Opportunity knocks in RBL transition phase

Advisers whose clients have taken out fixed-term pensions purchased with a lump sum post March 1, 2000 should review the method that’s been used to calculate the capital value for Reasonable Benefit Limit (RBL) purposes following a revised ruling by the Australian Tax Office (ATO).

Advisers whose clients have taken out fixed-term pensions purchased with a lump sum post March 1, 2000 should review the method that’s been used to calculate the capital value for Reasonable Benefit Limit (RBL) purposes following a revised ruling by the Australian Tax Office (ATO).

Prior to March 1, the capital value for these pensions was calculated using a formula containing the Pension Valuation Factor (PVF) — which could result in a capital value higher or lower than the actual purchase price. After this date, the ATO had ruled that the capital value was to be assessed on the purchase price (the method already used for annuities and allocated pensions).

However, the ATO recently announced that it would accept either methodology until the new draft determinations were finalised (currently due out on July 1, 2000). In the meantime, they offered to review on request any determinations that had already been made using the new system where the client would clearly have benefited if the PVF approach had been applied.

The reason given by the ATO for introducing these transitional arrangements was that many providers had failed to implement the new measures on time as they were already swamped under the pressures of updating systems for GST and tax reform.

These interim measures were designed to make sure that recipients of fixed term pensions from providers that had adopted the new methodology were not unfairly disadvantaged.

Advisers should note that the revised determinations are only available to clients whose original RBL determination was based on the purchase price method, not where the PVF approach was used. Also, the new methodology does not change the way lifetime pensions are calculated, where the PVF approach is still used to calculate the capital value for RBLs.

To determine whether your client’s RBL status needs to be reviewed, contact the ATO or the provider and find out which approach was used to calculate the capital value. If the purchase price method was applied, determine whether your client has an excessive determination and request a new determination. Even without an excessive determination it is important to do your sums (ie, compare the purchase price assessment against the PVF approach). This isn’t as straightforward as it may sound.

While a lower RBL amount may benefit a client wishing to access a lump sum RBL, a higher RBL assessment may favour someone who wants to access the pension RBL — as the two case studies below illustrate.

One of the key reasons that the ATO has decided to alter the methodology used to calculate RBLs is that financial planners were having difficulty applying the PVF approach. Likewise, the new method will provide consistency with the current RBL treatment of annuities and allocated pensions — a move that the Australian Retirement Income Stream Association has been advocating for some time.

The ATO is currently reviewing the methodology for determining the capital value of pensions not payable for life. Draft taxation determination TD2000/D6 covers defined benefit pensions and TD2000/D7 covers allocated pensions and fixed term pensions where the purchase price is identifiable.

Under the latter methodology, the capital value for fixed term pensions will be determined by the formula:

Capital value = purchase price — (undeducted contributions + concessional component + invalidity component).

The ATO is currently sifting through industry feedback on the new methodology before announcing their final determinations, which are expected to take effect from July 1, 2000.

Case Study 1 — PVF approach more favourable

A client aged 65 has a superannuation account balance of $600,000 (comprised of all post-1983 monies). He has no previously received benefits. The client commences a nil RCV fixed-term pension indexed at 5 per cent with a 20 year term, with annual payments of $38,000 per annum. (Assume a lump sum RBL of $500,000 and that the fixed-term pension is non-complying for RBL purposes.)

Method 1: Purchase price used to assess capital value

The capital value of the fixed term pension for RBL purposes is calculated as $600,000. This exceeds the client’s lump sum RBL by $100,000. The excessive component of the income stream is non-rebatable and taxed at the top marginal tax rate (plus Medicare) if commuted.

Method 2: PVF approach to calculating capital value

Capital value for RBL purposes

= (annual payment x PVF*) — undeducted purchase price + residual capital value

= ($38,000 x 12.77) — 0 + 0

= $485,260

* Under TD 97/20.

Using this method, there is no excessive component as the amount calculated for RBL purposes is within the client’s lump sum RBL. So the income stream is fully rebatable.

Case Study 2 — Purchase price approach more favourable

A client aged 65 has a superannuation account balance of $985,000 (comprised of all post-1983 monies) and wishes to access the higher pension RBL. She has no previously received benefits. The client commences a nil RCV fixed-term pension for $500,000 indexed at 5 per cent with a 20-year term and annual payments of $32,000 per annum. Assume a pension RBL of $1,000,000 and that the fixed-term pension is complying for pension RBL purposes.

Method 1: Purchase price used to assess capital value

The capital value of the fixed term pension for RBL purposes is calculated as $500,000. The remaining $485,000 is withdrawn in one month. To access the pension RBL the client needs to take the lesser of 50 per cent of counted benefits or the pension RBL in the form of a complying income stream. As $500,000 is more than 50 per cent of $985,000, the client has accessed the pension RBL and the lump sum is taxed concessionally.

Method 2: PVF approach to calculating capital value

Capital value for RBL purposes

= (annual payment x PVF*) — undeducted purchase price + residual capital value

= ($32,000 x 12.77) — 0 + 0

= $408,640

* Under TD 97/20.

The capital value of the fixed term pension for RBL purposes is calculated as $408,640. The remaining $485,000 is withdrawn in one month. The client does not meet the 50 per cent test (as 50 per cent of $893,640 is $446,820) and has accessed the lump sum RBL. The lump sum of $91,360 is taxed concessionally and the remaining $393,640 is taxed as an excessive amount.

RBL Tips & Traps for Advisers:

Tips:

1 RBL determinations are effectively ignored where the super pension/annuity is commuted within six months of commencement and rolled back into the accumulation phase of super. This may help, for example, where an incorrect amount was initially used to purchase an income stream that did not meet the 50 per cent test under the pension RBL.

2 Clients that have accumulated excessive benefits over their pension RBL can elect not to receive Superannuation Guarantee contributions. (NB: This doesn’t mean your client then qualifies as an ‘eligible person’.)

3 Timing is everything. If benefits in the accumulation phase are being finalised to access the pension RBL, watch out for changes to the account balance (eg, added growth, negative earnings) - in order to satisfy the 50 per cent test the benefit amount may have also changed.

4 Lifetime pensions (and fixed term pensions prior to July 1, 2000) can be used as a means to reduce otherwise excessive RBL amounts under the PVF approach. Careful planning is required.

5 Always check with the ATO as to whether your client has previously received benefits/transitional RBL.

Traps:

1 Many advisers provide their clients with ETP tax estimates, but often neglect to complete an RBL analysis. This can adversely affect the type of advice of how to receive an ETP and amount of tax payable.

2 Clients who access their lump sum RBL under age 55 have their lump sum RBL discounted by 2.5 per cent for every year they are under age 55. The pension RBL is not reduced because of a person’s age.

3 For pensions payable upon death to a spouse from the accumulation