Financial Planning

On 27 September 2016, the Government released the second tranche of draft superannuation legislation to give effect to some of the measures announced in the 2016/17 Federal Budget. This included the introduction of a transfer balance cap of $1.6 million, which will limit the amount that can be transferred to the pension phase of superannuation, where fund earnings are tax-free.

The limit applies per person and it’s possible for up to $3.2 million to be transferred to pensions by a couple. Modifications will apply to child account based pensions, income streams started with the proceeds of structured settlements and instances where commutations are made due to family law splits, fraud and bankruptcy.

Transfer balance cap

The transfer balance cap applies to ‘retirement phase recipients’. This is a new concept that describes a person who has commenced a superannuation income stream. A client will be a retirement phase recipient if either:

• a superannuation income stream is payable to them, or
• a deferred income stream is payable to them after a determined time.

A client must have satisfied one of the following conditions of release¹ for the income stream to be in retirement phase:

• Retirement
• Terminal medical condition
• Permanent incapacity
• Attaining age 65.

Therefore, a Transition to Retirement (TTR) income stream cannot be in ‘retirement phase’. However, once a client has satisfied one of the above conditions of release, a TTR income stream can be treated as being in retirement phase², where the transfer balance cap will apply and earnings will be tax-free.

Clients will have a transfer balance account at the later of³:

• 1 July 2017, and
• when a superannuation income stream is first commenced.

It’s important to understand when a client first has a transfer balance account, as this will determine the:

• transfer balance cap amount that will apply, and
• proportional indexation in future years (if applicable).

Transfer balance accounts will be maintained by the ATO, where credits and debits will be applied.

Credits

The transfer balance account will have credits made when an income stream commences from 1 July 2017

or if a retirement phase income stream exists at 30 June 2017. These amounts are called ‘transfer balance credits’.

Example 1

Danny, age 58, retires and commences an account based pension on 15 August 2017 with $1 million. He has no other superannuation income streams. Danny’s transfer balance cap is the cap applicable for 2017/18 of $1.6 million.

Example 2
Justin, age 65, retired in 2014/15 and started an account based pension at that time with $750,000. He has no other income streams. The account balance of Justin’s account based pension as at 30 June 2017 is $745,000. This valuation is credited against his transfer cap of $1.6 million.

Example 3
Leslie, age 62, retires in 2020/21 and commences her account based pension on 18 September 2020 with $800,000. She has not previously commenced a superannuation income stream. Leslie’s transfer balance cap is the cap applicable for 2020/21 of $1.7 million (assuming indexation).

Debits
The transfer account balance will have amounts debited, such as when a commutation is made from the income stream.

A debit will reduce the amount assessed against the client’s transfer cap balance. This ensures that amounts are not double counted, such as when the amount is rolled over to commence a new income stream with another provider.

Note: It is possible for a transfer balance account to be negative.

A debit will be added to a client’s transfer balance account if:

• a commutation is made to a lump sum and received in cash
• a commutation is made and the amount is rolled over to commence a new superannuation income stream
• a commutation is made and an amount is returned to the accumulation phase
• a contribution is made to superannuation under a structured settlement
• certain events arise, such as fraud, dishonesty or bankruptcy
• payments are split under family law
• an excess amount is transferred under a notice issued by the Commissioner.

Example 4

Nicki commences an account based pension on 11 September 2017 with $1.6 million.

In April 2019, she decides she is no longer happy with her current pension provider. She decides she will make a full commutation on 2 April 2019 and rollover to commence a new account based pension on 3 April 2019. Her account balance is now worth $1.7 million.

The commutation will trigger a debit against her transfer balance cap of $1.7 million resulting in a balance of negative $100,000.

The new pension will be assessed against her transfer balance account.

Note: Nicki does not receive an increase from the indexation of the transfer balance cap as she had already fully utilised her cap in 2017/18.

Excess transfer balance

A client has an excess transfer balance if the transfer balance account exceeds that client’s personal cap.

This will give rise to excess transfer balance tax. In the case of an excess, a client will need to:

reduce the amount held in pension phase (eg via a partial commutation), and pay excess transfer balance tax.

The excess transfer balance tax is to remove any benefit derived by having an excess amount held in the pension phase with earnings taxed at 0%.

The excess transfer balance tax is based on notional earnings. It commences to be calculated from the first day the excess amount is in retirement phase.

If the excess transfer balance tax is unpaid by the due date, the general interest charge is payable on the unpaid amount from the due date until the amount is paid.

Excess balance determination

The ATO may issue an excess transfer balance determination. A determination may not be issued by the ATO if the client has already taken action and removed their excess transfer balance. Excess transfer tax will still apply.

If a determination is issued, it will state the ‘crystallised reduction amount’. This is the amount that must be removed from the pension account.

If a client has more than one income stream, the determination will include the ability for a client to elect which income stream to have the crystallised reduction amount to be removed.

If no nomination is made, the ATO will issue commutation authorities to the client’s superannuation income stream provider to commute the excess amount.

Excess transfer balance tax

Excess transfer balance tax is payable for all days where an amount is held in the pension phase in excess of the cap. It is a tax on the individual. This tax is calculated based on notional earnings and is calculated as follows:

Excess transfer balance x notional earnings rate

The notional earnings rate is based on the General Interest Charge (GIC). It is compounded daily and the daily rate is determined as follows:

90 day bank Accepted Bill yield + 7%

Number of days in the year

Notional earnings accrue until a transfer balance determination is issued by the Commissioner. From this time, the excess transfer balance tax is payable. While this amount is unpaid, it will attract GIC.

Clients can roll out the excess amount at any time to minimise the amount of excess transfer balance tax payable.

Note: Transitional measures allow an excess transfer balance to be disregarded if it is less than $100,000, is in a pre-1 July 2017 income stream and the breach is rectified within 60 days from 1 July 2017 (ie before 31 August 2017).

Notional earnings are taxed at:

• 15% for the first breach, and
• 30% for the second and subsequent breaches.

Example 5

Leslie commences an account based pension with $2 million on 18 August 2017. This exceeds her $1.6 million transfer cap by $400,000. After 30 days, she realises her mistake and decides to make a partial commutation. The amount that must be commuted is the:

• excess amount of $400,000, plus
• notional earnings of $3,036.

The amount of $403,036 is debited against Leslie’s transfer balance account, bringing it back to $1.6 million.

As Leslie has reached her cap, she cannot have any further amounts added to the pension phase. The notional earnings will be taxed at 15%.

Example 6

Leslie from example 5 does not identify the excess herself. Information is provided to the ATO which makes a determination 60 days after the income stream started.

Sixty-five days after issuing the determination, the ATO issues a commutation authority, which is actioned by the super fund 10 days later.

Notional earnings are determined as follows:

The notional earnings on the original excess is determined via the formula and compounded daily. From the date of the determination, GIC is applied to the excess amount plus notional earnings using the simple interest formula.

The total notional earnings of $13,828 are taxed at 15%, as this is Leslie’s first breach.