In this article, we continue our journey through the Turnbull/Morrison super changes. Our topic this week is the new important concepts called the Transfer Balance Cap and the Transfer Balance Account. These two concepts start on 1 July 2017
Overall purpose
The overall purpose of these new measures is to restrict how much money you can use to purchase super retirement pensions and similar products called annuities from life insurance companies.
When you commence a pension, or you have one in place on 30 June 2017, it will be recorded in your Transfer Balance Account (TBA).
If that pension and any others that you have in place, takes the balance of your TBA above your Transfer Balance Cap (TBC) then action must be taken to correct the problem.
Transfer Balance Cap (TBC)
There are two TBCs – a general and personal TBC.
From 1 July 2017 the general TBC will be $1.6m.
This general TBC will be indexed by accumulated movements in Consumer Price Inflation in $100,000 lots.
Each CPI increase will be calculated on 1 July and will be accumulated until it reaches $100,000 at which point the general TBC will be increased.
For example, suppose inflation remains at 1.5% for many years. This will mean that it could take five years before the general TBC is increased to $1.7m.
On the other hand, annual inflation of 10% will mean the general TBC will increase to $1.7m after only one year.
However once the general TBC is indexed by inflation everyone’s personal TBC will be indexed by the portion of the general TBC they have not used. This is best explained by an example.
Suppose on 1 July 2017 I had in place a pension with an account balance of $1m which means I have used 62.5% of my $1.6m cap. If this is the only pension I have in place when the general TBC is indexed to $1.7m then I only receive my unused portion (37.5%) of this indexation which means my personal TBC will be $1.6375m and not $1.7m, if I had not started any pension.
Indexing only applies to the portion of my TBC that I haven’t used
What does this mean if you have a pension of $1.6m in your TBA on 1 July ’17 and that pension remains in place? It means your personal TBC will never receive indexation.
Transfer Balance Account (TBA)
The TBA “account” will hold information about the pensions you have in place. It is not a physical account like a bank account and consequently your TBA will not hold any money or other assets in it.
The TBA will be administered by the Tax Office and will operate very much like a bank reports account holdings.
When you commence a pension, its purchase price will be reported to the ATO. It will record this pension as a “credit transaction” in your TBA.
The following pensions aren’t recorded against your TBA:
- Transition to Retirement pensions (however the government has recently proposed adjusting the law so that once you’re fully retired or aged 65 – whichever occurs first – then such pensions will be recorded as a credit transaction against your TBC)
- Pensions which are deemed not to be compliant with the super laws (for example, because the required minimum for the pension has not been paid)
- Foreign pensions – that is, pensions paid from retirement schemes not based in Australia
A debit transaction – that is, a reduction in your TBA’s balance – will occur in the following situations:
- You partially or fully commute a pension (that is, you formally partly or completely stop a pension)
- Structured settlement contributions – these are compensation payments made because of a Court or legal settlements physical or mental illnesses – such as major car accidents – or professional malpractice; these payments do not include Total and Permanent Disability insurance claims which are excluded from this rule
- Losses due to convicted fraud/theft
- Splitting of pension benefits on formal Court approved spousal separation
- Unwound bankruptcy contributions – when a person seeks to place money in a super fund to frustrate creditors then a Court can order the withdrawal of this money even if it is being used to pay a pension
- Potentially - ministerial across the board TBA reductions because of economic shocks such as the Global Financial Crisis
It’s important to note the following will have no impact on your Transfer Balance Cap:
- Pension income payments
- Changes to asset values of underlying assets – for example suppose you commenced a $1.6m pension which is recorded in your TBA and the market value if its assets increases to $3m then there will be no impact on your TBA. Similarly if the value of your pension’s assets collapses to $100,000 then this also has no impact in your TBA and consequently you cannot add to your TBA with a new pension
Special TBA transactions apply if you want to cease one pension and move to another pension or fund. There will be a TBA debit transaction for the market value of a pension’s assets you wish to cease and then a credit transaction for the new pension.
How will the ATO receive data about your pension so it can record TBA credit and debit transactions?
Super funds will be required to tell the ATO about the commencement or commutation of pensions as quickly as possible. The timing of these communications for SMSFs has not been resolved. Funds regulated by the Australian Prudential Regulation Authority, that is, all super funds other than Self Managed Super Funds will, sometime from early 2018 onwards, report this data two to four weeks after the end of each month.
Excess Transfer Balance Accounts
You will have an excess TBA when the ATO determine that you have commenced one or more pensions that have pushed your TBA credit balance above your personal Transfer Balance Cap.
