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How pension accounts can exceed $1.6 million

One of the joys of being an academic, after 25 years in corporate life (besides not having to speak in that risk averse formal legal way), is you have the time to check the tax rules and then get one of those lightbulb moments.

A Cuffelinks reader asked whether an SMSF member who has already maxed out their $1.6 million Transfer Balance Cap (TBCap) can have additional earnings added to the fund account supporting their pension?

The answer is yes.

And here is the light bulb moment: there is no connection between the actual value of a member’s account when paying a pension and their TBCap. The Explanatory Memorandum specifically says that.

The Transfer Balance Account (TBAccount), the value of which is measured against the TBCap, is calculated, briefly, as the 1 July 2017 value for existing pensions or the value at commencement of subsequently-commenced pensions. Of course, there are credits and debits to that which can take the TBAccount over the TBCap but, briefly, they are credits for deemed earnings on commencing TBAccount excesses and debits for commutations, plus some more obscure events giving rise to debits.

That is, the TBAccount value for these purposes is frozen at commencement so that additional earnings added to the members’ account in the fund, and consequent additional pension because of the minimum 1 July account balance that must be paid, are ignored for this calculation.

What that means in practice is that, say, you have a fund roaring along at a 10% pa earnings rate which will then have an increased pension of that amount, the TBAccount will stay at the amount it was when the pension commenced.

In fact, that is the design of the system. The fund doesn’t have to annually check the TBAccount for a member, it is only done at commencement or when one of those specific credits or debits occurs.

If the TBAccount exceeds the TBCap at commencement, or otherwise, then there is a mechanism that is intended to reclaim the exemption from tax that the fund receives on the income from the excess. This is achieved by the rules deeming an earning rate on that excess TBAccount, which earnings are taxable to the member, but the fund will still continue to get the exemption from tax.

So, again, earnings allocations, and indeed losses, to the members’ account in an SMSF are ignored for the purposes of comparing their TBAccount with their TBCap.

I’m not sure the delight from these light bulb moments in academe actually makes up for the pay differential, but that is another discussion (sigh).

 

Gordon Mackenzie is a Senior Lecturer in taxation and superannuation law at the Australian School of Business, University of New South Wales. This article summarises the major points as understood by the author, it does not consider the needs of any individual and does not consider all aspects of the legislation.

16 Comments
Tiger Kelly
September 29, 2021

I retired in May 2015 & on 1st July 2017 had $1.565m in my pension account.
The account balance is now just under $2m.
I am about to start a SMSF pension.
How much can rollover to my new pension account - $1.6m, $1.7m or some other amount?

daniel
February 07, 2022

If the existing account-based pension was $1.565m - whatever that balance has accrued to will be allowed to rolled over to the SMSF Pension. (In your case just under $2m). You will be able to roll over slightly more as you didn't use the full $1.6 million cap at 1 July 2017. But that requires a bit of math so would probably be best to speak to a Financial Adviser to confirm exact figures.

Neil
April 09, 2018

This is an interesting aspect of the current rules. However, as we have seen with recent policy of ALP to restrict the refund of imputation credits, the rules can change. It will not be long before the treasury sees this "Scam" loophole, albeit clearly intentional, and closes it.

Andrew
October 31, 2017

Intuitively that makes sense, but it's all quite confusing. I did a bit more research and concluded:

If your total superannuation balance (TSB) is less than $1.4 million on 30 June of a financial year, then in the following financial year you can make NCCs and take advantage of the maximum bring-forward cap of $300,000 - your bring-forward period is 3 years.

If your TSB is $1.4 million or more, but less than $1.5 million, on 30 June of a financial year, then in the following financial year your maximum bring-forward cap is $200,000 - your bring-forward period is 2 years.

If your total superannuation balance is $1.5 million or more but less than $1.6 million on 30 June of a financial year, then in the following financial year you can only take advantage of the annual NCC of $100,000 - you have no bring-forward cap.

It would be worth checking this interpretation with the ATO.

Vicki C
October 30, 2017

Uh-oh - maybe not! Further down the same page the ATO says:

"For account-based super income streams, the debits and credits in the transfer balance account are disregarded. Instead, your modified transfer balance includes the current value of the super interest that supports the account-based super income stream at the end of 30 June of the relevant financial year. The current value is the amount that would become payable if you were to voluntarily cease the interest.

If you only have account-based income streams, generally your retirement phase value will simply reflect the current value of those income streams."

So it seems the NCC cap would be based on $1.4m, so the NCC contributions will be limited to $200,000 (at current values)

Vicki C
October 30, 2017

The new NCC rules include the "transfer balance" (ie not the account balance) of amounts in retirement (pension) phase so $1.2m is counted in the "Total Superannuation Balance" which is used for NCC eligibility.

See https://www.ato.gov.au/Individuals/Super/Super-changes/Total-superannuation-balance/

Laine
October 29, 2017

An aspect I would like clarified is this.

Assume you have $1.2m in pension mode as at 1 July 17. This leaves $400k still available for you to contribute and move into pension mode.

Now assume that at 1 July 18 your balance has grown to 1.4m in pension mode after payment of your income. You want to contribute $300k non-concessional to your super using the bring forward provisions and transfer the new amount in to pension mode.

Are you allowed to do this, using part of your still avalaible $400k or is the amount of your transfer balance recalculated at $1.4m when you add the new amount at 1 July 18 so you can only add $200k.

