Q1: I started a pension with $1.7 million on 1 July 2022. Can I move a further $200,000 into pension phase from 1 July 2023 post indexation?
Q2: At June 2022 I had a total balance of $1.9 million. I have established a pension of $1.7 million. The combined SMSF has increased in value to $2.4 million and I have also started withdrawing pension payments of $10,000 per month. I understand that if I make a lump sum withdrawal my transfer balance decreases by that amount. If I don’t remove any lump sums does the transfer balance cap remain at $1.7 million regardless of the amount of pension payments?
A: This is a question, again, that we got repeated a lot when this webinar was put out. And it’s all, for instance, around the transfer balance account or transfer balance cap. It’s a question, that we get because it’s the rules that apply to the transfer balance cap affect all of us. It’s a lifetime limit, essentially, on what we can move into pension phase. But it’s how these rules apply, and especially around indexation, that can create vastly different outcomes for each of us. So even though we’ve got this general transfer balance cap of $1.7 million, soon to be essentially $1.9 million on indexation. The way it actually applies individually to us can differ considerably. And we’ll look at that shortly by going through some examples. I’ll take you through the rules and how they apply, but then I’ll take you through how they apply under different examples and scenarios.
The two specific questions that we will look at is, first one from an anonymous reader around starting a pension with $1.7 million on 1 July, asking can they move a further $200,000 into pension phase from 1 July 23? From 1 July this year, post indexation. Remember, we have in written in legislation, rules that this transfer balance cap is subject to indexation, which is in line with inflation. And what we are expecting to see is from 1 July this year, 1 July 2023, that that cap of $1.7 million should be indexed to $1.9 million. Albeit subject to the government making changes before then, hopefully they won’t.
This person has used their $1.7 million, but they want to put a further $200,000 in post indexation. So we’ll look at that particular issue as well. The next question similar to that one, was in June 2022, total balance of $1.9 million and used up $1.7 million worth of their cap. We’ve got some increases to the value of the fund, taking some money out and wanting to know how that can affect their personal transfer balance cap.
So let’s look at what the specific rules are, the background to the transfer balance cap, and then we’ll look at some examples which hopefully explains how it works in real life.
So we need to go back to July 2017 and the super reform measures that came into place at that time and introduce this new concept of the transfer balance cap. Essentially a lifetime limit on the amount that can be moved from our growth or the taxable stage of super into the tax-free earning stage being pension phase or retirement phase of superannuation.
Now, initially the cap was set at $1.6 million, but as I mentioned, it’s subject to indexation. And it’s subject to indexation in $100,000 increments. The way it is indexed is by taking the prior December’s CPI rates, so inflation rate, and applying that to a formula that says, yes, the cap will be indexed, or no, it hasn’t hit a rate where it will be indexed. So the first indexation event took place on 1 July 2021 when it went from $1.6 to $1.7 million. Now, as I mentioned, it set again to go to $1.9 million from 1 July 2023, so from this year in about three and a bit months, unless the government changes the rules.
Importantly, indexation only applies to the unused portion of your transfer balance cap. So indexation doesn’t apply to all of your cap, all of your $1.7 (million). It only applies to the unused portion of your transfer balance cap. I’m 50 years old. I don’t have any amount in retirement phase. I haven’t accessed the transfer balance cap, so I still have 100% of my transfer balance cap remaining. So any indexation, I would get 100% of, because I haven’t used up any of my cap as of yet.
The second point is that the member’s highest ever transfer balance cap is used to determine if you’re eligible for indexation. And I’ll take you through a specific example on that. How much you have moved, the highest amount you’ve moved into retirement phase in the past. Again, as I said, I’ll take you through how that works with an example.
Example number 1, Garth starts a pension on 1 July 2022 with $1.7 million. I’ve used up my entire transfer balance cap because it’s $1.7 million at the time. So if the general transfer balance cap gets indexed to 1.9 million at 1 July this year, I don’t get any of that indexation. I don’t benefit from it. I’ve used up my entire transfer balance cap. So if you’ve used up your entire cap, indexation is irrelevant to you.
Second example is I started a pension on 1 July 2022, but I only used $850,000 to start the pension. So I have $850,000 remaining. So that’s the $1.7 million cap, less what I moved in the pension phase in July 2022, the $850,000. So I’ve got $850,000 left of my cap. I’ve effectively used 50% of my transfer balance cap.
So assuming that the transfer balance cap does get indexed to 1.9 million this year, I am eligible for partial indexation, and that would be the 50 %. So I’ve used 50%, therefore, I’m only eligible to 50% of the indexed amount. So if the amount of the indexation is $200,000, that’s the $1.7 (million) to the $1.9 (million), I only get half of that. I only get 50% of the $200,000, which is $100,000. So my personal transfer balance cap or account would go to the $1.8 (million), $1.7 (million) plus the $100,000 indexation. So again, you need to think about this, that all people out there in retirement phase could all have different levels of indexation eligibility. It is an issue, it’s complex. Just think, how is it relevant to you?
To specifically answer one of the questions, though, this is is covered here in example 3. I started a pension with $1.6 million in this example on 1 July 2020. I’ve still got $200,000 sitting there in my accumulation balance. I only was allowed to move $1.6 million in at that time. That was my cap. I did that and I had to keep $200,000 in my accumulation balance.
Now I know that the cap is going to be indexed, for instance, in June 2021. A bit of hindsight there. So I stopped my pension. I stopped my pension on 30th of June. So I completely stopped that and took my $1.6 million back to accumulation phase, which means the the balance of my transfer balance account on 30 June 2021 after stopping the pension is zero. Now, I did that because I was planning on starting a new pension with $1.7 million, taking advantage of the indexation.
But the rules don’t let me do that. The rules don’t allow us to stop the pensions to then get benefit of indexation because remember, the indexation is only relevant to the highest ever transfer balance. And for me, my highest ever was already the $1.6 (million). I’ve used up 100 %. I have no entitlement to the proportional indexation as my highest ever balance before that was equal to my personal cap. I’ve used it up and therefore my highest ever balance remains at $1.6 million. I can still start a new pension, but only with 1.6 because that’s all I was eligible to use. If I started one with $1.7 million, I would have an excess transfer balance account and I’d need to stop some of that pension to get back below it.
That’s important to note, those two points. One, the partial indexation around how much of the unused cap you’ve used. And the second one is it’s based on your highest ever personal transfer balance cap. That rule is there to stop people from commuting pensions just before the indexation event takes place. I hope that explains that clearly. Again, if you jump onto the website, there’s a couple of articles there – one around how the transfer balance cap works. And another one, which is taking advantage of the higher cap the indexation, which includes a calculator as well.
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