Amid the confusion surrounding the $1.6 million transfer balance cap on super pensions, and the short timeframes available to comply with this change (which took effect from July 2017), a small but important loophole was missed by the super experts, and continues to be ignored by the superannuation lobby groups, and more importantly, by the politicians themselves.
Many ex-politicians and most retired senior bureaucrats, who are aged under 60, will benefit from a loophole in the super tax rules which took effect from 1 July 2017. Current politicians who were elected before 2004, and who retire before the age of 60, will also benefit from the super loophole.
Current long-term senior bureaucrats, including public servants who advised the federal government on the super changes, are also likely to benefit from the loophole. Retired senior executives from large companies may also reap the benefit of this loophole, if they are under the age of 60.
What is the super loophole that favours only pollies and senior public servants?
The super loophole operates as follows: If an ex-politician or retired senior public servant receives a lifetime defined benefit pension from a public sector super fund (in the case of a politician the super fund is the Parliamentary Contributory Superannuation Scheme), and he is not also a recipient of a super pension from another super fund, and he is under the age of 60, then he will not be affected by the $1.6 million transfer balance cap rules for the time he is under the age of 60.
What this means in practical terms is that these politicians and public servants will pay less tax on their super benefits than other Australians receiving payments from super pensions.
All sitting politicians elected before 2004 belong to the Parliamentary Contributory Superannuation Scheme, and will be eligible for a defined benefit lifetime pension exceeding the equivalent of the $1.6 million transfer balance cap. If such a politician retires, or is voted out, before the age of 60 (or has to leave for other reasons), and he receives the DB lifetime pension only, then there will be no tax consequences for the politician in relation to the $1.6 million transfer balance cap. Even though the value of his defined benefit pension will be greater than $100,000 a year (and 16 times $100,000 means he has exceeded the $1.6 million transfer balance cap), he will have no administrative or financial consequences until he turns 60.
The loophole arises because the government has imposed extra tax on the benefit payments from defined benefit lifetime pensions received by Australians aged 60 years or over. Such pensions are received by retired politicians (elected before 2004), and older public servants, and in some cases, retired company executives. No financial consequences have been imposed on retired (or future retired) politicians or retired (or future retired) public servants who exceed the $1.6 million transfer balance cap, and are under the age of 60.
In contrast, all other Australians receiving super pensions under the age of 60, and with more than $1.6 million in retirement phase, are forced to deal with the $1.6 million transfer balance cap. All other Australians who in the future intend to start a super pension before the age of 60, will not be permitted to have more than $1.6 million in retirement phase, unlike our long-term politicians and long-term senior public servants.
Politicians, due to the vagaries of federal elections, often retire from politics well before the age of 60, and accordingly, will not be hit with the consequences of the $1.6 million transfer balance cap until they turn 60. Likewise, senior bureaucrats who retire before the age of 60, and receive a lifetime DB pension will not have to deal with the $1.6 million cap, and the additional tax on pension payments, until they turn 60.
According to an ATO spokesperson, “Individuals who only receive personal capped defined benefit income streams… will not experience tax consequences under the new rules until they turn 60.”
The spokesperson also said, that “while the majority of new tax consequences impact capped defined benefit income recipients aged over 60, there are limited situations where consequences can apply before recipients reach this age. This will occur when an individual receives a reversionary income stream where the deceased was aged over 60.”
In a time when travel rorts are rife, and controversial expense claims are commonplace, the politicians and senior advisers who created such a super loophole (even if unintended), have also created a political embarrassment.
How does the $1.6 million transfer balance cap work?
- For all Australians (except senior politicians and senior bureaucrats and some retired senior executives from large companies), if you had more than $1.6 million in pension phase before July 2017, then you must move the excess into an accumulation phase account, or withdraw the money from the super system.
- If a person is receiving a defined benefit lifetime pension AND the person is also receiving payments from an account-based pension that in total exceeds $1.6 million, then, he or she must have moved the excess from the account-based pension into an accumulation phase account, or withdrawn the money from the super system.
- If a person is solely receiving a defined benefit lifetime pension, and no other type of super pension, and the annual value of the benefit payments x 16 exceeds $1.6 million, then it is not possible to move money out of such a pension account. Instead, if the person is aged 60 years or over, he or she will pay extra tax on the benefit payments (for how this works see the ATO extract below).
