One of the more crazy elements of the 1 July 2017 superannuation changes was the treatment of market linked pensions.
Recent press articles have highlighted that there is a problem without necessarily explaining what it is. The key lies in understanding how amounts are added to or subtracted from the Transfer Balance Account for these pensions.
Instead of just valuing these at an amount equal to the account balance for Transfer Balance Account purposes, the legislation provides a formula. The formula is more or less:
- Work out the “next” payment due from that pension
- Annualise it (eg if it’s $3,000 per fortnight, multiply $3,000 by 365/14)
- Multiply that annualised amount by the number of years the pension has left to run (because remember market linked pensions last for a specific number of years, the annual payments are worked out so that the final year’s payment is 100% of the remaining balance).
This doesn’t make sense on a number of levels:
- There’s an account balance which is the absolute maximum the member can ever get out of this pension – what is the logic for using anything else?
- There’s no such thing as a fixed “next payment” from these pensions. They are more flexible than (say) defined benefit pensions where the payments are often fixed and defined as (say) $3,000 per fortnight or $6,000 per month etc. So how should one determine that next payment? Presumably it’s “whatever actually gets paid”. But then, how do we work out the period to which that relates? If there’s no requirement to take payments at a fixed frequency such as fortnightly or monthly, how do we annualise the “next” payment.
(And it’s almost as if Treasury realised this at the last minute because market linked pensions are valued using their account balance for Total Superannuation Balance purposes. What a shame no-one told the people writing the Transfer Balance Cap provisions.)
But an even worse problem is now receiving significant press coverage (at last).
Not surprisingly these pensions change sometimes – if a member transfers from one fund to another, their market linked pension is technically fully commuted (stopped) and then re-started in the new fund.
There are a range of problematic issues with re-starting the pension but this article just focusses on the first step – stopping the old pension.
It would be reasonable to assume that the formula used to add this pension to the Transfer Balance Account in the first place would also work to reduce this when the pension is fully commuted (although a new amount would be added when the pension started again in the new fund).
However, the wording in the law is sufficiently vague that two camps have emerged:
- View 1 (of which I’m a member) says : the formula involves calculating the value of the pension “just before” a commutation amount is paid. If you’re calculating something “just before” a key date, you should do the calculation as if that event (in this case the commutation) wasn’t happening. This would mean the calculation would be based on whatever the “next payment” would have been if the pension hadn’t been commuted (with all the problems that entails, there would at least be an amount to calculate!);
- View 2 says : while the formula does involve calculating the value of the pension “just before” a commutation amount is paid, the formula used to do this depends on a “next payment”. If this pension is fully commuted, there will never be a next payment. In other words, it will be $nil and so will the commutation value for the purposes of this Transfer Balance Account. That is, the commutation of the pension would not result in any reduction in the amount counted towards the Transfer Balance Cap. That’s clearly crazy since the new pension that starts in its place will add more to the Transfer Balance Account. This view would see the same money being counted twice for anyone who changes their market linked pension on or after 1 July 2017..
The example provided in the Explanatory Memorandum to the legislation ignores a number of practical problems but is at least consistent with View 1. (And probably all parties would agree that that this is surely what the lawmakers intended to achieve.)
However, even the EM is ultimately subject to the law and there is enough ambiguity for plenty of people who have carefully considered this law to land at View 2.
It would seem that the ATO’s position is that we need a legislative change to resolve this issue which puts the job firmly in the lap of Treasury.
Many industry participants have already identified this and explained the problem to Treasury and the recent publicity will hopefully expedite their consideration of it.
For now, the safest approach for those close to or over the $1.6m Transfer Balance Cap would be to leave market linked pensions untouched. Those who have already made the change might receive an assessment from the ATO under View 2 although hopefully they will hold off doing so until the issue is resolved. Clearly the current position cannot continue.