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Self Managed Super Fund (SMSF) Article
SMSF Defined Benefit Changes
By Tony Negline.
This article may be out of date.
19th May 2004
Surprise has greeted the closing of three superannuation concessions in last week’s Federal Budget.
The surprise is not that the concessions have been closed but the timing and method used to close them.
On many occasions when the government wants to remove an unintended concession, it has often used a sledgehammer to crack a nut. These new changes are no exception.
What concessions have been lost?
The first change has removed the ability of small funds to provide defined benefit pensions. These pensions may be payable for the remaining life of a member (often called “lifetime pensions”) or for a specified term (mostly called “term pensions”).
Over the last four or five years, an increasing number of investors have used lifetime pensions to obtain up to five concessions. Depending on individual circumstances, some people wanted all five concessions; others only wanted one of them.
First, if the lifetime pension were structured properly, the assets would be exempt for Centrelink assets test purposes. This concession was reduced in February this year to only 50% of the assets being exempt under the assets test.
Second, and the most important concession, the value of a lifetime pension for Reasonable Benefit Limit assessment purposes may be much less than the assets actually used to purchase the pension. (This concession arises because of the method used to work out the RBL value of lifetime pensions.)
Small fund trustees used this concession to reduce the value of a member’s total super assets below their RBL. Such pensions still generate the 15% rebate thereby significantly reducing the amount of income tax payable on each pension payment. By using this system, it was not unknown for people with more than $3 million in super assets to have all their super benefits fall under their pension RBL of $1.1 million.
The third concession involves lump sum withdrawals from pensions which are not determined to be in excess of the members RBL. Lump sums withdrawals from such pensions don’t face excess benefits tax of 48.5%. (Every lump sum withdrawal from pensions which contain an excess component do suffer this high tax rate on the portion of the withdrawal deemed to be an excess component.)
These RBL concessions have not been removed. They can still be obtained by lifetime pensions paid from super funds with at least 50 members. This means these RBL concessions is still potentially available for employees, such as some public servants, of larger employer super funds and investors in master funds that offer this style of product.
The fourth concession was designed to ensure that the assets used to provide the pension remained available to the member’s dependants after the member dies. That is, for estate planning purposes. This concession is traditionally not possible in other income stream vehicles such as lifetime annuities provided by life insurance companies.
The fifth concession ensured that the assets of the member were effectively hidden from any claims on those assets by creditors. This concession is still possible.
Anyone who has a lifetime or term pension in a SMSF that commenced before 12th May 2004 will be able to continue with this benefit in his or her SMSF. Some believe this concession extends to funds created before 12th May ’04 but this point hasn’t been confirmed.
Why has this change been made? The government has said they are concerned with the RBL concession and estate planning SMSFs could generate using lifetime pensions. The government wanted to return lifetime and term pensions to only arm’s length funds.
Over the last few years some SMSFs which have been paying lifetime or term pensions have found themselves in financial trouble. The financial trouble arises when an actuary determines that the SMSF may not be able to pay the future pensions payments. When this occurs the trustees must make some difficult decisions and the regulator must be informed. As the number of SMSFs paying lifetime and term pensions increased the regulator must have become increasingly concerned.
So what pensions can SMSFs pay members needing a new pension after 11th May 2004?
SMSFs can now only offer allocated pensions and the new growth pension (which the government likes to call market-linked pensions and can only be offered from 20th September 2004 onwards).
Does that mean SMSF will no longer be used for excess benefit strategies? Many wealthy investors must either decide to invest inside or outside the super system.
Outside the super system they face their marginal tax rates (often 48.5%) on any income they receive each year and capital gains tax whenever they buy and sell and asset for a profit.
If they invest in a SMSF, the income they receive will still be taxed at their marginal rates, assuming that the 15% rebate is not available on their excess pensions. But the SMSF advantage is that within the super environment, assets can accumulate in a 0% tax environment – in other words CGT doesn’t apply within a SMSF when uses assets to pay a pension. The capital profit will be taxed when it is withdrawn as income, so some careful planning is needed to work out what produces the best after-tax benefit.
The second and third changes require all SMSFs to automatically allocate all contributions made for a member to that member’s account. These new rules stop new employer contributions and existing account balances being placed into a reserve account to be distributed amongst other members of the fund. The Australian Taxation Office has been trying to close this provision for some time.
This strategy is often called ‘forfeiture’ and involves trying the transfer money from one member, who has a large super fund account balance greater than their RBL, to another member, often their spouse, who has a much smaller account balance. The objective is reducing the size of the excess benefit and improving the RBL position of the benefit.
At the last election the Coalition proposed allowing the splitting of contributions between spouses. This change is yet to be legislated but needs to be expanded to allow for the splitting of super account balances between spouses.
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