- What is the $1.6 million transfer balance cap?
- How will the $1.6 million transfer balance cap work?
- What is a person’s ‘transfer balance account’?
- What happens to Australians in pension phase before July 2017?
- What happens to super pension balances from 1 July 2017?
- Does the $1.6 million cap apply to each person?
- What happens to the transfer balance (TB) cap, and TB account, when a person dies?
- Are defined benefit fund members affected?
- Special rule applies to SMSFs and small APRA funds
- Seeking more information?
Newsflash! Superannuation changes are now law, passing both houses of parliament on 23 November 2016 (and receiving royal assent on 29 November 2016).
Note: Moving towards July 2017, most retirees will now need to monitor two lifetime superannuation amounts – their transfer balance cap, and their transfer balance account. The new policy applies to both existing and new super pension accounts from 1 July 2017, which effectively means the policy will apply retrospectively. Federal treasurer Scott Morrison claims the policy is not retrospective because the government “is simply limiting the amount that [can benefit] from the tax-free retirement phase from 1 July 2017”.
On 3 May 2016, the Coalition (Liberals/Nationals) announced that, effective from 1 July 2017, it intends to place a cap of $1.6 million on the amount of super that can be transferred into pension phase, and effectively force Australians to remove super benefits from pension phase if a pension account balance exceeds this amount as at 1 July 2017.
Background: On 27 September 2016, the government released an exposure draft of the proposed legislation for this measure and the submission period closed on 10 October 2016. Final legislation was passed by parliament on 23 November 2016, and the bill became an Act of parliament on 29 November 2016, when it received royal assent.
What is the $1.6 million transfer balance cap?
The $1.6 million transfer balance cap policy forms part of the Coalition’s 2016/2017 Federal Budget announcement, and in turn formed an important component of the Liberal/Nationals 2016/2017 Federal Election superannuation policy (for a summary of all of the now-legislated superannuation policies, see SuperGuide article Summary: 2016 Federal Budget superannuation changes now law).
The $1.6 million transfer balance cap is designed to limit the total amount of superannuation savings that can be transferred from accumulation phase into “a tax-free retirement account”, according to the 2016 Federal Budget papers.
The Coalition government claim very few Australians will be affected by this proposal because the average superannuation balance for a 60-year old Australian nearing retirement is $285,000, and that means that less than 1% of fund members will be affected by the transfer balance cap.
This claim is very misleading and to use a colloquial term, I consider the government’s claim is a load of codswallop!
The fact that the Coalition doesn’t state the numbers of Australians immediately affected by this policy, and doesn’t state the hundreds of thousands of Australians who will be affected by this cap over the next 25 to 30 years is misleading. Add the millions of Australian retirees who will now need to monitor their transfer balance cap (for periodic indexed increases of the cap), and the same millions who will also need to monitor their transfer balance account for new money going into pension phase, or existing money being removed from pension phase (commuting pensions into lump sums), and the claim of less than 1% of fund members being affected is text-book propaganda.
The government has just made retirement a lot more complicated for all Australians, including those with nowhere near $1.6 million in super.
As super balances increase, and the cost of a reasonable lifestyle in retirement increases, the $1.6 million cap (indexed for inflation in $100,000 increments), will be potentially within the reach of a hefty percentage of middle-aged and younger Australians currently in the workforce. Not only will millions of retirees have two lifetime amounts that they may need to be mindful of, but an increasing number of older Australians will have to monitor these figures for the rest of their lives. We will cover the detailed mechanics of the indexed $1.6 million transfer balance cap (limit to what can be transferred into pension phase) and the transfer balance account (how much an individual has used of his or her transfer balance cap) in later articles.
Note: The $1.6 million transfer balance cap applies to each individual, which means a couple could have up to $1.6 million each in separate pension accounts. For many current retirees, a single pension account in an individual’s name supports a couple, and the $1.6 million transfer balance cap applies in this circumstance, rather than the cumulative $3.2 million cap.
How will the $1.6 million transfer balance cap work?
Taking effect from 1 July 2017 (although if you have more than $1.6 million in super you will need to take action well before 1 July 2017), the Coalition has introduced “a $1.6 million superannuation transfer balance cap on the total amount of superannuation that an individual can transfer into retirement phase accounts.” The cap applies to “both current retirees and to individuals yet to enter their retirement phase.”
This $1.6 million superannuation transfer balance cap will be indexed in $100,000 increments, in line with increases in the consumer price index (rate of inflation).
According to the explanatory memorandum accompanying the legislation (Chapter 1), “The value of superannuation interests that support superannuation income streams as at 30 June 2017, together with the commencement value of new superannuation income streams that start after that date, count towards an individual’s cap.
“If an individual exceeds their transfer balance cap, the Commissioner of Taxation (the Commissioner) will direct an individual’s superannuation income stream provider to commute (reduce) their retirement phase interests by the amount of the excess (including excess transfer balance earnings) to rectify the breach. The individual will also be liable for excess transfer balance tax on their excess transfer balance earnings to neutralise the benefit received from having excess capital in the earnings tax exempt retirement phase. Breaches for the 2017-18 financial year attract a single tax rate. The tax rate on excess transfer balance earnings increases for second and subsequent breaches occurring in the 2018-19 financial year or a later financial year.”
