A super year-end tax plan

Superannuation is quite often overlooked in year-end tax planning in favour of more income tax-related solutions.

However, the reality is that superannuation, while complex in its various forms, has much to offer when addressing tax effective family planning strategies.

From January 1, 2006, small superannuation funds — that is those with less than 50 members — are prohibited from providing new defined benefit pensions.

This means the trustees of all self-managed superannuation funds (SMSFs) are now unable to commence defined benefit pensions for their members.

The only complying pension that can now be started in an SMSF is a term allocated pension (TAP).

Defined benefit pensions established prior to January 1, 2006, cannot be commuted and restarted in an SMSF. Previously, members were allowed to change certain features of a defined benefit pension, such as the indexation rate, a nominated beneficiary on divorce or early death of the beneficiary or the frequency of the pension payments.

These kinds of changes can now no longer be made within a SMSF, as the Australian Taxation Offices deems that to be the commencement of a new pension.

Of course, a member of a SMSF with an existing defined benefit pension can commute that pension and then commence a TAP within the SMSF.

However, defined benefit pensions commenced prior to September 20, 2004, are eligible for a 100 per cent assets test exemption for social security purposes, whereas complying pensions commencing on or after that date are only 50 per cent assets test exempted.

Extreme care should therefore be exercised when dealing with defined benefit pensions in a SMSF, as the financial consequences can be significant, if not properly planned.

Allocated pension draw down factors

The allocated pension draw down factors have been updated from January 1, 2006, to allow for current mortality rates and life expectancies. For allocated pensions commenced before January 1, 2006, the old factors (in Schedule 1A of the Superannuation Industry Supervision (SIS) regulations) must continue to be used.

For allocated pensions commencing on or after January 1, 2006, the pension payments made between January 1, 2006, and June 30, 2006, can be made using either the old or the new (in Schedule 1AAB of the SIS Regulations) factors, at the choice of the member.

However, for allocated pensions commencing on or after January 1, 2006, the new factors must be used for all pension payments made on and after July 1, 2006. If a pensioner commenced an allocated pension before January 1, 2006, and now wants to use the new factors, the pension must be commuted and restarted.

However, care should be exercised, as this will incur costs and increased reporting and may have reasonable benefit limit (RBL) and deductible amount implications.

Increasing life expectancy

As mortality rates have declined over time, this has resulted in life expectancies increasing. These improved life expectancies have now flowed through to the allocated pension draw down factors.

By way of example, for a 65-year-old, the old maximum factor was 8.1 and now it is 9.9, a more than 20 per cent change. The old minimum factor was 15.7 and it is now 17.3, a 10 per cent change.

In dollar terms, for a 65-year-old with an account balance of $250,000, the old maximum pension was $30,860, whereas the new maximum is $25,250. The old minimum pension was $15,920 and the new minimum is $14,450. So, a range of about $16,000 to roughly $31,000 has now become a range of about $14,500 to about $25,000.

The new factors will be beneficial for those pensioners who wish to minimise their pension payments and retain as much of their capital as possible in the superannuation environment.

However, for those with limited superannuation assets, the changes make it harder for pensioners to take a level of pension that will provide them with an adequate standard of living in the short term.

Term allocated pension changes

For TAPs commencing before January 1, 2006, the term of a TAP was a term between the life expectancy of the pensioner and the life expectancy if the pensioner was five years younger.

From January 1, 2006, the term of a TAP can be any term between the life expectancy of the pensioner and the greater of the life expectancy if the pensioner was five years younger or the term from the pensioner’s last birthday to age 100.

Regardless of the commencement date, the term of the TAP may be longer if the pension is reversionary to a spouse with a longer life expectancy, as the spouse’s life expectancy or the period to when the spouse reaches age 100 can be factored in.

Of course, if the TAP is reversionary, and the spouse’s life expectancy or age is used in selecting the term, on the death of the primary pensioner the pension continues to the reversionary pensioner. The reversionary pensioner does not have the option of commuting the pension payments to a lump sum. A lump sum benefit is only available after the death of both pensioners.

Practical impact

Let’s take a male aged 65, with a life expectancy of 17.70 years. One five years younger has a life expectancy of 21.66 years.

His spouse is aged 62 with a life expectancy of 23.71 years. A spouse five years younger has a life expectancy of 28.10 years.

For pensions commenced before January 1, 2006, the term could be between 18 and 22 years or between 24 and 29 years, if the TAP is reversionary. For pensions commencing on or after January 1, 2006, the term can be between 18 and 35 years or between 24 and 38 years, if the TAP is reversionary.

A TAP commenced before January 1, 2006, must be commuted and restarted for the pensioner to be able to use the extended ranges.

Again, this will have cost and reporting implications and may also have RBL and deductible amount implications.

Amount of the pension

Payments from TAPs can now be varied between plus and minus 10 per cent of the calculated amount.

A term is selected and the payment amount calculated in the normal manner, by dividing the account balance by the payment factor for the term selected.

