Separate pensions or one pension – what’s the difference?
Besides an opportunity to contribute to superannuation, there are a number of planning issues to contend with from the recent introduction of downsizer contribution rules.
The downsizer contribution rules which came into effect from 1 July, 2018 mean that upon sale of an eligible main residence, there is an opportunity for Australians to contribute up to $300,000 of the sale proceeds for individuals over the age of 65 into superannuation.
Further, where an individual has space available under the $1.6 million transfer balance cap, the downsizer contribution could then be used to start an account-based pension.
Besides an opportunity to contribute to superannuation, there are a number of planning issues to contend with from the introduction of downsizer contribution rules. This includes how the downsizer contributions are mixed with existing superannuation savings, paying attention to tax components.
Case Study – To consolidate pensions or not
Reyansh (80) is married to Gauri (75). Upon selling their main residence and downsizing, they have surplus sales proceeds of $600,000 (combined). Reyansh and Gauri have $1 million and $500,000, consisting entirely of a taxable component, in their account-based pensions respectively.
Advice is given to contribute $300,000 each to superannuation under the downsizer contribution provisions. To ensure that the clients’ savings are in a nil tax rate environment, these contributions are then intended to commence an account-based pension.
An issue for planners when recommending such a course of action is whether the intended account-based pension is consolidated with an existing account-based pension or kept separate.
It may be worthwhile for Reyansh and Gauri to keep separate account-based pensions, particularly if they have specific estate planning wishes or have grandfathering status for Commonwealth Seniors Health Card means testing.
Estate planning considerations
Reyansh and Gauri’s plan is to enjoy their superannuation savings during their lifetime but then to pass any residual amounts to their non-dependent children tax effectively.
Their plan is to provide an early inheritance of $300,000 upon either of them passing away to their children. Once they have both passed away, the balance of their superannuation savings are intended to be given to their kids.
By keeping their respective account-based pensions separate, they could achieve more flexibility and tax effectiveness with their superannuation death benefit.
They could consider maintaining their existing account-based pension, which consists entirely of a taxable component, and starting a separate account-based pension with the downsizer contribution, which will consist entirely of the tax-free component.
Of significance, the latter account-based pension, commenced from $300,000 downsizer contribution, will always consist of the tax-free component.
This is because the proportion of tax components in an income stream is fixed at commencement. As it commenced with 100 per cent of the tax-free component, this proportion will be maintained during the account holder’s lifetime and will continue to apply until the death benefit is paid to a beneficiary, as long as it is “paid as soon as practicable”.
Keeping the pensions separate allows for potential tax-effective cherry-picking - the early inheritance can be paid from the pension which was sourced from the downsizer contribution and which consists entirely of the tax-free component. Consequently, any death benefit from this pension would be tax-free in the hands of the non-dependent children.
If Reyansh consolidated and only had one account-based pension, the tax component backing the $1.3 million income stream would be 23 per cent tax-free and a 77 per cent taxable component. This means that if Reyansh was to pass away first, the $300,000 early inheritance paid to their non-dependent children would incur up to $39,270 in death benefit tax.
Similarly, if Gauri consolidated and only had one account-based pension, the tax-component backing the $800,000 income stream would be 37.5 per cent tax-free component and 62.5 per cent taxable component. If Gauri was to pass away first, the $300,000 early inheritance would incur up to $31,875 in death benefit tax. Furthermore, having two separate pensions also allows strategies to dilute the taxable component by targeting the income stream from which a higher proportion of the pension payments are drawn from. This may be relevant if the client’s drawdown needs to exceed the minimum pension payment requirement.
For example, if Reyansh needs to withdraw $100,000 from his income streams, having two separate pensions could mean that he could draw the minimum of seven per cent ($21,000), required because of his age, from the income stream that is entirely the tax-free component and the remainder of the required cash flow of $79,000 from the income stream that is the entirely taxable component.
This helps to dilute the taxable component through targeted drawdown and potentially save death benefit tax for his future non-dependant beneficiaries.
Grandfathering for Commonwealth Seniors Health Card (CSHC)
An account-based pension is considered to be grandfathered for CSHC purposes if it commenced prior to 1 January, 2015 and the account holder has been in continuous receipt of CSHC since 1 January, 2015. Grandfathering affords a significant concession for CSHC income testing as none of the income from the account-based pension is assessed.
Where an account-based pension is not grandfathered, the account-based pension balance is subject to deeming. If the existing account-based pension was rolled back to accumulation and a new income stream is commenced, consolidating the downsizer contribution, the grandfathering status will be lost.
Conclusion
By maintaining separate pensions, it could allow preservation of grandfathering status for the existing pension with the account-based pension balance sourced from the downsizer contributions subject to deeming. This could assist with maintaining qualification for CSHC as less income will be assessed compared to having a single non-grandfathered pension.
While we have discussed issues specific to downsizing contribution, the above considerations apply equally to any other large superannuation contributions, including CGT cap contributions of up to $1.48 million, bring-forward non-concessional contributions of up to $300,000 and personal injury contributions.
Rahul Singh is ANZ Wealth's technical services manager.
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