Holders of a market linked pension (sometimes known as a term allocated pension) and/or a complying life expectancy pension will be pleased to hear that a resolution may be in sight to correct a technical problem that has effectively resulted in it being unwise to commute one of these income streams.
Treasury Laws Amendment (2019 Measures No.3) Bill 2019 was introduced on 5th December which if passed will ensure that there is a debit to a member’s transfer balance account if the pension is commuted. Importantly, the bill has only been tabled - not passed - so at the time of writing is not law.
Note that the proposed amendments apply to both market linked pensions and complying life expectancy pensions, however in this blog I am concentrating on market linked pensions for the sake of simplicity. It would be rare for a member to seek to commute a complying life expectancy pension due to the nature of the pension.
What is the problem?
Under current law, a market linked pension that commenced prior to 1 July 2017 is considered a “capped defined benefit income stream”, and the “value” of the pension for the purposes of the transfer balance cap is derived from a formula, rather than the amount of the underlying assets. If this value exceeds $1.6m, special rules apply to ensure that the member does not exceed their transfer balance cap so long as the member does not have any other retirement phase income streams.
Sometimes a member might wish to restart a market linked pension, either in the same fund or by rolling to a new fund. There are several reasons for doing this, including to reset the term (and therefore change the pension amounts), or to add or remove a reversionary beneficiary, or simply just to move to a different provider, perhaps wishing to wind up their SMSF.
Restarting a market-linked pension, of course, requires it to be commuted first.
There is currently a “flaw” in the law when it comes to the calculating the value of the debit that would arise against the transfer balance cap when a market linked pension is commuted – resulting in a $Nil debit.
When the new market linked pension commences on or after 1 July 2017, it is no longer a “capped defined benefit income stream” subject to the special formula for determining the credit to the transfer balance account. The credit is calculated in the same way as for account-based pensions.
The member now has two transfer balance credits from essentially the one pension (one on 1 July 2017, and one when the new market linked pension commenced) with no debits to offset, effectively having the pension roughly double counted and risking the member breaching their transfer balance cap.
Furthermore, as the new market linked pension is no longer a capped defined benefit income stream, if the transfer balance account exceeds $1.6m, there are no longer any special rules applying that prevents the member from exceeding their transfer balance cap. As market linked pensions cannot be commuted and either rolled back to accumulation phase or paid out as a lump sum, there is currently no means of removing any excess.
The Proposed Amendment
If passed, the bill provides a method for calculating the debit value of a pre-1 July 2017 market linked or complying life expectancy pension that is commuted. If fully commuted, the debit value would be:
Original “credit” for the pension, less
- Amount of any other
“debits” in relation to the pension, other than debits due to payment
splits following a relationship breakdown (usually nil in practice), less
- In years prior to the
commutation, total of actual payments drawn (ie pension payments) after 1
July 2017, less
- In the year of commutation,
the greater of:
- Pension payments actually
drawn that year, or
- The pro-rated minimum
amount required to be paid prior to the commutation taking place.
The debit value is not related to the commutation value at all – they are quite different. The commutation value of a market linked pension is, of course, the account balance and for a life expectancy pension, the commutation value is determined using a formula.
Whether or not this amendment – assuming it passes – will be of use to holders of these pensions will be a matter of doing the numbers on an individual basis.
Our initial analysis tells us that it may be useful for those with pension balances below the $1.6m transfer balance cap.
However, for much larger pension balances, ie those that were large at 1 July 2017 or those that have grown since, the proposed debit value may not prove adequate to allow the pension to be commuted and restarted without adverse transfer balance cap consequences.
We will provide further analysis once the bill becomes law. In the meantime, please contact our technical team if you have a situation you would like to discuss.