Legacy pension relief for SMSFs

Why the need for change?

Legacy (complying) pensions were introduced and used as a way to maximise the pension recipient’s social security benefits and later as a way to address newer laws around reasonable benefit limits.

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This was achieved by placing tight restrictions on payment amounts that can be made each year to ensure the longevity of the pension. These pensions were often established for a defined and long-term period.

There were also further restrictions on stopping these pensions, and certain “liquidity and reserve” measures imposed on super funds that paid these types of pensions to members.

As newer and simpler types of pensions have been introduced into the market over the years, these older complying pensions have become harder to manage, especially for the SMSF market.

Many SMSF members have expressed a wish to stop their older legacy pensions and move their benefits into an easier to manage and less restrictive pension.

However, due to the restrictions mentioned above, and the often-significant tax and social security outcomes, this has not been possible, until now.

The changes that have now come into effect will assist to modernise retirement income streams and allow more flexibility to super fund members who were previously “stuck” in outdated retirement products.

What has actually changed

The first change is to relax the commutation restrictions that apply specifically to these types of pensions. This now allows members to exit their existing legacy pension without the nasty tax penalties that previously applied.

The super fund member can then either use the pension proceeds to start a new account-based pension, leave the proceeds in the accumulation phase or even withdraw these amounts from the superannuation system.

There is however a strict five-year period, starting on the 7^th December 2024 for these changes to be carried out.

Keep in mind that super fund members will still be subject to the usual constraints imposed by their transfer balance cap. So, take care and seek professional advice if required.

The other key change relates to the treatment of “fund reserves”. SMSF fund reserves are amounts that must be held separate to the member’s overall individual benefits within the fund. They act as a “buffer” where the SMSF is paying a complying pension or income stream. In years of strong performance where investment returns outweigh the required annual pension payments, investment returns may need to be allocated into these fund “reserves” to cover later years where performance is not as strong. This is usually carried out using the services of an actuary.

Where a super fund member wants to stop their complying pension, they would usually need to deal with these fund reserves at the same time, which often created significant contribution cap issues based on the old rules and regulations. However, with the passing of the new regulations, allocations from fund reserves as a result of commuting a legacy pension product will now be exempt from both the concessional and non-concessional contributions caps.

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Social security recipients

Complying pensions receive favourable treatment for social security assessment purposes.

If a complying pension ceases and the balance is moved into another pension type or left in accumulation or even withdrawn from the superannuation system, it could possibly affect your benefits.

It is important to have a clear understanding of what these changes mean to you, so you should seek advice or contact Services Australia for more information.

The bottom line

For SMSF members looking to benefit from these proposals, consider sitting down with a superannuation advisor or contact your SMSF service provider to see what you may need to do and to ensure that your personal circumstances are considered.

For SMSF members who have wanted to wind up their SMSF but have been restricted from doing so due to what were unfavourable outcomes from commuting a complying pension, these changes may now be your avenue to wind up.