- If a person is solely receiving a defined benefit lifetime pension, and no other type of super pension, and the annual value of the benefit payments x 16 exceeds $1.6 million, and the person is UNDER the age of 60, then there are NO tax consequences until the person turns 60.
Note: Any politician elected after 2004, does not benefit from the super loophole enjoyed by longer-term politicians and senior public servants, and retired senior executives of companies.
One rule for the politicians and senior public servants, and another rule for the rest of the Australian population – not a good look!
For general information on how the $1.6 million transfer balance cap applies to the defined benefit pensions, see SuperGuide article Defined benefit pensions and the $1.6 million transfer balance cap, and for more general information on the cap, see SuperGuide article Retirement phase: A super guide to the $1.6 million transfer balance cap .
What does the ATO have to say about this super loophole?
A spokesperson from the ATO provided the following explanation on how the $1.6 million transfer balance cap applies to non-commutable (unable to be cashed out) defined benefit income streams, and the fact that there are no tax consequences for recipients under the age of 60. See shaded box below. The underlined text has been underlined by SuperGuide.
Capped defined benefit income streams
The transfer balance cap makes certain modifications for ‘capped defined benefit income streams’. Note that there are specific legislative requirements that must be met for an income stream to be a capped defined benefit income stream. The table in subsection 294-130(1) of the ITAA 1997 lists those income streams.
Broadly speaking, as capped defined income streams are subject to commutation restrictions, they will be subject to additional tax consequences if their value exceeds the transfer balance cap.
The taxation that applies will depend on the components that make up the superannuation income stream and the value of that income. This is because superannuation funds may pay their members income streams which contain a combination of tax-free and taxable (taxed and untaxed) components. Additionally, the income will be subject to a ‘defined benefit income cap’, which is set at $100,000 for the 2017-18 year and will increase in line with the general transfer balance cap.
Taxed and untaxed income streams
From 1 July 2017, a recipient who is aged over 60 of a ‘funded’ capped defined benefit income stream that contains only a:
- tax-free component, and
- taxed element (of the taxable component)
will have their income up to the defined benefit income cap treated as tax-free.
If their income exceeds the defined benefit income cap, 50% of the combined ‘tax-free’ and ‘taxed element’ amounts that exceed the annual threshold will be counted towards the recipient’s assessable income and taxed at the individual’s marginal tax rate.
From 1 July 2017, a recipient aged over 60 of an ‘unfunded’ capped defined benefit income stream that contains only an:
- untaxed element (of the taxable component)
will continue be taxed at marginal rates, for amounts both below and above the defined benefit income cap.
However, the available 10% superannuation income stream offset will be reduced by 10% of the amount of the capped defined benefit income stream that exceeds the defined benefit income cap. This essentially means that the 10% tax offset will be capped at $10,000 from 1 July 2017.
Combination of taxed and untaxed elements
Where capped defined benefit income stream recipients receive a mixture of the above components, any tax-free component and taxed element is counted first (stacked) before including the untaxed element in making taxation calculations.
- aged 68 and retired
- receives $160,000 from a pension that is a capped defined benefit income stream in 2017-18 financial year
- pension is partially funded and unfunded
- pension includes:
- $100,000 untaxed element
- $40,000 taxed element
- $20,000 tax-free component
Khoi’s pension exceeds the $100,000 defined benefit income cap of $100,000 by $60,000.
The taxable and tax-free components ($60,000) are counted towards the defined benefit income cap of $100,000 first. As this amount does not exceed $100,000, he will not have any additional income included in his assessable income.
Khoi lodges his income tax return and includes the amount of the untaxed element in his assessable income (this is exactly the same as what happens prior to 1 July 2017). As the total pension ($160,000) exceeds the defined benefit income cap, Khoi will not be eligible for a 10% offset on the $60,000 excess. He will only be eligible for a $4,000 tax offset (10% of $40,000).
Impact on recipients under-60
While the majority of new tax consequences impact capped defined benefit income recipients aged over 60, there are limited situations where consequences can apply before recipients reach this age. This will occur when an individual receives a reversionary income stream where the deceased was aged over 60.
Individuals who only receive personal capped defined benefit income streams in their own right (i.e. not a reversionary income stream) will not experience tax consequences under the new rules until they turn 60.
For more information…
For more general information about the $1.6 million transfer balance cap, see the following SuperGuide articles: