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How to commute a pension on 30th June 2017 to comply with Balance Transfer Cap

Any member of an Self Managed Super Fund (SMSF) who is in pension phase with balance above $1.6 million (transfer balance cap amount) on 30th June 2017, must either withdraw the amount above this amount from the SMSF or commute one or all pensions and move the amount from retirement phase to accumulation phase before or on 30th June 2017.

A member of an SMSF who is pension phase on 30th June 2017, may or may not have an accumulation account in that SMSF.

The actual commutation of the pension account to accumulation account is a mere journal entry to credit an existing or newly created accumulation account of the member in the fund and debit to one or more pension accounts of the member to ensure that the remaining pension account is not more than $1.6 million.

Income, tax calculations and asset valuation are generally not available on 30th June 2017, the trustees may need some time to quantify the amount above the $1.6 million as on 30th June 2017 in the pension account. Since trustees may not know the exact member pension balance on 30th June 2017, the exact amount of commutation from pension account to accumulation account may not be known for some time.

 Click here to learn how to commence a pension in an SMSF

Commutation of pensions before 30th June 2017

On 1st July 2017 not more than $1.6 million can be in retirement phase or else you will breach the transfer balance cap amount, commutation of pension of all amounts in excess of the transfer balance cap must happen on or before 30th June 2017.

For some SMSFs it is not possible to work out the pension balance on 30th June 2017, as valuation of some assets will not be known till much later. For example, units in unlisted or listed trusts are only known when the final accounts of the trust are completed sometime in September 2017.

ATO has put together a guidance to assist SMSF trustees with valuation of the pension where an SMSF member is unable to determine what their balance is at June 30 2017. 

ATO in practical compliance guideline 2017/5 has suggested how these commutation requests from members should be recorded.

Trustees are not required to quantify the excess amount in the minutes they prepare for the pension commutation on 30th June 2017 but they need to be clear about how they intend to calculate the excess amount in the minutes, even though the amount of pension in excess is not determined much later than 1st July 2017.

This irrevocable request by the member and trustee accepting the request minutes must be in writing and must happen before 1st July 2017. These minutes must identify which income stream has to be commuted.

Click here to download a template of such a request by the member & minutes of the SMSF accepting such request.

Click here to download PCG 2017/5

Valuation of Assets on 30th June 2017

For some funds, commutation of pension accounts can create an administrative nightmare if there are several members, each with multiple pension accounts and where there are several properties in the fund. For starters, trustees would need to organize market value of these properties.

SMSF auditors should also be careful when auditing funds with large movements in unrealized gains or losses because fund balance / member balance on 30th June 2017 will determine funds exempt pension income status for future years.

If a member has more than one pension account, then the trustee will have to choose which pension account to commute first as each pension account has its own composition of tax free and taxable component.

When income is credited to a pension account, it increases the tax free and taxable component in the same proportion of the pension, whereas income increases only the taxable component of an accumulation account.

As a rule of thumb, pensions with maximum tax free components should move to accumulation account. This is because on death, non tax dependants (e.g. adult kids) have to pay 15% tax plus medicare levy on the taxable component of any death benefit they receive where as tax free part of the death benefit does not attract any tax. Further, non tax dependants cannot be paid a death benefit income stream from the fund.

Which pension should be commuted and which pension should continue can be advised only by a licenced advisor.  We are running a free webinar on limited licence for accountants at 2.15 pm on 15th June 2017.  Below Topics will be discussed

• What can an Unlicensed Accountant Can and Cannot do?
• Life after being Licensed (you cannot claim any exemptions which apply to accountants)

Click here to learn how to set up a SMSF

Segregation of Assets after 1st July 2017

Properties have varied investment returns, generally residential properties returns are lower as compared to commercial properties.

Members may want to retain properties with higher rental return in pension phase so that they can be exempted from tax. Any income and capital gain in accumulation phase is subject to 15% tax.

From 1st July 2017, you can no longer segregate pension assets from accumulation assets, all assets of the fund must remain un-segregated as that will be the members superannuation balance in the fund. An actuarial certificate will be required to determine exempt current pension income of the fund.

 Click here to learn how to apply for an Actuarial Certificate for $55

A person can be a member of multiple super funds. For example, if a member has two SMSF's, they may be able to achieve segregation between pension and accumulation assets. One fund up to $1.6 million could be in pension phase and the other fund can hold all the other assets in excess of $1.6 million and be in accumulation phase.

Fund with high return / income could then remain in pension phase and the pensions of the fund which has lower returns, such as residential properties, could be commuted to accumulation phase.

A second fund can be set up before 30th June 2017, however, SIS legislation does not allow rollouts of assets from one fund to another fund, unless where two funds are merging or in case of a marriage split. Rollovers of assets should not be confused with in-specie contributions where assets can be contributed to the fund, rollovers between two funds must always be in cash.

ATO has stated that they will be looking at applying provisions of Part IV A at situations where trustees are attempting to pull out or pull in assets from un-segregated pools to segregated pools . However, a genuine case where the trustee wants to set up one or two more funds for estate planning purposes should not be caught by these provisions.

SMSF as a Estate Planning Vehicle

If a member has more than one child, for estate planning purposes it can be beneficial to have one SMSF for each child, where the assets of the fund can pass on to the next generation without paying any capital gain tax.

These type of SMSFs typically will have three members, two parents and one child and once the child gets married, their spouse becomes the 4th member.

On death of one parent, the number of members will reduce and increase when a grandchild is admitted in the fund when he or she turns 18 years.

To implement this strategy parents should be gradually drawing down on pensions and gifting it to the child who will then contribute to the fund as non-concessional contribution, so that one day parents are phased out of the fund and kids (plus spouse) member balance represent the assets of the fund.

This strategy works to eliminate or limit capital gain tax when the asset is ultimately sold, presumably when the child or grandchild is in pension phase.

Investments making a gain and held outside of super will always pay capital gain tax, however this strategy can be used by multiple generations, as an SMSF can go on till perpetuity.

This similar capital gain tax shelter is only currently available on sale of principal place of residence i.e. on death of a parent, any capital gain on the sale of principal place of residence passes to the next generation without any capital gain tax liability. The cost base of the deceased for each investment property passes to the beneficiary at the time of death and capital gain tax paid on its ultimate sale.

 Click here to learn how SMSF can borrow

Multiple Superannuation Interests

Having one SMSF for each child  strategy ensures that assets move from one generation to the next without paying any or minimal capital gain tax on the assets ultimate sale with the advent of transfer balance caps which restricts the amount which can be in pension phase.

If you or your clients have only one fund and want to set up another fund (or funds) for estate planning purposes before 30th June 2017 and divide the assets of the current fund by moving some properties to the new fund, there is a further restriction imposed by exemptions contained in Section 66 of SIS Act.

Only business real property (BRP) can be acquired from a related party, the two funds would be considered to be related to each other and transfer of any residential property will be prohibited.

If BRP of one fund has to be moved to another fund, you will first have to rollover cash from one fund to the second fund so that trustees of the second fund are able to purchase BRP from the trustees of the first fund. Since the first fund is in pension phase, this sale will trigger a CGT event, however no tax will be payable as there is no capital gain tax on sale of assets which are 100% supporting a pension before 1st July 2017.

When BRP is sold to another SMSF, the beneficial interest in the property will remain the same as the property will move into the new fund for the same members, albeit in another fund, no stamp duty should be payable. Enquiries should be made with the office of state revenue before implementing this strategy.

Many investors are withdrawing the excess over the balance transfer cap amount and investing outside of super in structures like family trusts.

 Click here to learn more about family trusts

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