RBLs: beware of traps for older players

This is the first in our new series of fortnightly technical columns, in which a range of experts will outline timely issues and offer advice on how to maximise their benefits. Here, Nicholas Ingram (pictured) details the opportunities and the traps for advisers hoping to exploit recent changes offering easier access to the pension RBL.

The Federal Government's recent changes to the superannuation regulations have made it easier for superannuants to be assessed under the higher pension reasonable benefit limit (RBL). This limit is now available if your clients buy a fixed term annuity (FTA) meeting certain standards instead of the usual lifetime annuity.

But are these changes really any good? And what are their traps?

Remember the pension RBL?

The pension RBL is rarely used. It is currently worth $942,175 (unless your client gets a higher transitional value), which is double the lump-sum RBL.

Why is it used so rarely? Previously, to be assessed under the pension RBL your client had to put half their benefit into a 'complying' annuity or pension, and until now the only complying annuity was a lifetime annuity. These aren't popular because if the client dies young (and outside any 10-year guarantee period) the life office "wins", as it were, since any "balance" in the lifetime annuity goes to them and not the client's estate. Most people didn't want to take that risk and opted for the lower lump sum RBL instead.

These changes mean an annuity satisfying certain conditions can now be "complying" even if it's payable for a fixed term, thus removing the risk of the life office "winning". With these fixed term annuities, if your client dies young their estate, not the life office, will get the balance.

How does a fixed term annuity become "complying"?

If you follow the familiar assets test-exempt rules introduced in September you won't go wrong. Some of the rules include:

The annuity's payments should be "guaranteed";

Your client must buy the annuity on or after pension age; and

The annuity must have a term equal to your client's life expectancy (rounded up) or 15 years (whichever is less).

Advisers should, of course, ensure they read the regulations to get the precise conditions. The most important thing to remember is that your client has to be of pension age or older to use an FTA.

Are these changes any good?

Not as good as you might think, based on some preliminary modelling we have done at Westpac. We compared two strategies for a 65-year-old in excess of their lump sum RBL: the traditional one of taking the excess over the lump-sum RBL as a non-rebatable allocated pension and a newer one of taking half their benefit as a rebatable fixed-term complying annuity (15-year term) and being assessed under the pension RBL. The 15 year FTA we used was an "off-the-shelf" immediate annuity and we assumed their total benefit was under their pension RBL.

Surprisingly, we found that using an FTA instead of the traditional excess allocated pension brought few advantages, and the difference between the two strategies was usually line ball.

In general we found that the traditional excess allocated pension strategy (using the lump sum RBL) should be used if:

Your client has only a moderate excess above their lump sum RBL (say $200,000 or less); or

They expect to live well beyond their life expectancy; or

They expect to earn a substantial rate of return in their allocated pension (more than, say, 4 per cent per annum in excess of the return on the rival fixed term immediate annuity).

Whereas your client should consider using the new FTA strategy (using the pension RBL) if:

They have a large excess above the lump sum RBL; or

They are in poor health and don't expect to live to their life expectancy; or

They don't expect to earn a large return in an allocated pension.

As I stated earlier, this new strategy of putting half their benefit into an FTA to use the pension RBL assumes they buy an immediate annuity from a traditional provider such as a life office. The strategy depends on getting a good commutation value for this annuity upon death, so check with your provider for the value your clients will get on death before investing. Our modelling assumes they get the present value of any future remaining cash flows with little penalty.

Beware the pension RBL rules

The ability to use an FTA will definitely make the pension RBL more popular, so it's time to dust off the old pension RBL rules. These rules have been around for a decade but most advisers have paid little attention to them. There are a few traps, so make sure you understand them.

Firstly, be careful not to over-invest in a complying annuity. If your client is in excess of their pension RBL, they don't have to put half their benefit into a complying annuity but can settle for half the pension RBL. For example, say their pension RBL is $1 million and their total benefit is $1.2 million. They need only put $500,000 into a complying annuity, not $600,000.

Secondly, don't forget the benefits your client has taken previously. Any "superannuation" benefit (be it an Eligible Termination Payment (ETP) or an ETP income stream) your client has received since February 1990 needs to be taken into account when you're calculating how much to put into a complying annuity.

Undeducted, concessional and invalidity components don't count.

Thirdly, remember that employer ETPs receive unusual treatment. Ordinarily an employer ETP (ie one paid directly by an employer, not out of a super fund) will have only a small proportion assessed against the RBL if it isn't rolled over. But don't be lured into thinking that this proportion is all you need to remember when calculating how much to put into a complying annuity. The whole amount of the employer ETP must be taken into account.

Don't bother asking why - it's just the way the law works.

So remember there is now another option for getting the higher pension RBL. But take time to consider if it's really worthwhile for your clients, and make sure you're on top of the old pension RBL rules.

Nicholas Ingram is head of distribution development, Westpac Financial Services