occur until 12 months from the deceased’s date of death. The transfer balance cap credit amount is the value of the pension at the date of death.
In contrast, a non-reversionary death benefit pension will result in a transfer balance cap credit effective when the pension is commenced, based on the value of the pension at commencement.
Typically, the reversionary pension transfer balance cap credit timing will allow more time for the surviving spouse to arrange commutation of any existing pensions, and potentially avoid possible transfer balance cap excess penalties that might otherwise arise. In addition, because the value of the transfer balance cap credit (ie the value of pension as at the date of death) is known before the credit occurs, the amount of commutation of any existing pensions can be precisely determined.
For these reasons we expect that new account-based pensions will be more commonly established with a spouse as a reversionary beneficiary where the $1.6 million transfer balance cap is likely to be an issue for the surviving spouse upon the death of the other spouse. Some advisers may consider it worthwhile to alter existing pension arrangements to allow reversionary nominations to be made.
2017/18 action items:
If the $1.6 million transfer balance cap is likely to be an issue for a surviving spouse:
- Consider reversionary nominations for new pensions
- Consider whether it is worthwhile changing existing, non-reversionary pensions arrangements
Child pensions from 1 July 2017
The capacity of a child to receive a child pension as a result of the death of a parent has been restricted by the Super Reform measures.
From 1 July 2017, child pensions will be assessed against a modified transfer balance cap, an assessment which will extinguish upon cessation of the child pension (generally at age 25 unless the child is permanently disabled). This will leave the child’s general transfer balance cap intact for later in life when they ultimately commence a pension for other reasons, such as their own retirement.
Existing child pensions in place immediately prior to 1 July 2017 will be assessed against a modified transfer balance cap equal to the general transfer balance cap of $1.6 million. This assessment will occur on 1 July 2017.
Child pensions commencing on or after 1 July 2017 will also be assessed against a modified transfer balance cap, but the cap may be significantly reduced, based on a number of factors.
The modified transfer balance cap is the sum the cap increments shown in Table 1 below. The cap increments which apply depend on whether the deceased parent had a transfer balance account at the time of death. Generally, an individual will have a transfer balance account only after they have commenced a retirement phase income stream. Then, depending on whether the source of the child pension is from funds that were in the accumulation phase or pension phase, cap increments apply accordingly.
|Parent had transfer balance account?||Source of child pension||Cap increment|
|No||N/A||General transfer balance cap ($1.6 million) * child’s proportionate share of deceased’s superannuation death benefits|
|Yes||Parent’s retirement phase interest only||Value of pension(s) received|
|Yes||Parent’s accumulation interest only||Nil - death benefit pension is generally excessive|
|Yes||Paid partially from parent’s retirement and accumulation interests||Value of pension(s) received from retirement phase only.
Pension paid from accumulation phase is generally excessive.
For many clients, planning for child pensions will be based on the general transfer balance cap multiplied by the child’s share of the parent’s death benefit. If there are multiple children, the limitations may have impact, noting that four children could potentially receive child pensions valued at $400,000 each without exceeding their modified transfer balance cap.
2017/18 action items:
Review child pension death benefit nominations to ensure the modified transfer balance cap of each child will not be exceeded.
The Super Reform measures have required many adjustments to clients’ arrangements in the lead up to 30 June 2017.
Although most of the challenging work will have been done by 1 July 2017, financial services professionals should remain diligent about the ongoing implications of Super Reform for clients in 2017/18, and beyond.
Matters for further consideration in 2017/18 include reviewing the appropriateness of TTR pensions, ensuring SMSFs lodge their CGT relief elections, possible commutation of existing death benefit pensions and review of reversionary nominations and child pension arrangements.
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