5 tips when fully commuting a pension

Starting pensions is the main game in an SMSF but they are often also commuted (stopped). The driver might be a desire to move to another superannuation fund, combine the pension with new contributions or just stop getting so much income from super.

Firstly (Tip 1), any time a pension stops mid year, it’s important to make sure pension payments are up to date. There’s a formula for this purpose but very broadly speaking, if a market linked, account-based or a transition to retirement pension is commuted half way through the year, then half of the year’s minimum payments must be made first. Don’t forget that a partial commutation made earlier in the year won’t count.

Exempt current pension income (ECPI) can also be a trap for full commutations (Tip 2). When a pension is fully commuted, it stops being in pension phase and therefore stops giving the fund ECPI. That might not matter. For example, if the fund is claiming its tax exemption via an actuarial certificate, a full commutation that’s for a very short time (because – say – the money is quickly transferred out to another fund or paid to the member) will have very little impact on the actuarial percentage. But it can be disastrous if the fund is using the “segregated method” for claiming its tax exemption. 

Under this method the fund will stop being entirely in pension phase as soon as the trustee agrees to the commutation. Income after that time won’t be entirely tax free. But this might be when all fund assets are sold to pay out the member or transfer to a new fund. In other words, it might be exactly the wrong time to be paying tax! There are solutions here – sell the assets before formally commuting the pension.  Or use a combination of partial and full commutations if this can’t be done, for example, if the assets are being transferred in specie. (For more on how this works, see our blog here on partial commutations)

Tip 3 - tread very carefully when commuting pensions that started before 1 January 2015!  Account-based pensions before that time were completely ignored for the Commonwealth Seniors Health Card (CSHC). Since this card has no assets test, the generous income test treatment means even people with very large super balances might have access to this card. The rules were changed in 2015 and a deemed income amount is included for any new pensions after this time. Even simply changing funds or stopping a pension to combine it with new contributions could mean losing access to the card. That’s because both involve using the money to start a new – post 1 January 2015 – pension.

Don’t forget to report the commutation to the ATO by preparing a Transfer Balance Account Report (TBAR), Tip 4. For SMSFs, the frequency of reporting (quarterly or annually) will have been set way back when the fund had its first reportable event (eg the pension starting or 1 July 2017 if it was already in place). But even if the fund isn’t required to report the commutation until it prepares its SMSF Annual Return it may make sense to bring it forward. Someone with a largeish balance who is, for example, winding up their pension to transfer it to another fund is often well advised to make sure the SMSF’s reporting precedes the new fund’s reporting. Otherwise the money will be double counted and the member will potentially be initially assessed as having an excess in their transfer balance account.

And finally (Tip 5), remember that some pensions can’t be commuted without special care. For example, a complying lifetime pension can only be commuted if it’s being converted to a market linked pension or a life office annuity-style product. An existing market linked pension can’t be commuted unless it’s moved to another market linked pension. A transition to retirement income stream, for example, generally can’t be commuted and paid out to the member – although it can be transferred to another fund or another pension. Importantly, not all commutations are created equally.

Some of these tips also apply to partial commutations but they might be more nuanced and there are a whole lot of others to consider – we’ve covered these separately here. And some of the rules are different when it comes to commuting pensions that have been inherited because someone else has died. That will be covered in a future article!

The ability to fully commute a pension is hugely valuable and it pays to understand the rules. The ins and outs of pension commutations are covered in our online encyclopedia of superannuation the Super Companion. Subscribe now or book a free demo.