Help with this would be appreciated.

Andrew
October 29, 2017

Hi Laine, it's a good question. This example on the ATO website may be a good indicator.

Ben is 60 years old, about to retire with an accumulated super balance of $1.5 million. Ben plans to retire during 2017–18. ... If Ben starts an account-based pension valued at $1.5 million, he will still have $100,000 available cap space. Even if the value of Ben’s pension grew due to investment earnings, the amount of available cap space ($100,000) would not change.

The ATO site also states "a superannuation interest that supports a superannuation income stream that increases in value because of investment earnings (capital gains, interest and dividends) does not have its growth reflected in your transfer balance account".

I'm not an expert and happy to be corrected - but based on that, it seems that $400k of cap space is still available.

Ramani
October 27, 2017

I am struggling to grasp what legitimate investment strategies available now will be denied to a SMSF (or indeed an APRA fund when members keep their pension balances) post 1 July 2017, as long as the transfer balance cap rules are observed. If Kevin can give some examples, it would help clarify his concernsfor everyone.

I also do not follow 'free funds' he mentions. In a SMSF, net assets are usually fully allocated to members, and ATO has already warned any gaming of the TBC through unallocated reserves will receive scrutiny, as an anti-avoidance measure. The risk is not worth it, given that the tax exemption on earnings might be compromised.

Kevin Buxton
October 27, 2017

I understand where Andrew is coming from - subject to the imposition of the tbc, growth in a fund's pension account will be determined by future capital appreciation and income growth of the underlying assets. Effectively the tbc creates two asset pools in circumstances where more than $1.6m is held in a fund structure from 1 July.

A further ATO initiative has been to eliminate asset segregation as the basis for determining a fund's tax liability. In reality assets supporting taxable and non taxable
income streams within a fund structure are now considered " non specific ".

My contention is that revised tax regulations effectively eliminate certain investment
strategies previously available to trustees. Certainly " organic " growth is available
as stated above - however re-investment of free funds could be interpreted a
" capital injection" when applied to the existing ( non specific ) asset pool underlying
a funds pension account.

To be candid this may or may not make sense meaning the situation warrants further clarification. All comments welcome as always - perhaps the ATO may wish to
comment.......

cheers

Andrew
October 27, 2017

My interpretation of this is as follows:

If you start a pension account with $1.60m, your TBAccount is $1.6m.

If your pension account grows in the first year at 10% and your pension is paid at 5%, the pension account will grow by a net 5% (ie $80k) to $1.68m. Your TBAccount remains at $1.6m.

Your pension account can either grow or fall depending on the performance of the assets held and pension paid, and could fall below $1.6m. Your TBAccount remains at $1.6m.

If your pension account's average net growth (ie asset growth - pension) was say 2 % over the longer term (eg 20-25 years), your pension account could grow to ~$8-10m through compounding. Your TBAccount would remain at $1.6m.

Kevin Buxton
October 26, 2017

I may have been the reader referred to in this article - what concerns me is that the newly introduced tax regulations will eliminate re-investment strategies previously available to smsf trustees.

It is not unrealistic to assume that many self managed super funds have the capacity to generate cash surpluses after meeting minimum pension requirements and other fund expenses. Prior to 1 July, regulations did not preclude the re-investment of "free funds". With the introduction of amended regulations, for any smsf with member's funds in excess of the tbc, the re-investment option is no longer available... or so it seems.

The amended regulations also eliminated asset segregation as a basis for determining tax liability, meaning that any re-investment strategy will result in the smsf exceeding its tax free threshold thereby rendering it non-compliant.

Gordon has pointed out that "fund surpluses" can be paid to members and this outcome will appeal to many. On the other hand, the opportunity to implement a strategy designed to maintain ongoing fund viability in an increasingly uncertain financial environment has been denied... or so it seems.

Would welcome all pertinent comments on this issue.

Vicki C
October 26, 2017

Kevin, I'm not sure what you are referring to.

It's true that there is no segregation available for a fund with a retirement phase member over the $1.6m cap. That would not prevent "reinvestment". The trustees can choose whatever investment option they like with any funds, subject of course to meeting their investment strategy.

There is no "tax-free threshold" for an SMSF.

It sounds like you think a fund member balance can never go over $1.6m which is not the case.

Frank
October 25, 2017

The proposed downsizing contribution is not counted and can also be used to exceed the $1.6m cap

Damon Erby
October 26, 2017

Pedro, You may have $2m in your pension account at 30 June 2017. Due to the rule changes, you are now forced to:
1. Take out $400k cash or
2. 'commute' the $400k to accumulation phase (meaning you will have $1.6m 'pension account' earnings of which are tax free, and a $400k 'accumulation account', earning on which get taxed at 15%.

No matter what option you took, you will have a pension balance of $1.6m (which the ATO will know as your TBAR cap transfer amount - which you have maxed out).

If that $1.6m is invested very well, it may grow to $1.7m by 30 June next year, even after taking out a $64k pension payment. That is fine, there is no 'excess'. The earnings on the entire $1.7m are still tax free.
IF the next year goes even better, and grows from $1.7m to $3m (wouldn't that be nice!), that is still fine, all earnings are tax free. For "TBAR cap" purposes, you still have only used $1.6m of your cap.

Pedro Gonzales
October 25, 2017

If anyone can enlighten me with some real world examples I would be very grateful. I'm struggling to understand this Eureka moment

 

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