There are several key differences between a partial commutation and a
full commutation that make distinguishing between the two extremely important.
Firstly, when a pension is fully commuted, the law requires the member to draw at least a pro-rated minimum payment first. If instead the pension is only partially commuted (ie a balance remains in the pension account after the commutation), there is no requirement to take this pension payment upfront. Rather, the requirement for a partial commutation is that the amount left over after the commutation is enough to allow the pensioner to meet the full year’s minimum payment requirements. For example, if the pensioner had already drawn half the year’s minimum payments the amount remaining after the partial commutation would need to be at least enough to cover the remaining half.
Secondly, if the pension is only partially commuted, the trustee must ensure that a full year’s minimum pension is paid even though the balance remaining may be much smaller. If this is not done, the pension will fail the minimum payment requirements. Depending on the size of the shortfall and whether the fund has used a special rule to overlook small shortfalls in the past, the pension might lose its tax exemption on investment income (ECPI) for the whole year and a range of other consequences. This is not required if a pension is fully commuted as the obligations to make payments end with the pension – hence the requirement (described above) to make a pro-rated minimum payment first.
Finally, when a pension is fully commuted, it ends for ECPI purposes as soon as:
- the member makes a valid request to commute, and
- the trustee agrees to do so
By definition this will be before the payment is made.
This can have some extremely important consequences for ECPI in a fund that is entirely in pension phase and using the “segregated method” [ITAA 1997 s.295-385] to claim its exemption. A full commutation will mean the fund stops being entirely in pension phase and has a short period (potentially only days) where the actuarial method applies for determining ECPI. When the commutation is (say) an in specie transfer, this will occur precisely when the capital gains are realised.
Ted and Tia both have a $1m account-based pension (70% tax free component) and Tia has a second account-based pension of $500,000 (nil% tax free component). They want to transfer a property out of their fund in specie and it is worth $600,000.
They decide to do so by:
- fully commuting Tia’s second pension after making the required pro-rated minimum payment first (let’s say this is $25,000), and
- partially commuting Tia’s first pension.However, fully commuting Tia’s pension means that for a short while, the fund has $475,000 in accumulation phase in a fund worth nearly $2.5m. And it’s at that time the capital gain on disposing of the property is realised.
Hence at least some of the capital gain will be subject to tax.
A partial commutation is entirely different. It does not cause the pension to end and in fact the payment itself is specifically defined as being a superannuation income stream benefit (a pension payment) exclusively for ECPI purposes. If Ted and Tia had treated the in specie transfer of the property as two partial commutations (one from each of Tia’s pensions), the fund would remain segregated throughout the year and the capital gain would be entirely disregarded.
This is one of the reasons the special documentation we prepare to record a client’s decisions to treat payments from their fund in a particular order (see our blog here ) is very specifically worded to ensure that no payments ever result in a full commutation of the pension. We deliberately ensure that even very large payments from a particular pension are treated as partial commutations to avoid the risk that a full commutation will create unintended ECPI consequences.
To stay informed on changes to rules and legislation subscribe to our Super Companion. It's our go-to online resource and knowledge centre – we use it internally to support our staff as they navigate SMSF accounting and compliance for our clients. It's so good that we've opened it up for all – find out more and sign up here.