Managing the new Transfer Balance Cap for Pensions

Managing the new transfer balance cap for pensions – You now need to consider whether to treat payments as an income stream (normal pension payment) or a lump sum.

The transfer balance cap applies from 1 July 2017. It is a new limit on the total amount of superannuation that can be transferred into retirement phase and it is currently $1.6 million.

Why does it matter whether a payment is an income stream payment or a lump sum?

The short answer is that lump sums affect the transfer balance account; whilst income stream payments do not.

Perhaps the first thing that needs to be clarified is what is meant by taking a lump sum from a pension. Many people think this means taking a once-off or infrequent payment from their pension account rather than taking it, say, monthly or fortnightly. That sounds reasonable enough, but unfortunately that isn’t what is being referred to. A ‘lump sum’ relates to the intention and documentation surrounding a withdrawal; not the timing or frequency.

In the past, taking a lump sum after retirement was generally for Centrelink Age Pension reasons or for those under 60 who could utilise the low rate cap. As such, it was relatively uncommon to treat payments as a lump sum, especially for those over 60 and retired. The new transfer balance cap has changed that and it is likely that the taking of lump sums will become much more common.

Here’s an example of the different treatment between a lump sum payment and an income stream payment for cap purposes:

Scenario 1

On the 1^st of July a pension is started with $1.6 million which fully utilises the cap. There is a $1.6 million credit to the transfer balance account that is reported to the ATO (This isn’t a bank account; it’s more like a ledger account that keeps track of transactions that affect the cap. Being under the cap is okay, but exceeding it will entail penalties). Because $1.6 million has been applied to the cap the person is not able to put any additional money into pension phase.

With $1.6 million in pension on the 1^st of July the person needs to withdraw at least the minimum at some stage during the year. This could be a once-off annual payment, monthly payments or even ad hoc payments as they are needed. For a person that is 65 years old the minimum is 5% or $80,000. If only the minimum pension payment is going to be taken for the year then there’s no need to consider the lump sum strategy. That’s because that $80,000 has to be taken as a normal income stream payment to meet the minimum pension payment requirement. Lump sums no longer count towards the minimum pension payment effective 1 July 2017.

If, however, the person plans to take more than that during the year then a decision needs to be made about how to treat the excess over the $80k. Let’s say that $150k is needed.

• Income Stream

We know that $80k of that has to be treated as an income stream payment. The extra $70k could be treated like that as well and that would not cause any compliance issues. In fact, if nothing is done, that $70k, by default, will be treated as an income stream payment and is exactly how most pensioners have treated it in the past. In this scenario, taking the excess as income stream payments each year doesn’t give the option to transfer more into pension at a future time.

• Lump Sum

However, if an election is made to treat that $70k as a lump sum then it will create a $70k debit to the transfer balance cap. That then means that instead of using the full cap of $1.6 mil and not having the ability to put more money into pension at a later date, the person has utilised $1.53 mil and has $70k of the cap remaining. This may not sound like much, but after a few years it could potentially add up to a reasonable sum that allows an additional transfer of money into pension phase at a later date. Contrast that with several years of taking excess income stream payments and not having the ability to put more into pension at a later date if desired.

• Does this apply to me if I have less than $1.6m?

Now, it may seem that this is only relevant for people that have at least $1.6 mil. While that might not be the position a retiree is in at this time there needs to be a consideration of what the situation may look like if, say, they became entitled to a reversionary pension which had the potential to exceed the cap, a potential inheritance or other money outside of super that they are able to contribute at a later date.

Managing the cap along the way will provide the most flexibility for the future.

How do I elect for a payment to be considered a lump sum?

To do so, an election must be made for the payment to be treated as a lump sum and not as a superannuation income stream benefit. The ATO stipulates that this election must be made before the payment takes place. If the election isn’t made, then the payment is treated as a normal pension payment. A lump sum payment from a pension account (that doesn’t clear the balance to nil) is a partial commutation of the pension.

We’ve added a template to our website, under Downloads & Forms that you can use to make this election. It can be found here:

Once the election has been completed and signed, the payment can be made. The original should be kept by the trustee and a copy of the signed election should be provided to us at that time. That will allow us to record it properly in the accounts and advise the ATO in the required timeframe (which is currently under review by the ATO and will be the subject of another article when finalised)

Can I take more than one lump sum during the year?

Yes, but each lump sum payment requires an election and possible notification to the ATO. From an administrative point of view keeping the number of lump sums to a minimum is desired, but that does not preclude you from taking more than one.

Lump sum from accumulation account may also be something to consider

So far, we’ve only considered taking the excess over the minimum pension payment as a lump sum from the pension account. If there is also an accumulation account that has the ability to have lump sums taken (i.e. it has unrestricted non preserved components) then that should be considered as well. A lump sum from the accumulation account won’t affect the transfer balance cap but it will reduce the amount in the fund that carries a less favourable tax consequence.

Scenario 2

Let’s say that the member is 65 and has $2.0 mil in super. Of that, $1.6 mil is in pension and $400k is in accumulation. They intend to withdraw $150k from the fund during the year. The minimum pension payment is $80k so at least $80k of that has to be treated as an income stream payment from the pension account. As per the previous example, the excess $70k could be treated as a lump sum from the pension account or as an income stream payment. In this case, it could also be treated as a $70k lump sum from the accumulation account. Here’s a table of what the 3 different options would look like:

A Word of Caution

If you are going to elect to treat a payment as a lump sum, please ensure that you don’t count that payment as part of the minimum pension payment made for the year. Lump sums no longer count towards the minimum. If you include it by mistake in your calculations and then don’t take the minimum pension payment for the year, the pension will cease from the beginning of the year and the fund will lose the tax exemption on earnings supporting a pension. You cannot retrospectively change your mind and instead treat a lump sum as a normal income stream payment if you find that the minimum payments weren’t taken.

This is applicable for account based pensions and the new TRIS – in retirement phase for those people that have met a full condition of release. It is not relevant for people who are solely in accumulation or have a normal TRIS, market linked pension or defined benefit pension. Any personal tax consequences or effect on the tax-free/taxable components of the various balances has also not been considered in the examples provided.

This information is general in nature and should not be considered advice. We are not licenced to provide financial advice and cannot recommend whether a particular strategy would be appropriate to your circumstances. You may wish to seek the assistance of a licenced financial advisor for further information and advice.