Important: Transitional arrangements will apply for existing super pensions as at 1 July 2017, if the individual is in breach of his or her transfer balance cap by less than $100,000 on 1 Jul 2017. The transitional arrangements mean that “an excess transfer balance is disregarded if it is less than $100,000, is caused by existing superannuation income streams on 30 June 2017, and the individual rectifies the breach within 6 months”.
Note: Capital gains tax relief is available for a super fund which moves an asset or assets from pension phase to accumulation phase, in order to satisfy the $1.6 million transfer balance cap rules taking effect from 1 July 2017. The CGT relief allows the cost base to be reset to market value as at 1 July 2017 (that is, the asset is deemed to be sold and repurchased at market value so the CGT rules are triggered, and only future capital gains are counted going forward). If a super fund uses the CGT relief, then the 12-month timeframe for the 33% discount also restarts. A super fund can choose not to take advantage of the CGT relief.
What is a person’s ‘transfer balance account’?
As at 1 July 2017, each individual will have a “personal transfer balance cap reflecting the total amount they can transfer to the retirement phase”, and to track this cap, each individual will have a transfer balance account. The transfer balance account is created when an individual first commences a super pension or other type of superannuation income stream.
According to the explanatory memorandum accompanying the legislation, the Australian Taxation Office (ATO) will be able to provide individuals with information “that it holds at the time” about their transfer balance account.
Note: If you fully utilise your $1.6 million transfer balance cap when moving in retirement, or fully utilise at a later date, then you cannot take advantage of the periodic $100,000 indexed increases in the transfer balance cap. If you have not fully soaked up your $1.6 million transfer cap, you can take advantage of the indexed increases to the cap, assuming of course you have the savings to do so.
What happens to Australians in pension phase before July 2017?
Note: Australians already in retirement as at 1 July 2017, and holding pension balances of more than $1.6 million will be forced to take action, to avoid excess transfer balance tax on their excess transfer balance earnings, and to avoid further tax on continued breaches of the $1.6 million cap. If you expect to fall into this category, you have two choices:
- You can transfer the excess above $1.6 million into an accumulation account within your existing super fund, or another super fund, OR
- You can withdraw the excess above $1.6 million out of the super system.
The financially disruptive consequence for current retirees is if they have more than $1.6 million in pension phase, they will need to withdraw the excess balance out of the super system, or revert the excess amount to accumulation phase by 1 July 2017. Superannuation savings in accumulation phase are subject to 15% earning tax. Subsequent earnings on the remaining $1.6 million pension balance while in pension phase, from July 2017, will not be required to be withdrawn.
Important: If you run an SMSF and you use a segregated approach for working out your exempt pension earnings on a pension asset, and the pension asset is then treated as an unsegregated asset due to complying with the transfer balance cap rules, then you may be eligible to take advantage of capital gains tax (CGT) relief, which effectively resets the cost base (as discussed earlier in this article). We will cover these complex CGT relief provisions in a later article.
RETROSPECTIVE: This measure is RETROSPECTIVE, because it applies to Australian super balances that have been accumulated in the past, under existing laws. The lack of grandfathering indicates this policy applies retrospectively.
What happens to super pension balances from 1 July 2017?
Once the transfer balance cap is applied to an existing pension balance as at 1 July 2017, or a new super pension balance from 1 July 2017, any subsequent increase in a retirement balance due to earnings, or drops in the balance due to pension payment withdrawals, are not counted towards (or deducted from) the $1.6 million transfer balance cap.
If an individual decides to commute (convert to a lump sum or revert to accumulation phase), or partially commute a super pension, then an individual’s transfer balance account will be reduced accordingly.
Note that post-July 2017 investment earnings or losses do not change the value of a person’s transfer balance account.
Important: From 1 July 2017, partial commutations of super pensions will no longer be counted towards the annual minimum pension payment requirements for super pensions, to ensure retirees don’t recycle pension payments back into the pension phase. I am not sad to see this aspect of the pension rules disappear. I never agreed with the interpretation that partially reverting a super pension to a lump sum, or into accumulation phase, would also satisfy the requirement to make a minimum annual pension payment. Moreso, the government’s main objective in banning this treatment is to stop Australians retiring before the age of 60 taking advantage of the low-rate cap for lump sum payments (the taxable component of super lump sums paid to Australians under the age of 60, but who have reached preservation age, is tax-free up to the lifetime low-rate cap of $195,000 (indexed)). I will provide more detail on how this will work in practice at later date, because I am still trying to work out the practical implications of the change to this rule.
For those have been around the super industry for a long time, like myself, you might be feeling rather flat. Have we not been here before, and did we not have a Liberal government (and have these policies supported by subsequent ALP governments) who thankfully removed this mindless complexity to save retirees stress and cost in their later years?
The explanatory memorandum pages for the $1.6 million transfer balance cap runs to roughly 70 pages, plus fact sheet, plus legislation and related materials.
