Prior to the calling of the Federal election and the dissolution of Parliament, a legislative instrument was registered that allows the commutation of certain income stream products that commenced on or after 1 July 2017 to the extent an individual has exceeded their personal transfer balance cap. From an SMSF perspective, the new SIS regulations will allow a member to commute their market linked income stream (MLIS) (also known as a ‘term allocated pension’) to the extent of an excess transfer balance account amount included in a commutation authority. However, this new measure will only apply to an MLIS commenced on or after 1 July 2017.
Why did we need this legislative fix?
An MLIS can only be commenced from the commutation of an existing ‘complying pension’, being a lifetime pension per SIS reg 1.06(2); a life expectancy pension per SIS reg 1.06(7) or a MLIS per SIS reg 1.06(8). The first two pensions and generally the MLIS would have been commenced prior to 1 July 2017 and consequently were ‘capped defined benefit income streams’ (CDBIS) and subject to special transfer balance cap (TBC) rules and to the defined benefit income cap, currently $106,250. Where the annual pension amount for a CDBIS exceeds the defined benefit income cap, 50% of the excess is fully assessable and taxed at the individual’s marginal tax rate, regardless of the member’s age or the tax components of the pension.
A restructure strategy involves a full commutation of the CDBIS with the commuted amount used to commence an MLIS. Depending on the particular circumstances, such a restructure strategy provides potential estate planning and/or tax benefits. A commutation of a CDBIS and the commencement of an MLIS are both Transfer Balance Account (TBA) that will give rise to TBA debits and credits.
It has been common for this restructure strategy to be put on hold where it is expected that the TBA debits and credits give rise to an excess TBA amount. Where the only pension was the post 30 June 2017 non-CDBISMLIS, the excess TBA amount could not be commuted and consequently the excess TBA amount could not be rectified. This is due to the post 30 June 2017 non-CDBIS MLIS also being a non-commutable income stream.
The Federal Government announced as part of its December 2020 Mid-Year Economic and Fiscal Outlook (MYEFO) that it would amend the law to ensure that in such a scenario an affected member would be able to undertake the necessary partial commutation. We now have the relevant amendment to allow a partial commutation of a post 30 June 2017 SMSF non-CDBIS MLIS.
Where an SMSF member has commenced an MLIS on or after 30 June 2017 and it results in an excess TBA amount, the legislative instrument will effectively allow the member to commute the MLIS to the extent of the excess amount notified in a commutation authority issued by the ATO. The commuted amount can be paid out of the fund as a lump sum benefit or retained in the member’s accumulation interest. Depending on their TBC space, it could also be used to commence a new retirement phase account-based pension (ABP).
Let’s consider the example from the Explanatory Statement to the legislative instrument:
On 1 July 2018 Steven purchased a market linked pension (the credit) directly from the lump sum resulting from a commutation of his CDBIS life-expectancy pension (the debit). As his new market-linked pension commenced after 1 July 2017, it was not classified as a CDBIS for transfer balance cap purposes.
Under the Regulations, the debit and credit for this commutation and commencement will arise in his transfer balance account on the date the Regulations commence. The debit arises prior to the transfer balance credit.
Steven will then have an excess transfer balance amount that he would have been unable to resolve if it arose before the commencement of the Regulations.
Steven will then receive a determination of his excess transfer balance amount. The excess transfer balance amount on the determination will be the amount that exceeds Steven’s personal transfer balance cap and the deemed earnings that accrue after the Regulations commence. Steven will not have accrued any transfer balance credits for deemed earnings between 1 July 2018 and the commencement of the Regulations.
A commutation authority will enable Steven to commute the excess amount as a lump sum from his market-linked pension to an account in the accumulation phase, where it can be retained or be paid out as a lump sum.