Tony Negline says superannuation fund administrators often face problems when dealing with self-managed super fund pension transactions
Pensions, and the various different transactions which can occur with them, always present problems for superannuation fund administrators. This is particularly the case with self-managed super funds. This is the first in a series of articles explaining various pension transactions. In drafting this article I have relied on a paper written by my colleague Michael Hallinan, senior counsel at Townsends Business and Corporate Lawyers.
For the past 20 years, most pensions provided by small super funds and retail super funds have not been “set and forget”. They require active management from at least three perspectives – asset allocation, income management and liquidity management. Liquidity management is the process used to ensure there is always sufficient cash to meet the pension income payments. Of particular importance is the range of specific administrative and legal issues that have to be considered when cashing out, rolling back, rolling over, refreshing, merging, and establishing/ resetting any reversionary beneficiaries. In this article we’ll look at cashing out and rolling back transactions. Before we look at specific issues that apply to the transactions, there are a couple of points which are common to all transactions that involve cashing out or rolling back a pension.
Before a lump sum is paid or the pension rolled back, the pro-rata minimum pension must have been paid. Once the lump sum has been paid or pension rolled back, some people recalculate the annual required minimum pension payment. Ordinarily this minimum pension amount is worked out each July 1. The rules don’t allow the minimum pension to be recalculated. To be explicit, the minimum pension payment is not recalculated because of a lump sum commutation or rolled back pension. From the financial services law point of view, the lump sum is deemed to be similar to the purchase of a financial product. This means that if a licensed financial adviser has recommended the lump sum payment or rolling back the pension, then they should issue a Statement of Advice (SoA) and detail why taking the lump sum is an appropriate course of action as well as all the costs involved in the transaction.
Cashing out pensions
Cashing out a pension occurs when a lump sum is withdrawn from the pension. This lump sum might be for some or all of the pension’s account balance. Pension payments will continue to be paid from any remaining account balance after the lump sum has been paid. The purpose of this transaction is to release money from the pension. In some cases a lump sum of money cannot be paid. For example, Transition to Retirement pensions can only have a lump sum paid from them if the pensioner is officially retired. The lump sum cannot be used to satisfy this minimum pension payment requirement. There is some conjecture on this point in superannuation circles. Some argue that the words used in the super laws provide that the lump sum can be used to meet the pro-rata minimum pension payment.
Others respond that this is making too much of the words used in the super laws and would not have been the intention of the Government who drafted these rules. The lump sum paid is split between the tax-free and taxable percentages, which were worked out when the pension commenced. (Special rules can apply to some pensions which commenced before July 1, 2007.) These percentages are used to work out the taxable and tax-free components. If the pensioner is under 60 when the lump sum is paid and it contains some taxable component, then tax may have to be deducted by the super fund. How are these benefits taxed? If the person doesn’t specifically nominate that they want to receive a lump sum then they will be deemed to be receiving a pension payment. For those aged at least 55 but under 60, the pension payment will be taxed at their marginal rates less a 15 per cent rebate.
For those over 60, these pension payments will be tax-free. If tax does need to be deducted, then the super fund will have to be registered for Pay As You Go (PAYG) Withholding purposes. The process of applying for this PAYG Withholding is relatively simple but can take a bit of time to finalise. This can be a pressure point if the lump sum is needed urgently. Once the lump sum payment has been made there is no adjustment to the tax-free and taxable proportions in the pension. From a financial services law point of view, in most cases, the lump sum payment does not involve issuing a financial product and as a result the super fund trustee does not need to issue a Product Disclosure Statement.
How are these transactions typically completed? It’s generally a 10-step process:
-Member requests payment or notifies that they have the right under the terms of the superannuation product;
– The trustee confirms entitlement to cash out a lump sum;
– The trustee issues a Pre-payment Statement – a specific document issued by the ATO;
-The Pre-payment Statement is completed and signed by the super fund member and returned;
– The trustee acknowledges whether the member wants the payment to be treated as a lump sum or pension payment;
– If required, the trustee applies to be a PAYG
– If required, the trustee works out what the pro-rata minimum pension payment should be just before the lump sum is paid;
– The trustee sells/transfers assets to make the lump sum payment;
– The trustee adjusts the pension account balance;
– Finally, the trustee pays the lump sum and if required withholds PAYG tax.
Rolling back a pension
Rolling back a pension effectively means moving some or all of a pension’s account balance back into the growth or accumulation part of a super fund. In general this accumulation part is taxed at 15 per cent inside the super fund, whereas the pension part is taxed at 0 per cent. Rolling back some part of a pension’s account balance into the accumulation part of the super fund will affect future pension income payments. Obviously if all of the account bal- ance is rolled back then all future income payments from that pension will cease. The purpose of this transaction is either to eliminate the payment of excess income or to seek protection from creditors. Creditors can often claim income payments, including pension payments, to repay debts but may find it harder to attack a super fund account balance.
All account-based pensions – including Transition to Retirement pensions – can be rolled back to the accumulation phase. In some rare cases the rules of a pension do not allow it to be stopped for any reason. This typically applies with death benefit pensions and is designed to stop a spendthrift spouse wasting all the money. The amount rolled back from the pension will not be a contribution for super law purposes and, as noted above, it cannot be used to satisfy the minimum pension payment rules. Before the pension is rolled back, the super fund trustee must make sure that the pro-rata minimum pension has been paid.
As this type of transaction is conducted within a super fund, no part of the account balance rolled back will be taxed in the super fund member’s hands. The amount rolled back will form a member interest within the super fund separate from the member’s pension interest. If the member already has a growth interest, then the amount rolled back will be added to it. There will be no adjustment to the dollar value of the tax-free component of the pension if the whole pension account balance is rolled back. The taxable component will be the balance. A slightly different rule will apply if part of a pension’s account balance is rolled back. In this case the original amount of tax-free component remains unchanged and is split between the amount rolled back and the remaining pension account balance. As noted above, the amount rolled back will not be a contribution for super law purposes.
The rolled back amount will also not be a contribution for tax law purposes and hence will not count towards the member’s concessional and non-concessional contribution limits. From a financial services law point of view, depending upon the relationships involved, some financial advisers might be able to rely on replacement product advice rules. Typically these rules reduce the amount of material that has to be disclosed again to an investor. In most cases rolling back will involve issuing a financial product. This means that a super fund trustee should only roll back the pension after receiving an eligible application from the member. A Product Disclosure Statement (PDS) must also be issued unless an exemption can be used. For example, if the member already has the current PDS and it provides all
How are these transactions typically completed? It’s generally a six-step process:
– Member requests rollback of pension or notifies that they have the right under the terms of the superannuation product;
– The trustee confirms entitlement to rollback and acknowledges member election;
– If required the trustee works out what the pro-rata minimum pension payment should be just before the rollback is made;
– The trustee sells/transfers assets to complete the rollback;
– The trustee adjusts the pension account balance;
– If the super fund trustee uses segregated accounts for pension and non-pension assets then the trustee will need to ensure that appropriate assets are transferred between pension and non-pension accounts.
Tony Negline is general manager, corporate strategy, at SUPERCentral – www.supercentral.com.au. He is also the author of ‘A How to Book of Self Managed Superannuation Funds’.