In this blog we discuss the options available to members (and their advisers) who have a complying defined benefit pension in their SMSF and find they are required to change this arrangement.
Importantly, complying defined benefit income streams are non-commutable except to rollover to another complying income stream (or in other limited circumstances defined in legislation, such as a divorce settlement payment).
From a Centrelink and Department of Veterans (DVA) perspective, complying defined benefit pensions paid to a member in an SMSF are eligible for 100% Asset Test Exemption (ATE) if they were commenced prior to 20 September 2004 or 50% ATE if commenced between 20 September 2004 and 31 December 2005. The ATE means that the value of the assets supporting the income stream are not assessed under the Assets Test means testing when determining Centrelink/DVA entitlements. Retaining the ATE might be an important consideration for those retirees receiving a part or full age pension.
A condition of retaining the ATE is that an actuarial certificate is obtained each year stating that, in the opinion of the actuary, there is a high probability (i.e. greater than 70%) that there are sufficient assets in the fund to be able to pay the required future benefits. Under the Social Security Act 1991, trustees are required to obtain these certificates by 29 December and submit to Centrelink/DVA by 19 January each year.
Options for commuting existing complying defined benefit pensions
There are two key options available to members who wish to commute their existing complying pensions.
Option 1: Commute to a retail complying annuity
If the complying pension is 100% ATE and retaining the ATE is a key priority for the SMSF member, the trustee could roll out the assets supporting the defined benefit pension to purchase a complying annuity with a life office. As the ATE is retained, this option minimises the impact on the member’s age pension entitlements.
A complying annuity provides an income stream for the person’s lifetime or fixed term, and is held in the individual’s name outside the SMSF. To meet the requirements of being a complying pension, the annuity must be non-commutable. However, a benefit may be available on the death of the member (generally equal to the present value of the remaining payments). The complying annuity may also be an attractive option for those members in the pension phase who no longer want or are able to deal the administrative complexity of running an SMSF.
It is important to consult with Centrelink/DVA to ensure the proposed complying annuity satisfies the requirements to retain the ATE.
Option 2: Commute to a market linked pension (TAP)
A market linked pension is the only type of complying pension that can be commenced in an SMSF. Commuting the existing complying pension into a market linked pension would allow the member to retain the assets within the SMSF.
For more information on market linked pensions refer to Accurium’s technical article ‘Understanding Market Linked Pensions’.
Whether the new market linked pension will retain the original pension’s ATE status will depend on the commencement date of the existing pension. Please refer to the flow charts for more information.
It is important to consult with Centrelink/DVA to ensure the new market-linked pension satisfies the ‘waiver of debt’ provisions and any requirements to retain ATE.
Note: It is our understanding that market-linked pensions and complying retail annuities commenced on or after 1 July 2017 will not be treated as capped defined benefit income streams under the transfer balance cap. If the purchase price of a new market-linked pension or retail annuity exceeds the member’s transfer balance cap then an excess transfer balance will be raised that cannot be commuted. Please consider the member’s circumstances and impact of any reversionary pension on future beneficiaries prior to making a decision.
The information in this document is provided by Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, tax advice or legal advice and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. Tax is only one consideration when making a financial decision. We recommend that you seek appropriate professional advice before making any financial decisions.