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Self Managed Super Fund (SMSF) Article
Moving from one pension to another one

By Tony Negline.

This article may be out of date.

1st March 2006

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Restructuring superannuation investments is very common when investors retire.  A popular  strategy is to take a lump sum withdrawal, pay some tax and then contribute the net amount into super.  This is often called the re-contribution strategy.

The purpose of this strategy is to deliver a higher level of tax concessions over the longer term as the re-contributed amounts are undeducted contributions.  Undeducted contributions form part of a pension's Undeducted Purchase Price (UPP).

If a pension has an UPP, every income payment will have some UPP in it.  For allocated pensions, the amount of UPP paid in each income payment is worked out by dividing the UPP by the investor's life expectancy.  The UPP is paid tax-free to an investor and it is this tax concession which makes this strategy very popular.

However retiring with maximum tax efficiency is a complicated beast and full of unexpected and unnecessary traps and sometimes expected tax concessions can be fools gold.

Many retirees might think that once they have bought a pension they will never have to move to a new one.  If only this were true.

There are a wide variety of reasons why someone might want to move to a new pension.  For example, the pensioner might be in a product which has become expensive, the fund manager's investment performance is poor, the investor might be in pension provided by a public offer super fund but would prefer to run their own Self Managed Super Fund and finally an investor may want to access a new pension feature which the government has introduced but the only way to access it may be by stopping an existing pension and moving to a new one.

When an investor moves from one pension to another, two events occur which can drastically alter a person's retirement funding plans.  Sadly most people are probably completely unaware of these events.

Firstly, the Eligible Termination Components of the pension are recalculated.  At the same time, the original UPP is adjusted to take into account the amount of UPP paid with each income payment.

For example suppose Roger Wilson started an allocated pension in August 2000 when he was 63.  The purchase price of his pension was $500,000 and it was all Undeducted Purchase Price.  As his life expectancy was 17.70, $28,249 of the income paid to him each year will be tax free.  This tax-free income will be paid to him for every year that he receives income from the pension.

Roger is happy with his pension but he needs to know if he should move to a new allocated pension.  He has heard that the government recently released new factors which determine the minimum and maximum income that can be paid from an allocated pension (these factors are called Pension Value Factors or PVFs).  And he knows that he can only access these new factors by moving to a new pension.

If Roger were to move to a new pension after six and a half years we would need to recalculate his ETP components in that pension.  Up to this point $183,600 of tax-free income via his original UPP will have been paid to Roger.  His UPP will therefore be $316,400 (that is $500,000 less $183,600) and the remaining account balance will be split between his pre July and post June 1983 components.

If his current account balance was $550,000, then $233,600 will be split between pre and post 1983 components.

The UPP based tax free income will be based on $316,400 and his new life expectancy number which will now be 14.78.

When the new pension starts the second issue which most people are unaware of takes place.  The pension will be assessed for Reasonable Benefit Limit purposes.  In particular the pre and post 1983 components of that pension will be assessed against a person's RBL.

Before the ATO assess a new benefit against an RBL, they add all benefits that have already been assessed against a person's RBL and index those benefit by movements in Average Weekly Earnings.  The new benefit and the indexed previous benefits are then assessed against the investor's relevant RBL.  If the new benefit and indexed previous benefits are greater than the RBL then an excess benefit is created.

Lets assume that before he started his first allocated pension, Roger did the re-contribution with $350,000.  The approximate value of that $350,000 after the ATO index it will be approximately $455,000.

When Roger's new pension starts, the ATO will count $233,600 – his pre and post '83 components – of that pension and the $455,000.  The total amount $688,600 is assessed against Roger's lump sum RBL of $648,946.

As $688,600 is greater than his lump sum RBL, an excess benefit is created and his new pension will receive less tax concessions than Roger's current allocated pension.

The only way Roger can avoid this RBL problem is to remain in the pension product he started when he retired.  But his existing allocated pension may no longer suit his circumstances.  This places a heavy burden on Roger and his advisers.  The super system changes constantly so how is anyone meant to know what will suit Roger for even a short period of time?

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This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.

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