The transfer balance cap is the new limit on how much a member can have in their pension account and accordingly is a limit on how much a super fund can have in “pension phase”. Income and capital gains are tax free to the extent they are in pension phase. To the extent that a super fund is in “accumulation phase” its income is taxed at 15% and capital gains, on assets held for more than 12 months, are taxed at 10%.
The transfer balance cap regime does not generally affect how a member’s benefits are taxed. They will remain tax free for members aged 60+. The exceptions to that rule are defined benefit pensions and market linked pensions (discussed in another update).
The transfer balance cap measure commences on 1 July 2017.
The cap limit - $1.6 million
The cap limit at 1 July 2017 is $1.6 million. The cap will increase with CPI indexation in $100K increments.
Working out the transfer balance account - credits and debits
The transfer balance cap regime works by allocating a transfer balance account to each member who starts a pension. The transfer balance account is measured against the member’s transfer balance cap to see if the member has exceeded their cap.
The legislation introduces the concept of credits and debits to a member’s transfer balance account. These concepts are analogous to a bank account – credits increase the amount of the account and debits decrease the amount of the account.
Credits and debits are not limited to any one superannuation fund account but capture all of a member’s superannuation accounts across all of their superannuation funds.
A member begins to have a transfer balance cap when the first credit occurs. Credits include:
- At 1 July 2017 any existing account based pensions or defined benefit pensions (including market linked pensions);
- After 1 July 2017 any new account based pensions or defined benefit pensions that are commenced; and
- Death benefit pensions payable to a member (whether as a reversionary pension or a new death benefit pension).
It is important to note that only the initial amount contributed to the pension are counted as credits. Future earnings are not. For example, if the member’s pension is initially valued at $1.6 million but due to investment returns increases to $2.6 million, then the member’s transfer balance account would stay at $1.6 million (ie the member has not exceeded their transfer balance cap) and the full $2.6 million would stay in “pension phase”.
Debits are amounts which reduce a member’s transfer balance account (ie enabling them to commence further pensions). Debits include:
- Amounts commuted out of the pension accounts as lump sums (whether as a lump sum out of the super fund or to the member’s accumulation account or as a rollover to another super fund);
- Structured settlement payments for personal injuries – this means that such amounts contributed to super funds can be used to commence a pension without affecting the member’s transfer balance account or cap;
- Where the pension balance is reduced by fraud;
- Where the pension balance is reduced from a bankruptcy claw back;
- Where the pension balance is reduced as a result of a family law split;
- Where the pension ceases to be a complying pension (for example, failing to pay the minimum pension payment in which case the full value of the pension at the end of the year will be a debit).
It is important to note that negative investment returns and pension payments are not counted as debits. For many members this will mean that their pension account balance is less than their transfer balance account amount.
Negative transfer balance caps.
It is possible to have a negative transfer balance cap.
For example, at 1 July 2017 a member has a transfer balance account of $1.6 million. Two years later the member’s pension is worth $2 million due to positive investment earnings. The member commutes the pension in full. The commutation debit is worth $2 million being the current value of the pension. The member’s transfer balance cap is therefore -$400K (ie $1.6 million account balance less a debit of $2 million). The member could then start a pension of up to $2 million.
Proportional indexation of the cap
This is arguably one of the most overcomplicated parts of the new measures. Rather than give each member the full $100K indexation each time the cap is increased, the Government has decided that each member who has an existing transfer balance account will only receive a proportional indexation.
This is best explained by way of example. Say a member starts a pension equal to $400K. This is a credit to their transfer balance account of $400K, while their transfer balance cap is $1.6 million. The member has therefore used up 25% of their cap and has 75% of their cap left. When the cap increases by $100K to $1.7 million (due to indexation) this member will only receive indexation to extent of the proportion they have left in their cap (ie 75%). Therefore, the member’s cap is increased by $75K (ie 75% of $100K) to $1.675 million).
This calculation must be made every time the transfer balance cap is increased with indexation.
If a member has reached their cap, they will not receive any indexation.
What this means is that once indexation starts to increase the general cap every member with an existing pension (and transfer balance account) will have their own personalised transfer balance cap that will have to be calculated.
Consequence of exceeding the cap
A member who exceeds their transfer balance cap will trigger excess transfer balance tax. The tax works by allocating to the member notional earnings equal to the general interest charge rate (currently 8.76%) from the date the excess occurs to the date the excess transfer balance is rectified or the date that the ATO issues a determination. The tax payable on the earnings is at the rate of 15% for the member’s first offence. Earnings on subsequent excess amounts are taxed at 30%.
The ATO will issue a determination to a member who has exceeded their transfer balance cap setting out the “crystalised amount” which must be removed from their pension account. The member has 60 days to elect which super fund and pension account to deduct the crystalised amount from or to confirm that the excess has already been rectified. The ATO will then issue a commutation authority to the chosen fund (assuming the breach is not rectified). If the member does not notify the ATO then the ATO will issue a commutation authority directly to the member’s super fund .
If a super fund fails to comply with a determination within 60 days then the pension will be deemed to not be in pension phase from the start of that financial year. In addition, a debit will arise to the member’s transfer balance account at the end of the period that the super fund was required to comply with the commutation authority.
What if a pension ceases to be in retirement/pension phase?
As noted above, pensions can cease to be in retirement phase in certain circumstances.
Under the new laws, a pension will cease to be in pension phase if the super fund does not release an excess transfer balance as required under a commutation authority. Pension phase for the fund, in relation to that pension, will be deemed to cease at the start of the financial year. For the member’s transfer balance account, an auto debit will occur for the full value of the pension at the time required under the commutation authority.
A pension will also cease to be in pension phase if the trustee fails to pay the minimum pension payment. In this situation, for the transfer balance cap regime, the pension will cease at the end of the financial year. An auto debit will occur at that time equal to the value of the pension at the end of the financial year. In the ATO’s view, pension phase in relation to that pension will cease from the start of the financial year.
In both situations, if an auto debit occurs, then the trustee would need to start a new pension which in turn would cause a credit to the member’s transfer balance account.
Death benefits and the transfer balance cap and child caps
Death benefit pensions are included in a member’s transfer balance account. Reversionary pensions do not count for a member’s transfer balance cap for 12 months after the death of a member. There are special rules for death benefit pensions paid to children. These issues are dealt with in another update.
Market linked pensions and defined benefit pensions
These pensions are treated differently to account based pensions. These pensions are discussed in another update.
Transition to retirement income streams
Transition to retirement income streams are not covered by the transfer balance cap regime as such pensions will no longer qualify for pension phase from 1 July 2017.
Transitional CGT relief
Super funds in pension phase are eligible for a cost base reset on 1 July 2017. This is discussed in another update.
SMSFs using the segregated method
Self managed superannuation funds (SMSFs) that have at least one member who has more than $1.6 million of benefits can no longer use the segregated method for calculating their exempt current pension income (ie pension phase) from 1 July 2017. SMSFs who don’t have any members who have exceed their cap can continue to use the segregated method.
Therefore, at 1 July 2017, SMSFs with at least member who has more than one member who has $1.6 + million in benefits, must use the proportionate method.
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