The actual payment for the year can now be between 90 per cent and 110 per cent of the amount so calculated.

This change applies to all TAPs, regardless of their commencement date.

Let’s look at a 65-year-old male with an account balance of $250,000.

Using the old ranges, the longest term was 22 years and the payment was $16,480. Now the term can be up to 35 years and the minimum payment can be as low as $11,250, being 90 per cent of $12,500. The shortest term is 18 years and the maximum payment can be as high as $20,850, being 110 per cent of $18,950.

If the pension is reversionary to a 62-year-old spouse, the longest term was 29 years and the payment $13,860. Now the term can be up to 38 years and the minimum payment can be as low as $10,800, being 90 per cent of $12,000. The shortest term is again 18 years and the maximum payment can be as high as $20,850, being 110 per cent of $18,950.

Again, the changes are beneficial for those pensioners who wish to minimise their pension payments and retain as much of their capital as possible in the superannuation environment.

Since their introduction in September 2004, TAPs have not had the take-up rate a lot of people expected. This has been mainly due to the fact that they cannot be commuted and the fixed nature of the payments.

However, TAPs may now become the pension of choice for many new pensioners, especially as a TAP is the only complying pension that can now be started in an SMSF.

TAPs will also become more popular in situations where the pensioner has excess benefit problems, compared to the current almost exclusive use of allocated pensions in such cases.

Contributions splitting

Contributions splitting is now a reality. It applies to contributions made on or after January 1, 2006.

The first split can be made in the 2006-07 financial year for contributions made between January 1, 2006, and June 30, 2006.

Thereafter, a split can be made in one financial year in respect of contributions made in the previous financial year.

However, if the entire benefit is being transferred or rolled over in a current financial year, an application can be made to split contributions made in that current financial year.

Only one split per financial year is allowed.

What can be split?

Eighty-five per cent of deductible contributions may be split. That is, those that attract contributions tax, such as employer Superannuation Guarantee contributions.

Also, 100 per cent of non-deductible contributions can be split, such as personal after tax contributions.

The following items cannot be split:

~ existing benefits and contributions made prior to January 1, 2006;

~ rolled over, transferred and allotted amounts;

~ transfers from eligible non-resident, non-complying superannuation funds;

~ employer eligible termination payments (ETPs);

~ deemed ETPs in respect of the capital gains tax (CGT) small business retirement concessions;

~ benefits that are subject to a family law flag or split; and

~ defined benefit interests.

Are there any other conditions?

The short answer is yes. The receiving spouse must be under their preservation age or between their preservation age and age 65 and able to provide a statement to the trustee that they are not permanently retired. This condition is to prevent contributions being split where the receiving spouse would have immediate access to the contributions in cash.

Spouse includes de facto relationships, but does not include interdependency relationships, so same sex couples cannot contributions split.

The application to split must specify separately the amounts of both deductible and non-deductible contributions to be split and these amounts cannot exceed the limits.

Access to contributions splitting

Contributions splitting is optional for trustees, but we expect the vast majority of trustees to offer it. SMSF trust deeds and rules will need to be amended to allow for contributions splitting.

If a trustee offers contributions splitting and receives a valid application, the split must be made within 90 days.

The split will be made by the means of a contributions splitting ETP, if the split is to a different fund, or by allotting the split, if the spouse is a member of the same fund.

The Eligible Service Period and Eligible Start Date of the transferring member are not carried over.

The amount rolled over, transferred or allotted will only have a post-June 83 component and an undeducted component, depending on the make up of the split.

The transferred benefit will, of course, adopt the Eligible Service Period and Eligible Start Date of the receiving spouse in the fund to which the benefit is transferred.

The contributions split will be subject to preservation in the receiving spouse’s account.

The intention behind the introduction of contributions splitting is to allow a low income or non-working spouse to accumulate and control their own superannuation.

The provisions will give a lot more flexibility to couples and give them much greater scope to access two tax-free, post age 55 ETP thresholds and two RBLs.

Transition to retirement provisions

There has been a fair amount of press about the transition to retirement provisions and whether or not Part IVA of the Tax Act would apply to some such arrangements.

The Commissioner of Taxation has issued a statement that “normal” transition to retirement arrangements, that is, those where an existing account balance is converted to a non-commutable pension and an employed member then salary sacrifices to superannuation, will not be caught under Part IVA.

A logical extension of this thinking will allow an employed member to access a non-commutable pension, salary sacrifice to superannuation and then split the salary sacrificed contributions with a spouse.

Again, it would appear that such an arrangement would not be caught by Part IVA, as it is merely a combination of three legitimate strategies, namely accessing a non-commutable pension, salary sacrificing and contributions splitting with a spouse. The combination of the strategies would be designed with the dominant purpose of improving a couple’s financial position in retirement.

As with the transition to retirement provisions, any arrangement that is “artificial or contrived” will attract the attention of the ATO and will be closely scrutinised.

Mark Pizzacalla is partner-in-charge — tax consulting at HLB Mann Judd.