In this article 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. This article in particular considers complying defined benefit pensions in the SMSF that are lifetime complying pensions and life expectancy complying pensions.
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 below 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.
Transfer balance cap implications
Complying defined benefit pensions in an SMSF will generally be capped defined benefit income streams for transfer balance cap (TBC) purposes and a credit will have been applied to the member's TBC back at 1 July 2017 based on a special value calculation.
When a complying defined benefit pension is commuted a debit value will need to be reported for TBC purposes and the calculation of this debit value is different for lifetime and life-expectancy complying pensions.
Further, when a new market linked pension or complying retail annuity is commenced on or after 1 July 2017 this will not be treated as a capped defined benefit income stream under the TBC.This means the purchase price of the new market-linked pension or retail annuity will be counted as the credit against the member's TBC and if this amount exceeds the member's TBC an excess transfer balance will be raised that cannot be commuted.
Prior to making a decision to commute a complying defined benefit pension please consider the member's circumstances and also the impact of any reversionary pension on future beneficiaries.
Below you will find two decision flow charts to assist you in understanding the options for commuting a complying pension.