On 7 December 2024, the SMSF sector was handed a somewhat unexpected, but much welcomed, early Christmas present.

The SMSF Association definitely deserved this reward after their extensive advocacy efforts over several years.

The many hundreds of hours in lobbying and public consultation eventuated in the passing of the Treasury Laws Amendment (Legacy Retirement Product Commutations and Reserves) Regulations 2024.  The law introduced a 5 year amnesty period, allowing affected long-suffering SMSF members to exit legacy pensions.

The lobbying and consultations commenced in 2019 (including annual Budget submissions), and included strong arguments against joining the proposed legislation with other tax policies such as the proposed Division 296 tax.  The simplified legislation was then voted in, much to the relief of the SMSF Association, it’s members and clients.

Retirees can now be free from the non-commutable legacy pensions, including legacy lifetime, life expectancy, and market-linked income stream products; Treasury estimates that almost 17,000 SMSF legacy pension accounts could be affected.

In view of the fact that members in these legacy products were in their 60s and 70s when they commenced the pensions over 20 years ago, we are now seeing genuine opportunities to restructure their retirement savings tax effectively.

Who is affected? 

• Pensioners currently receiving a lifetime defined benefit pension, life-expectancy pension or market-linked pension (including ‘newer’ conversions from defined benefit pensions)
• Members who previously restructured their defined benefit pensions and were left with an reserve in the Fund 
• SMSFs with reserves relating to deceased members

Timeframe of five years

The new Regulations relax the existing commutation restrictions that have historically stopped members exiting legacy pension products.  Now affected members can use the capital to commence another retirement phase interest, leave the balance in an accumulation account, withdraw it from superannuation, or a combination of these options.

The Regulations outline the need to undertake a full commutation within 5 years from 7 December 2024.

This relaxing of the rules will allow some individuals to exit obsolete products and in some cases wind up SMSFs that may have become unsuitable for their circumstances.

Further Government lobbying is likely, to further request partial commutations and, in exceptional / unforeseen circumstances, for the ATO Commissioner’s discretion to approve commutations beyond the 5-year period.

Reserve allocations – another positive

Under current rules, allocations from a Fund’s reserve are often counted towards the receiving members’ concessional contributions cap – in 25FY being $30,000.

Trustees allocating small amounts of a reserve each year, if ‘fair and reasonable’, would avoid members’ triggering excess contributions consequences; however this would often result in large unallocated reserves often being ‘stuck’ in the superannuation system.

These new regulations provide that where a reserve supported an income stream (i.e. a pension reserve) and that income stream has ceased or been commuted, and the reserve is allocated to a former recipient of that income stream, including a reversionary beneficiary, the allocation will not be counted toward their concessional nor non-concessional contribution cap.  This is a significant change, meaning the allocation can be made via a new cap-free pathway.

For allocations from other non-pension reserves, these regulations ensure that all other reserve allocations, will now be counted towards a member’s non-concessional contributions cap, rather than their concessional contributions cap.

These rules are now also effective 7 December 2024, and importantly do not have a 5 year time frame.

It is expected that the new Regulations will enable trustees to review a Fund’s pension and reserves structure for simplification and efficiency going forwards.

Things to watch out for

It’s not all positive news, particularly in situations where a pensioner member has passed away.  The allocation of a pension reserve will not be able to receive the same generous tax treatment.

As an example, when a life expectancy pension’s term ends, the pension ceases. The resulting reserve amount associated with the pension remains in the Fund – awaiting allocation to a member account.

Under these new regulations, where the reserve allocation is made to someone other than the pension recipient – for example, the pension recipient has subsequently died – the cap-free pathway is no longer available.

Instead, any reserve allocations will be counted toward the beneficiary’s non-concessional cap – unless allocated under the ‘fair and reasonable’ approach. Of course, in some cases this is potentially still a better outcome than being assessed against their concessional contribution cap.

Social security impacts

It is concerning to some members that are receiving social security benefits that a Centrelink debt may arise from the commutation of these legacy pensions.

The Government has provided assurances that the required social security legislative instruments will be enacted in due course to alleviate these concerns.  Until this eventuates, concerns still linger that social security sensitive members may be negatively impacted by this recent development.

It is known that the pension asset value will lose the asset test exemption moving forward, however it would be comforting to see this legislation passed to ensure they are not also issued a debt notice if it were to count for the assets test for the last 5 years.