When this occurs the tax office will communicate with you and say that you have an excess TBA. At the same time it will nominate a pension account that must be partly or fully commuted - that is, stopped. If you have more than one pension then it will give you an opportunity to nominate a different pension you may wish to cease.
Once the pension nomination process is complete the ATO’s next step will be to communicate with your super fund and demand the partial or full commutation of your pension.
Once this has been done, the super fund will tell the ATO so it can adjust your TBA and it will then determine how much Excess Transfer Balance Tax you have to personally pay. It is payable for the days you commence the pension until the right amount of money is withdrawn from the pension.
What happens if your super fund ignores the ATO’s demand to commute pension?
Firstly, a debit transaction is deemed to place in your TBA. This ensures that Excess Transfer Balance Tax will stop accruing.
However your pension will lose its tax exemption for the whole income year and any future years that it remains in place. Once a pension has lost its tax exemption because a super fund has ignored the ATO’s demands to partially commute it, then that pension will never have any pension tax concessions.
To regain the super fund earnings tax exemption you would need cease that pension and commence a new pension that didn’t cause an excess TBA credit balance.
In addition if a SMSF ignores a demand to commute a pension then the ATO have an ability to ban the trustees of that SMSF from holding that position. In the majority of cases, once you are no longer permitted to be a trustee then you would need to leave that SMSF.
No Excess Transfer Balance Account – No ATO communication
If you commence a pension and an excess TBA balance doesn’t occur then there is no obligation on the ATO to tell you. I recommend that you request this data from the tax office to ensure no errors have been made.
Valuation of pensions for TBA reporting purposes
The assets supporting your account based pensions must be valued at market value.
This can be a tricky issue to solve for illiquid assets which have an uncertain value such as real estate. However, the valuation you use must be realistic and you must be able to justify it. I will have more to say about this in a future article.
For all other pension types (such as guaranteed lifetime pensions provided by a public sector super fund) have a different set of valuation rules which we will not review here.
Estate planning considerations
I think everyone will need to carefully consider their superannuation retirement planning because any pension paid as a result of death will be counted against the recipient’s TBA.
For example suppose a retired couple have an SMSF and on 1 July 2017 the fund pays one of them a pension with an account balance of $1m and the other a pension has an account balance of $800,000. Let’s assume they have no other super pensions in place.
Ordinarily neither of these pensions will create a TBA pension excess while both remain alive.
However, if on the death of one spouse, the survivor would be paid a pension, then that person would create a $200,000 excess TBA ($1.8m less $1.6m) and appropriate action would need to be taken to correct the problem.
If the death benefit pension is partially commuted then the lump sum benefit would need to be paid from the super system.
If this death benefit pension’s documentation says that it automatically reverts to the surviving spouse then the pension will be a credit transaction in the survivors TBA one year after they first begin to receive it. In practise this will mean it will be included 12 months after the date of death. This timeframe is designed to give the survivor time to re-arrange their affairs.
If the deceased’s pension ceases on death and a new pension is paid to the survivor then this new pension will count against the survivor’s TBA when it is first paid to them which may be less than 12 months after death.
Similar rules apply for people who are not retired. Suppose we have someone with $2.5m death insurance in their super fund who is yet to retire. The plan on death is that the insurance proceeds would be paid as a $2.5m pension to their spouse. This is clearly more than $1.6m and a pension account balance above this maximum will not be permitted. That is the spouse will only be allowed a pension with a $1.6m balance.
This rule applies regardless of the surviving spouse’s age and $1.6m death benefit pension will mean the spouse can never receive a retirement pension because their TBA has been “maxed out”.
Any insurance amount not used to pay a pension will have to be paid out of the fund as soon as possible as a death benefit (in some cases it may be possible to pay a pension to minor dependent children).
The $1.6m TBA maximum applies for your life.
In these situations any excess TBA pension will need to be commuted and as they are death benefits received after 1 July 2017, the money not in the pension will need to be paid out of superannuation.
Special rules apply for death benefit pensions paid to minor children. They will receive a special Transfer Balance Account for such pensions which will run until these have to cease. Often these pensions must cease when a child reaches age 25 unless they suffer from a mental or physical disability. Children in this situation will then have their own TBA.
Total and Permanent Disability (TPD)
If you are not retired and are permanently disabled due to physical or mental ill-health then in some cases you can take your super benefits, potentially including a TPD life insurance policy, as a pension or lump sum. Tax concessions are offered in these situations.
Any pension received in these situations will count against your Transfer Balance Account regardless of your age without any concessions which means you’re restricted to a pension of $1.6m.