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Self Managed Super Fund (SMSF) Article
Undeducted Contributions & RBL Assessments

By Tony Negline.

This article may be out of date.

15th February 2006

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How to retire with maximum tax efficiency is a complicated beast and full of unexpected and unnecessary traps.

Consider Roger Wilson who started an allocated pension in August 2001.  The opening account balance of this pension was $500,000 and it was all undeducted contributions.  As a result all of his purchase price forms part of his Undeducted Purchase Price (UPP).

When he retired, he took $520,000 out of super as a lump sum, paid some tax on the withdrawal and contributed the net of tax proceeds – $500,000 – into super.  As his total super benefits were less than his lump sum Reasonable Benefit Limit he thought he had not created any RBL problems in 2001 or later.

In August 2001 Jim was 63 and back then his life expectancy would have been 17.70.

This means that the pension will pay him $28,249 income tax free each year.  Jim will receive this tax-free payment for each and every year the pension pays him and income.  If Jim receives pension payments for 30 years then he will always receive over $845,000 in tax-free income.  When Jim takes into account the 15% rebate, he can receive over $55,000 income from his pension before paying any income tax.

Taken together these are considerable concessions.

Lets move to March 2006.  It is now about five and a half years since Jim started his allocated pension.  He has heard that the government recently changed the factors that work out the income that an allocated pension must pay.  The new factors will pay him a lower income which will help his retirement savings last longer.  Jim is concerned about running out of money before he dies.

But the only way Jim can access these new factors is to leave his current allocated pension and start a new one.

Under the tax laws if a pension is stopped then the Eligible Termination Payment components are recalculated.

The original UPP is reduced with each pension income payment.  In Jim's case he has paid himself $183,612 of his undeducted contributions.  His remaining undeducted contributions are therefore $316,388.  In effect he has been running down his UPP at 5.6% per annum as can be seen by the diagram.

Assuming Jim had paid himself the minimum pension for every year and also assuming his fund had an average return of 10% (after fees and charges) since the pension commenced then his current account balance will be $556,400.  After we deduct the UPP, the remaining balance, or $240,000, is split between his pre July '83 and post June '83 service periods.

When Jim starts his new pension, the $240,000 of pre and post 1983 monies will be assessed against his Reasonable Benefit Limit.  However as we have already mentioned, before he started his first allocated pension he took $530,000 out as a lump sum.

When his new pension starts the ATO will take all benefits received beforehand and will index them up by movements in Average Weekly Earnings.  The $520,000 received in August 2001 has a value of about $645,000 in March 2006 assuming increases of 4% per annum in average weekly earnings.

The current benefit and the revised value of the previous benefits are then added together and assessed against the relevant RBL.  His current lump sum RBL is $648,946 and the total benefits assessed against it are $885,000.  This means that if Jim moved to a new pension he would be generating a large excess benefit.

The only way Jim can avoid this RBL problem is to remain in the pension product he started when he retired.  This places a heavy burden on Jim and his advisers.  The super system changes constantly so how is anyone meant to know what will suit Jim for even a short period of time?

Additionally there are many reasons an investor might want to move from one pension product to another.  For example, an investor's current product may have poor investment returns or the product issuer  might provide poor service.  People in these circumstances also need to approach the movement of their pension products with a great deal of caution.

Notional account balance ETP components

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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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