As I have written many times before, using a sledgehammer on the retired population to deal with a small minority of retirees who may be receiving too much of a tax advantage from the super system is lazy policy and wastes good industry brains who now have to spend a ridiculous amount of time administering a flawed policy. What was needed were special rules to deal with the four or five thousand of Australians with many millions in super, rather than forcing this massive compliance cloud over all retirees who are just trying to live their lives.
Does the $1.6 million cap apply to each person?
Yes, the transfer balance cap applies to each person, but note that if a pension account is in one person’s name, and that account is financing the retirement of a couple, the single pension account is eligible to use only one $1.6 million cap. If a couple have 2 separate pension accounts in separate names of each member of the couple, then the $1.6 million cap applies to each pension account, potentially taking the transfer balances to $3.2 million.
What happens to the transfer balance (TB) cap, and TB account, when a person dies?
An individual’s transfer balance account only closes when the individual dies (except in the case where a child of the deceased receives a superannuation death benefit pension).
If a fund member arranges for a superannuation death benefit pension, or a reversionary pension, to be paid to a spouse when the fund member dies, then the value of the pension is added to the surviving spouse’s transfer balance account (note that it is not added to the surviving spouse’s transfer balance cap).
In the exposure draft explanatory materials supporting the draft legislation, the government decided that the surviving spouse has less than 6 months to get his or her act together to reduce the transfer balance account to within his or her transfer balance cap. In October 2016, I highlighted the hardline nature of this timeframe and challenged the Treasury boffins to lengthen the time available for reducing the transfer balance accounts to give affected widows and widowers more time to grieve! Imagine having to worry about this issue mere weeks after losing your partner. The good news is that the decision-makers listened to certain sections of the super industry and commentators like myself and extended the timeframe to 12 months for reducing the transfer balance accounts of surviving spouses, BUT ONLY FOR REVERSIONARY PENSIONS.
The payment of regular death benefit pensions (commenced after the death of the fund member), and the timeframe for dealing with reducing the transfer balance account to within his or her transfer balance cap, still remains as 6 months (or more strictly ‘as soon as practicable’, which in the past the ATO has indicated to mean within 6 months). For more information on how the transfer balance cap works when a fund member dies (including the 6-month timeframe, see SuperGuide article, Superannuation death benefits and the $1.6 million transfer balance cap.
Are defined benefit fund members affected?
The short answer is ‘yes’. According to the Coalition’s 2016 Federal Budget papers, “to broadly replicate the effect of the proposed $1.6 million transfer balance cap, pension payments over $100,000 per annum paid to members of unfunded defined benefit schemes and constitutionally protected funds providing defined pensions, will continue to be taxed at full marginal rates, however the 10 per cent tax offset will be capped at $10,000 from 1 July 2017.
“For members of funded defined benefit schemes, 50 per cent of pension amounts over $100,000 per annum will be taxed at the individual’s marginal tax rate.”
The treatment explained above is confirmed in the explanatory memorandum accompanying the legislation. The most recent information also confirms that individuals receiving defined benefit pensions only, that exceed a person’s transfer balance cap, will not mean the person has breached their cap (due to the difficulty in changing the structure of such a pension). The pension income payments derived from such pensions will be taxed at a higher rate (if income exceeds a separate defined benefit income cap) to recognise the excess capped defined benefit pension does not breach the person’s transfer balance cap.
If you receive both a defined benefit pension and an account-based super pension, and you exceed your transfer balance cap, then like the rest of the country, you will be expected to withdraw the excess from the super system, or revert the excess to accumulation phase (using the account-based pension).
If you receive a defined benefit pension, or expect to receive such a pension, I suggest you chat to your super fund about how the new rules will affect your benefit. For more information about how the new cap affects defined benefit pensions, see SuperGuide article Defined benefit pensions and the $1.6 million transfer balance cap.
Special rule applies to SMSFs and small APRA funds
If you are a member of a self-managed super fund (SMSF) or a small APRA fund, and you, or a fund member, has substantial superannuation savings then you need to be aware of a special rule that applies to small funds (SMSFs and small APRA funds). Quoting from the explanatory memorandum (Chapter 10) accompanying the new legislation:
SMSFs and small APRA funds will not be able to use the segregated method to determine their earnings tax exemption for an income year if:
- at a time during the income year, there is at least one superannuation interest in the fund that is in retirement phase; AND
- just before the start of the income year:
- a person has a total superannuation balance that exceeds $1.6 million; and
- the person is the retirement phase recipient of a superannuation income stream (whether or not the fund is the superannuation income stream provider for the superannuation income stream).
Note: Under the current rules, there is no restriction on super funds using either segregated or proportional method (subject of course to meeting the respective compliance requirements). Currently, all super funds can use either the segregated and proportional methods when calculating the amount of earnings that are tax exempt (that is, determining earnings on assets that are used to discharge current pension liabilities).
Seeking more information?
For a summary of the superannuation policy changes planned by the Coalition government, see SuperGuide article Summary: 2016 Federal Budget superannuation changes now law