SMSF five-year clawback explained

Julie Steed looks at the complexities around the waiving of the five-year clawback for SMSFs.

On 25 August 2011 a social security specification came into effect which will permanently waive the Centrelink five-year clawback for self-managed superannuation funds (SMSFs) and small APRA funds (SAFs) that restructure asset test exempt complying pensions to a term allocated pension.

The arrangements apply to both 100 per cent and 50 per cent asset test exempt lifetime and life expectancy pensions in SMSFs and SAFs. The exemption does not apply to retail income stream products.

This news will be welcomed by many clients whose account balances have reduced to the point where the balance no longer effects their Centrelink entitlements under the assets test. This may also provide relief for ageing clients in SMSFs who no longer want the burden of running their own fund. 

Centrelink five-year clawback 

If a lifetime or life expectancy pension is converted to a term allocated pension then the assets test exemption that applied to the pension is lost. In addition, Centrelink will generally assess the pension against the assets test for the previous five years.

If including the pension account would have resulted in a lower amount of pension being paid, then Centrelink will raise a debt. The debt cannot be paid from the pension – it must be paid by the pensioner from personal sources.

Many clients have experienced a decline in the value of their complying pension, either as a result of continued drawdowns and/or the effects of recent poor investment returns.

As a result, many clients’ Centrelink benefits will not be affected by the current pension account being included in their assets test. However, the five-year clawback debt could still be a significant deterrent. 

Previous relief

In response to the global financial crisis, the Government announced temporary relief for the 2009/10 year. The relief was offered to clients whose complying pensions had failed to meet the high probability test.

This test requires an actuarial certification that the fund has a high probability (typically a 70 per cent probability) of meeting its future liabilities. Any assets test exemption was lost going forward, but the five-year clawback did not apply.

Despite much lobbying from the industry, no relief was extended for the 2010/11 year.

Importantly, the current relief does not require that pensions have failed the high probability test – the relief will be available to all lifetime and life expectancy pensions.

Options for clients

The new regime will provide three avenues for clients with asset test exempt complying pension in SMSFs and SAFs to restructure their pensions: 

Pre-20 September 2004 pensions

1. Restructure to a term allocated pension within the SMSF or SAF. The pension will lose its 100 per cent assets test exemption but no five-year clawback will apply.
2. Restructure to a term allocated pension with a retail provider. The pension will lose its 100 per cent assets test exemption but no five-year clawback will apply.
3. Restructure to a life office complying annuity. The pension will retain its 100 per cent assets test exemption and no five-year clawback will apply.

Pensions commenced between 20 September, 2004 and 31 December, 2005:

1. Restructure to a term allocated pension within the SMSF or SAF. The pension will lose its 50 per cent assets test exemption but no five-year clawback will apply.
2. Restructure to a term allocated pension with a retail provider. The pension will lose its 50 per cent assets test exemption but no five-year clawback will apply.
3. Restructure to a life office complying annuity. The pension will retain its 50 per cent assets test exemption and no five-year clawback will apply.

Term allocated pension options

The SMSF or SAF may be able to commence a term allocated pension in their existing fund. The trust deed will need to be reviewed to ensure that members are able to commence this type of income stream.

Clients may also look to transfer to a retail offering. Term allocated pensions may also be known as market linked income streams or non-commutable income streams.

Many product providers closed their term allocated pension products around September 2007 when the 50 per cent assets test exemption was reduced to nil.

Review of the workings of a term allocated pension

Advisers may wish to brush up on the workings of a term allocated pension as we do not usually recommend them to clients since the 50 per cent asset test exemption ceased at 19 September 2007.

The purpose of a term allocated pension is to provide a pension, paid at least annually for the required payment term. This type of pension is designed to last for a specific term, based on a client’s life expectancy, and to have a zero capital balance at the end of the term.

A term allocated pension may be commenced with either a rollover from a lifetime or life expectancy complying pension account or a rollover from another term allocated pension account.

Conclusion 

This relief provides an opportunity for advisers to assess the value of the current Centrelink asset test exempt status of any complying pensions held by their clients in SMSFs and SAFs and to restructure to a term allocated pension if this meets the client’s needs.