David Barrett looks at what financial advisers need to understand now that the TTR changes come into place.
It’s not long now until the kick off of the superannuation reform measures on 1 July 2017, so it’s important to think about a number of timing issues with transition-to-retirement (TTR) pensions.
Recent developments have provided welcome clarity on previously uncertain issues. There has been contention about the treatment of a TTR pension where a member meets certain conditions of release (CORs). For example, where a member retires, does their TTR pension automatically convert into an ordinary account-based pension?
Another key development is the application of the super reform transitional capital gains tax (CGT) relief measures to TTR pensions. Where at one stage it appeared that TTR pensions might need to be commuted prior to 1 July 2017 to access the CGT relief, that action now appears to be unnecessary.
Both these issues have been addressed in a bill which was recently passed by Parliament.
Retirement phase income stream
The concept of a ‘retirement phase income stream’ is an important feature of the post-super reform regime because only retirement phase income streams will be:
Assessed against the $1.6 million transfer balance cap; and
Tax exempt (that is, income from assets supporting these income streams will generally be tax exempt).
It’s important for financial services professionals to understand how TTR pensions fit in with the retirement phase income stream concept.
Effect of a COR on a TTR pension
The Australian Taxation Office (ATO) and the Treasury have confirmed that once an income stream is commenced as a TTR pension, it remains a TTR pension regardless of whether a member has met a subsequent COR, including attaining age 65.
The impact of meeting a nil cashing restriction COR is the restrictions associated with TTR pensions (10 per cent limit on maximum pension payments per annum and cash commutation limitations) are removed.
In the pre-super reform era, the resultant TTR pension is operationally identical to an ordinary account-based pension, so there was no issue in the distinction between the two different types of income streams.
The 1 July 2017 super reform measures (which became law on 29 November 2016) mean that the distinction has become important as the original definition of retirement phase income stream specifically excluded TTR pensions. This meant that all TTR pensions, including those where the member had met a nil cashing restriction COR, would be taxable from 1 July 2017 and would not be assessed against the $1.6 million transfer balance cap.
The good news is that the Treasury Laws Amendment (2017 Measures No. 2) Act 20170 (‘Amending Act’), which was recently passed by Parliament, addresses the issue.
Meeting certain CORs (retirement, permanent incapacity, terminal medical condition and attaining age 65) may result in a TTR pension becoming a retirement phase income stream.
If the requirements are met before 1 July 2017, the TTR pension will be a retirement phase income stream effective from 1 July 2017.
Where the relevant COR is attaining age 65, there will be no need for action or notification from the member – the TTR pension will automatically become a retirement phase income stream.
If either of the other three CORs (retirement, permanent incapacity, and terminal medical condition) are met, the member is required to notify the trustee of the COR before the TTR pension can become a retirement phase income stream.
The Amending Act removes the need to commute a TTR pension and commence an ordinary account-based pension to achieve assessment against the transfer balance cap and maintain the pension’s tax exempt status. This is a positive development for financial services professionals and their clients as it reduces the advice requirement and administrative burden that may have resulted.
CGT relief and TTR pensions
A second issue addressed by the Amending Act is the application of the transitional CGT relief to certain TTR pensions not previously covered by the laws enacted on 29 November 2016. As a result there will be consistent application of the CGT relief to TTR pensions regardless of whether a TTR pension is (or was) commuted prior to 1 July 2017 or continues to run into the 2017/18 income year, and regardless of whether the super fund uses the segregated or proportionate method for calculating its exempt current pension income (ECPI).
This is also good news for financial services professionals as it’s no longer necessary to commute a TTR pension prior to 1 July 2017 purely for CGT relief purposes. Financial services professionals can instead base their recommendation to commute (or not) a TTR pension on the more fundamental issue of the client’s cashflow needs.
Table 1 summarises some of the issues for TTR pension clients.
COR notification timing
As mentioned, where a relevant COR (retirement, permanent incapacity and terminal medical condition) has been met, the change of status to a retirement phase income stream will not occur until the super fund trustee has been notified.
Table 1 shows where a relevant COR has been met and notified, the CGT relief will be available only in consequence of complying with the $1.6 million transfer balance cap.
If the member is not required to comply with the cap because they have less than $1.6 million in retirement phase income stream balances (for example, their only interest is a TTR pension valued at $800,000), then no CGT relief will be available. This may not be a negative issue as the tax exempt status of the TTR pension will continue after 30 June 2017, and any subsequently realised capital gains will be broadly taxable on a similar basis as prior to 1 July 2017.
However, if trustee notification of the COR occurs after 30 June 2017, the CGT relief may be available. This may result in positive benefits in the self-managed super fund (SMSF) context, where changes to the exempt current pension income (ECPI) calculation method and ECPI percentage of the fund, as super entitlements grow, can impact on the potential CGT liability.
TTR pension commutation timing
Commuting an existing TTR pension prior to 1 July 2017 will, from the date of commutation, result in income attributable to the assets previously backing the pension being subject to tax.
If those assets include managed funds and other trust interests, it’s possible that distributions will be declared on 30 June 2017. Those distributions will generally be taxable if the TTR pension is commuted prior to the date of declaration.
Depending on the amount of trust distributions, it may be preferable to defer commutation until after 30 June 2017.
Note also that the super law requires payment of a pro-rated minimum pension prior to full commutation. As the pro-rated minimum pension payment is based on the proportion of elapsed days to total days in the income year, the longer the commutation is delayed, the greater the amount that must be paid out of the super system. Commuting the pension as soon as possible after 30 June 2017 will reduce the impact of this pro-rated minimum pension payment.
For these reasons, commutation of a TTR pension on 1 July 2017 may be preferred in some circumstances, but other factors may impact on the timing.
The amendments in the Treasury Laws Amendment (2017 Measures No. 2) Act 2017 are positives for financial services professionals with TTR pension clients, as they:
- Remove the burden of commuting TTR pensions and commencing an ordinary account-based pension once a relevant COR has been met; and
- Ensure a consistent application of the CGT relief to TTR pensions.
Now that the Amending Act has been passed by Parliament, financial services professionals can proceed with more focussed advice for their TTR pension clients.
David Barrett is head of technical services at Macquarie Group.