Legacy Pension Amnesty now law

Late last week the SMSF sector was handed a somewhat unexpected, but much welcomed, early Christmas present.

But this gift was richly deserved – just reward for your Association’s extensive advocacy efforts over several years

After much lobbying, and following the recent public consultation, Treasury Laws Amendment (Legacy Retirement Product Commutations and Reserves) Regulations 2024 – which heralds the introduction of an amnesty period, allowing long-suffering SMSF members to exit legacy pensions – is finally law!

With the Association making repeated representations to government on this issue since 2019 (including Budget submissions), and more recently advocating strongly for this measure to be made a standalone policy priority and not entangled with other tax policies such as the proposed Division 296 tax, these regulations notch up a big advocacy win for your Association.

More importantly, these newly registered regulations bring much-needed reform to retirees trapped in non-commutable legacy pensions, including legacy lifetime, life expectancy, and market-linked income stream products – with Treasury estimates indicating there are upwards of 16,900 SMSF legacy pension accounts.

Given the age of these superannuants, they now have a genuine opportunity to restructure their retirement savings effectively.

These new regulations offer an escape route by providing them with a five-year timeframe to exit these pensions while providing more flexible pathways to allocate benefits tied up in reserves.

While it will no doubt be celebrated as a win for the SMSF sector, the solution is less than perfect and not all the industry’s concerns have been addressed.

Five-year amnesty

These Regulations relax the existing commutation restrictions that will provide members with a choice to exit legacy pension products – with the resulting capital used to commence another retirement phase interest, left in an accumulation interest account, or withdrawn from superannuation.

However, the commutation must be a full commutation and be completed within the 5-year grace period – beginning on 7 December 2024.

Not only will this allow individuals to exit obsolete products, but it removes a barrier that has prevented some members from winding up SMSFs that are no longer suitable for their circumstances.

While definitely a positive step forward, we note that the Association’s calls for the Government to allow partial commutations and for the ATO Commissioner to be given discretion to approve commutations in exceptional circumstances beyond the 5-year period to deal with unforeseen circumstances, were not heeded.

Reserve allocations

Currently, allocations from a fund reserve are often counted towards the receiving members’ concessional contributions cap.

Further, to avoid members triggering excess contributions consequences, it has been common for trustees to allocate small amounts of the reserve each year through ‘fair and reasonable’ allocations – resulting in large unallocated reserves often being ‘stuck’ in the superannuation system.

However, these regulations provide that where a reserve supported an income stream (i.e. a pension reserve) and that income stream has ceased or been commuted, and the reserve is allocated to a former recipient of that income stream, including a reversionary beneficiary, the allocation will not be counted toward their concessional nor non-concessional contribution cap – that is, the allocation can be made via a new cap-free pathway.

And, for allocations from other (non-pension) reserves, these regulations ensure that all other reserve allocations, which were previously counted towards an individual’s concessional contributions cap, will now be counted towards their non-concessional contributions cap.

It’s also noteworthy that the changes to the tax treatment of reserve allocations made by these regulations are not subject to the 5-year period referred to earlier. That is, they are now the new norm for all reserve allocations made on or after 7 December 2024.

Both these developments will assist in the uptake of this legacy pension amnesty and help to ensure a more expeditious wind-up of fund reserves.

The downside

The new cap-free pathway referred to above has some limitations. For instance, while it will be beneficial in circumstances where a reserve allocation is made to a pension recipient that is still alive, it will not be available where a ‘pension reserve’ exists, but the former pension recipient(s) has died.

For example, when a life expectancy pension’s term ends, the pension ceases. The resulting reserve amount associated with the pension remains in the fund – awaiting allocation to a member account.

Under these new regulations, should the reserve allocation be made to someone other than the pension recipient – for example, the pension recipient has subsequently died – the cap-free pathway is no longer available.

Instead, any reserve allocation(s) will be counted toward the beneficiary’s non-concessional cap – unless allocated under the ‘fair and reasonable’ approach. Of course, in some cases this is potentially still a better outcome than being assessed against their concessional contribution cap.

In our submission on the draft regulations, we noted it was common practice for legacy pensions to cease rather than be commuted on the death of the primary beneficiary or on the completion of the payment term. We encouraged Treasury to consider the inclusion of an additional cap-free pathway to allow a pension reserve to be exited from the system where the pension recipient(s) has died. Unfortunately, this was not heeded so it appears an opportunity has been missed to more quickly and efficiently eliminate these potentially large reserves. It also creates differing outcomes for pension recipient members who predeceased the introduction of this long-awaited measure.

Social security impacts

One of industry’s concerns upon release of the draft regulations was the potential social security ramifications of the then proposed changes.

Notwithstanding industry’s recommendations for Treasury to work with the Department of Social Services to ensure these concerns were addressed, at the time of writing, we are not aware of any social security legislative instruments, or other supporting materials, that serve to alleviate any of these concerns.

While we understand a legislative instrument to resolve these social security concerns is likely, without further clarification or developments on this front, concerns still linger that social security sensitive members may be negatively impacted by this recent development.

The Division 296 trap?

While the future of the proposed Division 296 tax is looking something less than certain, should it be passed into law, impacted members who would also like to access this pension amnesty may need to consider acting quickly.

That’s because, based on the current drafting of the Division 296 tax legislation, reserve allocations made from 1 July 2025 are at risk of being counted toward that members’ superannuation earnings (for the purposes of Division 296 tax).

The fate of this tax is not expected to be determined until early February 2025. As such, clients who may be impacted may have less than 5 months to get their affairs in order – before potentially being subject to tax on the allocation.

Overall, these regulations are a strong endorsement of your Association’s ongoing advocacy efforts, and is a welcome development to all concerned. Yet, there is a lingering sense that some opportunities to further enhance the regulatory framework surrounding this measure may have been missed.

But as Christmas is a time for giving, we are grateful for the timely introduction of a measure that has been on the Association’s Christmas wish list for far too long.