Avoiding the slip downstream with the effective RBL planning

Considerable attention has been focussed recently on the use of an Eligible Termination Payment (ETP) purchased annuity or superannuation pensions for Reasonable Benefit Limit (RBL) planning.

This flood of attention has come on top of the already considerable exposure these income streams received last year with amendments to the Social Security Act giving us asset-test exempt income streams.

In the media, we have also seen a varied array of industry representatives advocating the use of everything from life office provided annuities to fixed term pensions paid from superannuation funds (with their unique RBL assessment method). This has been coupled with an unprecedented push from some quarters of the benefits of paying complying pensions from self-managed superannuation funds.

At the end of the day, however, some of your clients are not going to want to purchase a complying income stream. Be it a perception of low nominal returns; the prohibition on the availability of a residual capital value; or the cost and complication of the self-managed alternative, some clients will not be swayed by the many advantages such income streams may be able to provide.

However, a number of simple strategies exist for effective RBL planning, without the use of so-called "complying" income streams.

Defer excess benefits

If not immediately required, taking excess benefits should be deferred as long as possible (subject to legislative requirements).

For example, if a client with $571,088 in accumulated superannuation benefits at age 58 could consider taking $471,088 (ie their lump sum RBL) in lump sum form and retain the $100,000 within the accumulation phase of super until age 65.

This has two advantages. Firstly, it defers triggering an excess calculation while retaining funds in the concessionally taxed accumulation phase of super.

Secondly, should death arise prior to age 65, the amount that had been retained in the accumulation phase could be paid to dependants (as defined for tax purposes) tax-free because the death benefit is counted against the deceased's higher pension RBL.

Contrast this tax-free result with what would have happened if such a client had already commenced a non-rebatable allocated annuity (with the $100,000 all excessive amount). On his or her death, if the annuity were to be cashed out as a death benefit ETP and the proceeds paid to a dependant, they would attract tax at the top marginal tax rate plus Medicare even though they may have been within the deceased's pension RBL. As the legislation presently stands, the higher pension RBL is not applicable in these circumstances.

Non-rebateable income streams

Tax on excess benefits can be eliminated by rolling over the excess benefits into an income stream. While the income paid from the excess benefit will be subject to tax at marginal rates of tax and will not receive the 15 per cent tax rebate, the full amount of the benefit can be invested.

Example 1

Tom is 65 years of age. He has just terminated employment and is about to receive his superannuation benefits, $100,000 of which is an excess benefit.

Tom is aware that if he takes the excess benefit in cash he will be subject to tax at 48.5 per cent (including Medicare levy). He has, however, been advised to roll the excess benefit into an income stream. He is attracted to the allocated annuity concept and decides to investigate two options:

Either Tom could take the excess benefit ($100,000) in cash, pay tax at 48.5 per cent ($48,500) and invest the balance ($51,500) with the bank or he might purchase an allocated annuity with the excess.

We will assume that an earning rate of 5 per cent applies to both investments; the minimum amount is drawn from the annuity; and a similar amount is drawn from the bank investment. His marginal tax rate in retirement is 35.5 per cent (including Medicare levy). Fees are ignored for the purpose of this exercise.

Results

The asset value in the allocated annuity at end of Year 10 is $78,876, compared to Nil for the bank investment. The life expectancy for a male aged 65 is 15.41 years.

The bank investment runs out in Year 10; five years before the life expectancy figure.

After year 29, there is still an account balance of $13,122 in the allocated annuity.

While this strategy should not be used to encourage people to overfund, it simply demonstrates that excess benefits can be used to advantage by rolling them into an income stream and avoiding the excess benefits tax otherwise payable.

Death

As discussed earlier, where the owner of a non-rebatable income stream dies, the subsequent payment of a death benefit ETP will attract tax at the top marginal rate plus the Medicare levy.

Rather than allow this to occur, it may be preferable to choose an income stream which, on death, does not automatically pay out a lump sum death benefit, but instead has the flexibility to provide an income stream to the deceased's dependants.

Example 2

Assume Tom had purchased an allocated annuity that was flexible enough to enable the income stream to continue on his death to be paid to his wife, Paula.

Paula, who had only enjoyed minimal superannuation coverage during her working life, commences to receive the allocated income stream payments following Tom's death. The income stream payments will be fully taxable in her hands with no rebatable proportion, because Tom had acquired the income stream wholly with an excessive amount.

After a period of time has expired (six months from the date of Tom's death or three months from the granting of probate, whichever is later), Paula decides to commute the income stream.

The commutation amount will not be a death benefit ETP but an ordinary ETP which (like any other ETP) she is able to rollover.

If she rolls it over into the accumulation phase of a superannuation fund, not only will no RBL testing occur at that time, but the link to the previous excessive amount will be broken.

When the amount (together with any earnings) is subsequently withdrawn from the superannuation fund, it will be counted against her personal RBLs . Should it be within her RBLs, any excess benefit problem will be eliminated.

Paula could take the amount in cash (benefiting from any pre-June 1983 service Tom may have had) and any unused post-June 1983 tax free threshold she may have.

Alternately, she could roll the amount over to commence a fully rebatable income stream.

Capital gains tax

Consideration should always be given to purchasing an income stream where an individual receives an ETP having a capital gains tax (CGT) exempt component which, when added to previous benefits received, would result in an excess benefit.

A unique advantage afforded to CGT exempt components arises because the entire component will form part of the undeducted purchase price of the income stream, notwithstanding that the income stream may be non-rebateable.

Andrew Lowe, technical services, AMP