It’s been nearly eleven years since Treasurer Peter Costello introduced the ‘Simpler Super’ reforms in the 2006 Federal Budget. The new rules certainly removed layers of complexity from the system – notably by abolishing Reasonable Benefit Limits – but it quickly became clear that the benefits were flowing disproportionately to the well-off.
The super laws have been tweaked almost every year since then to rein in these tax advantages, particularly by cutting back contribution limits. While this has been partially successful, recent economic modelling suggests that the system continues to favour the wealthiest two deciles of the population.
The super changes announced in the 2016 Federal Budget are an acknowledgement that just restricting how much you can put into super is not enough; there needs to be some limit on account balances as well.
$1.6 million Transfer Balance Cap
Hence the introduction of a $1.6 million Transfer Balance Cap (TBC) which will take effect from 1 July 2017. The TBC limits the amount of money you can keep in a tax-free pension account or ‘retirement account.’ It also includes the estimated capital value of any defined benefit income streams and there is talk that limited recourse borrowing arrangements could be caught in the net as well.
Those who exceed the $1.6 million TBC on 30 June 2017 will need to commute the excess balance back into an accumulation account or take it out of the superannuation environment altogether.
To compensate for the loss of tax benefits by moving pension money back into an accumulation account, the Government has announced that certain funds will be able to reset their capital gains tax (CGT) cost base during the ‘pre-commencement’ period. This is from when the policy changes were announced on 9 November 2016 until they begin on 1 July 2017.
The rules are slightly different depending on whether the relevant super fund has ‘segregated’ or ‘unsegregated’ assets.
A segregated super fund is one that has its investments specifically allocated to a particular member’s account. For instance, one member might hold a portfolio of shares and another might hold an investment property. In an unsegregated fund, all the assets are lumped together in one pot and each year an actuary determines how much is assigned to each member’s account.
A super fund that is solely in accumulation phase or solely in retirement phase is treated as a segregated fund. That would be the case, for example, if a super fund comprised two retirees who only had pension accounts. But if the same two retirees also had money in an accumulation account as at 9 November 2016, the fund would be classified as unsegregated. The fund’s tax-exempt and taxable income would then be split proportionally based on the average balance during the financial year.
If a member has a pension account balance of above $1.6 million cap, they will have the option to reset the cost base for each asset or parcel of assets in their account.
While this sounds like good news, it’s not that straightforward or generous. People in pension mode can already reset their CGT cost base virtually anytime they like by selling the asset and buying it back at some suitable point in the future. The CGT cost base reset option just allows them to do this without incurring brokerage or stamp duty.
The investments that qualify for the CGT cost base reset are different for segregated and unsegregated funds. For a segregated fund, the member’s investments can be reset using one of two options:
- by reallocating the segregated asset from the pension asset pool to the accumulation pool and continuing to keep the fund segregated, or
- by adopting the proportional method to assets that support superannuation pensions.
The main difference is that under Option 1, only assets that have been reallocated back to the member’s accumulation account get their cost base reset to the current market value. Other assets in the pension pool keep their original cost bases. The reallocated asset is then deemed to have been sold and repurchased at its market value on 30 June 2017.
Under Option 2, CGT relief can apply to all the fund’s pension assets, not just those that the trustee has allocated back to the accumulation pool.
For the current financial year, there is no immediate difference between the two options but over the longer term, the proportional method probably has some advantages because, as noted above, it allows the cost base to be reset on all the fund’s segregated pension assets.
When determining what to do, you need to keep in mind that resetting the CGT cost base is deemed to be a sale for tax purposes. It therefore restarts the clock on the 12-month holding rule for the 50% CGT discount and the 45-day rule for franking credits on dividends.
Even more importantly, if the CGT reset results in a notional capital gain, then this will need to be reflected in the super fund’s tax return like other capital gains.
But there is a little bit of good news on this score. Trustees will be able to make an election to defer the gain – in which case it will not be realised until the asset is sold – or make no election to defer which means the gain will be brought to account in the 2017 financial year. Any carry forward or other capital losses can be used to reduce this notional gain.
What strategies are available?
As you can see, the latest rules will unleash a raft of new compliance costs and complexity on super fund administrators, although they will probably be a boon for accountants, lawyers and advisers.
In fact, the proposed changes are arguably worse than the previous Reasonable Benefit Limit regime. By our calculations, the 2007 Pension RBL of $1,356,291 would now be around $1.921 million based on changes in average weekly earnings. That’s over $300,000 higher than the new Transfer Balance Cap.
On the plus side, there are several strategies that clients might be able to use to mitigate the impact of the TBC.
- Equalising superannuation balances. Where one member of a couple has a superannuation balance that is likely to exceed the transfer balance cap, it’s worth exploring whether superannuation money can be moved into the lower balance partner’s name.The easiest way to do this is via a re-contribution strategy. This involves withdrawing money from the higher balance account and contributing it to the lower balance partner’s account, either as a concessional or non-concessional contribution. For clients over age 65, the usual work test requirements will need to be met. Namely, the person must have worked 40 hours in a consecutive 30-day period prior to making the contribution.Some members could also consider splitting future contributions into their spouse’s superannuation account or contributing pension payments from an income stream into the lower balance partner’s account.
- Where a member requires more retirement income than the minimum drawdown from their pension account, they should try to take lump-sum commutations from the accumulation account rather than the pension account or by increasing their pension payments. Pension payments do not free up space under a person’s transfer balance cap but commutations do.
- For members who have commenced income streams with 100% tax-free super savings, it can be beneficial to keep any commutations in a separate accumulation account. This can provide estate planning benefits in cases where death benefits are expected to be paid to non-tax dependent beneficiaries.
GENERAL ADVICE WARNING: Wren Advisers has not taken into account your particular objectives, financial situation or needs when preparing this publication. It is therefore not financial product advice and may not be applicable to your circumstances. You should consider your circumstances and consult with a qualified adviser before making any investment decision. Past performance is not an indication of future performance. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), we do not accept responsibility for any loss suffered by any person arising from reliance on this information.