By Mark Ellem
There’s a known technical issue concerning the commutation of market-linked pensions (MLP) and life expectancy pensions (LEP). The ATO have acknowledged the problem and have announced the approach they’ll be taking from a compliance perspective.
Get ready to concentrate.
The issue applies to these pensions, where they were commenced prior to 1 July 2017. Such pensions are included in the definition of a ‘capped defined benefit income stream’ (CDBIS), which means that the credit to the member’s transfer balance account (TBA) is the ‘special value’ of the pension, calculated as ‘annual entitlement’ x remaining term of the pension, rather than the actual balance of the MLP or LEP. For the remainder of this article I will concentrate solely on the issue as it applies to an MLP.
When a pre-1 July 2017 MLP is commuted, the debit or reduction to the member’s TBA is also the ‘special value’, again calculated as ‘annual entitlement’ x remaining term. The actual commuted amount is not relevant when calculating the debit amount to the member’s TBA.
The technical issue is specifically in relation to the calculation of the debit value.
Here’s an example of how the ‘special value’ was intended to be calculated, which is taken, in most part, from the Explanatory Memorandum to the Bill that introduced the $1.6m transfer balance cap (TBC).
Grant commences an MLP in January 2017. The term of the pension is five years. At 30 June 2017, the pension has an annual entitlement of $100,000. The remaining term is rounded up to five years. The pension has a special value of $500,000 ($100,000 x 5), which the credit to Grant’s TBA on 1 July 2017.
One year later, on 30 June 2018, Grant’s pension has an annual entitlement of $90,000. The remaining term of the pension is four years. The pension has a debit value of $360,000 ($90,000 x 4).
Grant decides to fully commute his MLP on 30 June 2018. A debit of $360,000 arises in Grant’s TBA. The balance of his TBA, after the debit, is $140,000.
Let’s take this one step further from the example in the EM, with Grant commencing a new MLP on 1 July 2018, after the commutation and roll over of his existing MLP ($320,000) to another superannuation fund. As the new MLP commenced after 30 June 2017, it is not a CDBIS and consequently the credit to Grant’s TBA is not the ‘special value’, but simply the amount used to commence the new MLP - $320,000. Grant’s TBA balance would now be $460,000.
In the ATO’s view, the debit value for a commutation of a pre-1 July 2017 MLP will always be zero. The ATO believes that there is a deficiency in the drafting of the law and it does not operate as intended and as explained in the EM.
Applying this to the example of Grant, he would not receive a debit of $360,000 to his TBA upon the commutation of his pre-1 July 2017 MLP. Consequently, Grant’s TBA balance, after he commences his new post 30 June 2017 MLP is $820,000, not $460,000. In effect Grant has received a double count of the MLP.
Not receiving a debit to the TBA can result in an excess TBA and potential notional earnings. It could also mean less retirement benefits being used in an account-based pension.
On 14 June 2018, the ATO issued an SMSF news alert specifically on this zero-debit value issue. Importantly, the alert noted that “The government recognises the unintended consequences associated with the current law and is committed to ensuring smooth implementation of the 2016 super reform measures”.
Where an excess TBA would result due to zero debit value for the commutation of a pre-1 July 2017 MLP, the alert advises that the ATO will take the following practical compliance approach:
Which option to adopt will depend on the circumstances for the member. For example, taking the option of not reporting the commutation and commencement of the new market-linked pension, will not alter the member’s TBA balance. Further, you would have to ensure that both the commutation and commencement events are not reported.
As noted, only a pre-1 July 2017 MLP is a ‘capped defined benefit income stream’, which is subject to the $100,000 defined benefit income cap. Consequently, a full commutation of a pre-1 July 2017 MLP and commencement of a post 30 June 2017 MLP will mean:
A full commutation and re-start may also occur where it is decided to wind up the SMSF and rollover the pre-1 July 2017 MLP to an APRA regulated fund. In this scenario, the option of not reporting the commutation will depend upon whether the APRA regulated fund will or will not report the commencement of the new MLP.
Besides this zero-debit value issue, there still exists the issue of the commencement of a post 30 June 2017 MLP, where on its own, the commencement value is more than $1.6m TBC. The ATO alert does not deal with this issue and industry continues to await any news on how the ATO or Government will approach a solution to this quandary.