New Market-Linked Pension Laws: The Good, the Bad and the Ugly

On the 5th of April 2022, new super regulations took effect to allow members of SMSFs with post 1 July 2017 re-structured market linked pensions (also known as term allocated pensions), to remove any excess transfer balance amounts.

These changes impact all SMSF members who, on 1 July 2017 had a complying life expectancy pension or market linked pension and opt to commute anytime thereafter, to start a new market linked pension.

Market linked pensions commenced on or after 1 July 2017 are not regarded as capped defined benefit income streams for Transfer Balance Cap (TBC) purposes. This results in a difference between the special value debit on commutation of the original complying life expectancy or market linked pension and the credit that arises when the new market linked pension starts, which is based on the pension account balance. Where the credit is greater than the debit, the start of a new market linked pension will lead to an excess transfer balance amount.

Prior to the registration of the new SIS Regulations, there was no ability to commute any excess amount from a post 1 July 2017 re-structured market-linked pension and individuals found themselves in perpetual excess. These regulations now address this unintended consequence but, is it all good news?

Below we consider some of the consequences associated with this latest law fix.

The Good

The new regulations are already in operation, lifting the commutation restrictions that ordinarily apply to a market linked pension to allow an SMSF trustee to action a commutation authority issued by the ATO to remove an excess transfer balance amount from the new, post 1 July 2017, market linked pension.

The new regulations also have retrospective effect and apply to any complying life expectancy pension or market linked pension that was commuted on or after 1 July 2017 to fund the start of a new market linked pension.

Despite the shortcomings of the formula for determining the transfer balance debit for the commutation of the original complying life expectancy or market linked pension that existed on 1 July 2017, these new regulations do not complicate things further by making any changes to the formula. In simple terms, when a capped defined benefit income stream is fully commuted, the debit value is calculated as the original “credit” for the pension reduced by the total of actual pension payments drawn from the pension in the years leading up to the commutation, as far back as 1 July 2017. The value of the debit will be determined at the time the commutation takes place so there is nothing stopping SMSF trustees from reporting the commutation event as a matter of priority.

When determining the amount that exceeds an individual’s personal TBC the value of the debit is calculated at the time of the actual commutation. However, the debit does not arise in an individual’s transfer balance account until immediately after the commutation occurs or on the commencement of these regulations, whichever occurs later. The new regulations also ensure that the subsequent credit for the new market linked pension arises immediately after the debit. This is a relief for any restructured pensions during the period 1 July 2017 to 5th of April 2022, as excess transfer balance earnings and the associated tax liability, do not start accruing until the 5th of April 2022.

The sooner a trustee reports these events to the ATO, the sooner the Commissioner will be able to make an excess transfer balance determination. Only once the Commissioner issues the determination will the excess transfer balance earnings be crystalised in calculating how much capital needs to be removed from a retirement income stream.

Individuals actioning a commutation authority issued by the ATO, will have the choice of retaining the excess amount in their fund or taking the amount as a lump sum benefit payment. This raises opportunities to keep monies in a concessionally taxed environment for members otherwise unable to contribute due to their total superannuation balance or age. It may also create opportunities for individuals to take a lump sum to fund deductible personal contributions.

The Bad

For all restructured pensions on or after 1 July 2017, trustees need to lodge their Transfer Balance Account Report (TBAR) with the ATO immediately. If the restructured pension is likely to give rise to an excess transfer balance, given excess transfer balance tax starts to accrue from 5 April 2022 (or immediately after the commutation if that occurs later), we do not recommend that SMSF trustees wait until a formal announcement is made by the ATO that these transactions should now be reported.

The earnings that attract excess transfer balance tax will continue to accrue until the commutation authority is actioned.

It is important that SMSF trustees wait for the ATO to issue a commutation authority before commuting any amount from a market linked pension. Withdrawing amounts before the ATO issues a commutation authority is a breach of the payment standards as these types of pensions have strict commutation restrictions.

The regulations recognise the need to vary the annual pension payments from a complying life expectancy pension to account for the reduced capital supporting the pension once the commutation authority has been actioned. However, no equivalent provision has been made for market linked pensions. Despite a commutation to remove the excess, trustees will still be required to continue to pay the minimum pension drawdown, as calculated on 1 July in the year of the commutation. Failing to pay the minimum pension payment may result in the market linked pension no longer being treated as a retirement income stream for tax purposes.

The Ugly

The treatment of any resulting reserves on the restructure of a capped defined benefit income stream was not addressed by these new regulations. Industry simply must remain optimistic that last year’s budget announcements, to allow members to exit legacy pensions, sees the light of day and that it extends to any surplus reserves that were once supporting a capped defined benefit income stream in place on 1 July 2017.

Finally, these new Regulations are in force, but they are still within their disallowable period which means any member of Parliament can still give notice of a motion to disallow the Regulations. If these Regulations are disallowed, which appears unlikely, we will need to revisit these issues, yet again.

These new regulations provide the certainty that industry was seeking with respect to meeting reporting obligations for capped defined benefit income stream already commuted and the resulting market linked pensions started. In the meantime, we will continue to work with the ATO to understand how these new regulations impact on TBAR lodgment obligations for impacted SMSFs.

We anticipate that the ATO will continue to take no compliance action on SMSFs that are impacted by these new regulations but have yet to meet their TBAR obligations. However, it is unknown for how long they will be prepared to extend this administrative approach. Regardless, we remain of the view that SMSFs should report as soon as possible to the ATO to limit the accrual of excess transfer balance earnings and tax.

The new regulations also apply on a go forward basis. However, whether individuals in receipt of a capped defined benefit income stream on 1 July 2017 should opt to re-structure to a market linked pension, will depend on a range of individual factors.