Devil in the detail with indexed super transfer cap

Most self-managed super fund members and their advisers were coming to grips with the new rules around transfer balance caps. But then along came indexation.

When the Transfer Balance Cap (TBC) was introduced on July 1, 2017, the federal government’s aim was to introduce a lifetime limit on the amount of superannuation that could be transferred into a tax-free super pension account.

The TBC was set at $1.6 million and superannuation members who had a pension balance more than that limit before the start of the cap were given two choices: withdraw the excess pension balance from the fund or transfer the excess pension amount back to the accumulation phase in the fund or another fund.

Although complicated, it appeared most self-managed super fund (SMSF) members and their advisers were coming to grips with the new rules. But then along came indexation.

Set to take effect on July 1, 2021, all the complexities caused by the 2017 changes are set to be compounded when the indexation of the TBC takes effect in a shade over three months.

The TBC will be increased by $100,000 to $1.7 million. This may seem simple enough but, for superannuation members who have begun a retirement phase income stream before July 1, 2021, it is anything but simple.

This is because their TBC will not increase by $100,000 but a lower amount.

The actual increase will be determined by the ATO and will be based on the amount of the TBC that the individual has not previously used.

For example, if an individual starts a retirement phase income stream before July 1, 2021, with a balance of $800,000 they would have used 50 per cent of their TBC.

Assuming no lump sum withdrawals (commonly referred to as commutations) were made from this pension before July 1, and no other retirement phase income streams were begun, on July 1, 2021, their personal TBC will be $1,650,000. That is $1.6 million plus 50 per cent of the $100,000 indexed amount.

Confused?

Even the ATO seems to be implicitly acknowledging the complexity by their constant reminders to advice professionals and SMSF trustees of the need to ensure the reporting of pension commencements and pension commutations are up to date.

Possible tax penalties

The reporting after July 1 of pension establishments and, in some cases, pension commutations that occurred before July 1 will require the ATO to recalculate an individual’s personal TBC.

This may result in the individual breaching their TBC and possibly incurring tax penalties if they had acted on the ATO’s calculation of their personal TBC before the recalculation occurring.

And this brings me to the question you may well be asking yourself. Why does all this matter?

If you have begun a retirement phase income stream before July 1, 2021, then you have already been assessed against the $1.6 million TBC, so what is the relevance of your personal TBC?

Even if you have begun a retirement phase income stream before July 1, 2021, and have therefore been assessed against the $1.6 million TBC, this may not be the last time you interact with the TBC system.

For example, if you decide to begin another retirement phase income this will trigger a reassessment of your pension balance against your TBC.

The commencement of an additional retirement phase income stream commonly occurs in situations where an individual who has already begun a retirement phase income stream returns to work, say on a part-time basis, and makes further contributions to their fund.

Once a condition of release has been satisfied these amounts can then be transferred to a retirement phase income stream or can be added to the individual’s existing retirement phase income stream by transferring the existing income stream back to the accumulation phase, adding in the new amount, and then restarting a new retirement phase income stream with the combined amounts.

In both situations knowing your personal TBC will enable you to determine the maximum amount that can be transferred to the retirement phase without breaching the TBC rules.

Similarly, if on your spouse’s death their retirement phase income stream automatically reverts to you, this amount will also be counted against your TBC.

An excess pension balance will arise if your transfer balance account, together with the reversionary pension balance, exceed your personal TBC.

It will be important to know what your personal TBC is in these situations to ensure you do not breach the TBC rules.

The important point is that knowing what your personal TBC is will be critical to ensuring you get the calculation right.

In situations like this it may be necessary to transfer some of your existing retirement phase income stream back to the accumulation phase to avoid breaching the TBC rules.

Alternatively, you may choose to withdraw the excess pension amount by making a lump-sum commutation from the reversionary pension. If you do the latter, you must ensure the amount is withdrawn from the fund and not just transferred back to the accumulation phase.

Whatever approach you take, the important point is that knowing what your personal TBC is will be critical to ensuring you get the calculation right and you do not end up inadvertently breaching the TBC rules.

You will be able to access your personal TBC from your MyGov account from July 1.

If you have already begun a retirement phase income stream, it may pay to check your transfer balance account to ensure the commencement value of your income streams and any lump sum commutations have been correctly reported and are reflected in your account.

You can access your transfer balance account via your MyGov account. As mentioned earlier, on July 1 the ATO will use this information to calculate your personal TBC so a little time spent now checking these details may save a lot of time and effort later.