ATO provides clarity on treatment of excess pension payments

For administrative ease, where members opt to take withdrawals in excess of their minimum pension as a lump sum, it is an acceptable industry wide practice, for members to have valid documentation in place at the start of a financial year electing that any amounts above the prescribed minimum pension drawdown required in a financial year be treated as a lump sum withdrawal.

Traditionally, we know that this practice is acceptable to the ATO but at our recent Technical Day 2020 it generated a lot of discussion on how it applies to pension account withdrawals made in 2019/20. Recognising that there was no unanimous industry view, we sought clarity from the ATO to ensure that as an industry we are consistent in our application of the law and that any associated tax liabilities and Transfer Balance Account Reporting (TBAR) obligations are met.

The ATO have stood by their view currently published on their SMSF FAQ website, confirming that it is not possible to re-classify pension payments already received by a member. Essentially, pension payments made up to 24 March 2020 (the date of the Government’s announcement) in excess of the new reduced minimum annual payment will be treated as pension payments in 2019/20 and cannot be treated as lump sums.

More importantly, the ATO have confirmed that this treatment also applies where a valid election was in place as far back as 1 July 2019, requesting that the trustee treat any payment over the minimum pension amount required for the year as a lump sum. In this situation, only payments made to a member, after 24 March 2020, in excess of the reduced minimum annual pension drawdown, can be treated as a lump sum. The need to ensure that a valid election from a member is in place prior to the payment of any lump sum is still required.

Unfortunately, what this means is that some retirees will be disadvantaged. Essentially, it’s just bad luck for any member who took more than the reduced minimum amount as a pension before the change became law on 24 March 2020, despite having in place a valid election to treat any excess pension payments as lump sum commutations. These members can only treat payments made after 24 March 2020 as lump sum commutations.

On the other hand, for those members who chose to receive their pension in the later months of 2019/2020, provided they had a valid election in place prior to receiving the payment, they will be able to take advantage of the retrospective nature of the reduction in the annual minimum pension drawdown requirements and can treat any excess pension payments as lump sum commutations. For SMSFs impacted who have quarterly TBAR obligations, the reporting of any partial commutations in the last quarter of 2019/2020 was due by 28 July 2020.

For example, on 1 July 2019, Simon aged 66 instructed his fund to treat any withdrawal from his account-based pension, in excess of the minimum pension drawdown amount, as a lump sum. Simon’s pension balance on 1 July was $1m and his minimum pension withdrawal was originally calculated as $50,000 for 2019/20. His reduced minimum was re-calculated to $25,000.

Simon had arranged to withdraw $5,000 on the last day of every month for 2019/20. As at 24 March 2020, he had withdrawn $40,000 from his SMSF. Even though this amount was greater than his reduced minimum, he must treat the entire $40,000 as a pension in 2019/20. The remaining withdrawals, valued at $20,000, could be treated as lump sums.

Had Simon opted to withdraw his benefits in two equal payments, one in December 2019 and the other in June 2020 then only the $25,000 received prior to 24 March 2020, will need to be treated as a pension payment. The entire $25,000 received in June 2020 could be treated as a lump sum because at the time of the payment, Simons’ reduced minimum had already been paid.

Although unintentional, this is an example of how retrospective law changes can sometimes lead to inconsistent treatment of retirees. Another example is the retrospective changes made to the calculation of the transfer balance cap debit on the commutation of a market linked pension. A new formula was enacted in June 2020 but applies from 1 July 2017 which means that members who restructured into new market linked pensions based on the original formula, may find themselves at risk of being in excess of their transfer balance cap. We continue to work with the ATO on this issue and have called for the use of the Regulator’s regulation-making powers to essentially create a write-off transfer balance account debit for those members who, prior to the announcement of the new formula, restructured into a new market-linked pension in good faith based on the original law. This is a whole new issue and we will keep you posted on our efforts to find an administrable and fair solution.