There are some quirky aspects of the application of the minimum drawdown and related tax rules for account-based pensions which have caused uncertainty, particularly for clients aged from 55 to 59 inclusive. However, recent Australian Taxation Office (ATO) statements appear to remove all but a few of the remaining mysteries. This article examines some interesting tax implications that can arise for account-based pension clients under the age of 60 depending on the manner in which they make their drawdowns.
Importance of meeting the minimum drawdown requirement
As a starting point, it is worth emphasising the importance of a client with an account-based pension (ABP) receiving total annual payments necessary to meet the Superannuation Industry (Supervision) Act 1993 (SIS) minimum drawdown requirement. As the ATO has made clear in Tax Ruling TR2013/5, if this requirement has not been met then it considers that an ABP will have ceased at the start of the relevant income year (or not started at all, if it was to have been the first year). The tax consequences for that year are typically unfavourable and include no fund earnings tax exemption and potentially higher tax on benefits paid. The ATO can only exercise discretion to overlook failure to meet the minimum drawdown in very limited cases.
How the minimum drawdown requirement is met for a client varies depending on the preservation status of their super benefits; that is, typically, the extent to which their benefits are classified as unrestricted non-preserved, restricted non-preserved or preserved. For clients aged 55 to 59 this often turns on whether or not they have retired for the purposes of SIS.
The retired account-based pension client
Assume Milan is 58 years old, retired for the purposes of SIS and started an ABP in his SMSF in 2014/15 with unrestricted non-preserved benefits, all taxable component. His minimum drawdown requirement for this year is $30,000 and he has already drawn $10,000 by way of regular income payments. He is contemplating making a partial commutation and cashing a further $20,000 in one lump.
Note that, prior to any partial commutation, the cashings during the income year must have been at least equal to a pro rata amount of the minimum, based on the number of days the ABP was payable in the financial year up to the commutation date. Alternatively, after a partial commutation the remaining ABP balance must be enough to pay any outstanding minimum requirement. Assume Milan meets these requirements.
Can a partial commutation count towards meeting the minimum? While SIS makes a distinction between partial commutations and other payments for various purposes, cashings arising from partial commutations count towards the minimum drawdown requirements in the same way that regular income payments do. The ATO has acknowledged this in its Self Managed Superannuation Fund Determination SMSFD 2013/2.
Can the partial commutation be taxed as a lump sum benefit? The table below sets out the tax treatment of lump sum benefits and income stream benefits for Milan.
| Lump sum benefit | Income stream benefit | |
| Taxable component |
|
|
Milan’s regular pension payments will be taxed as superannuation income stream benefits by default. While he will be entitled to a tax offset of 15%, assume his marginal tax rate is higher than that so the payments will give rise to a tax liability.
However, if he makes a written election in advance of the payment, the $20,000 partial commutation can be treated as a superannuation lump sum benefit for tax purposes. The low rate cap referred to in the table above is an indexed lifetime limit ($185,000 in 2014/15) that is reduced by the taxable component of any lump sums Milan has already received in a previous financial year on or after reaching preservation age (age 55 for someone born before 1 July 1960, such as Milan). Assuming Milan has not previously cashed a lump sum benefit, if he makes an election for the payment to be a lump sum benefit the $20,000 partial commutation will fall within his low rate cap and no tax will apply to that payment. (For some clients the temporary budget repair levy may be payable on some or all of such a payment.)
Note that Milan’s fund was liable to make a series of periodic income stream benefit payments which it made prior to his decision to take the lump sum benefit. Had that not been the case it is possible that the ATO may have taken the view that there was no pension under SIS nor was the fund entitled to a tax exemption (refer to Tax Ruling TR2013/5 and Division 295 of the Income Tax Assessment Act 1997).
The transitioning account-based pension client
Assume Roma’s circumstances are similar to Milan’s except that she has not retired and her ABP is a “transition to retirement” (TTR) pension. She started the pension this income year and it comprised of preserved benefits except for around $30,000 of unrestricted non-preserved benefits (URNP) (which were sourced from a benefit rolled over from an employer-sponsored fund upon resignation many years ago). The ATO’s view is that SIS requires payments from a TTR pension to be paid first from URNP benefits, then from restricted non-preserved benefits (but there are none here) and then from the preserved benefits. Roma has received $10,000 in regular pension payments and is contemplating making a partial commutation of the remaining $20,000 of URNP benefits. For TTR pensions, SIS allows URNP benefits to be commuted (but not restricted non-preserved or preserved benefits).
Can a partial commutation count towards meeting the minimum? The ATO has recently issued SMSF Determination SMSFD 2014/1 which confirms that, on the one hand, the partial commutation cashing does not count toward the maximum drawdown constraint for a TTR pension but, on the other hand, it does count towards the minimum. So, while SMSFD 2013/2 indicates otherwise, SMSFD 2014/1 clearly indicates that the ATO would now accept that Roma will have met the minimum once the $20,000 partial commutation is cashed.
Can the partial commutation be taxed as a lump sum benefit? It should follow that Roma can make a written election in advance of payment that the $20,000 partial commutation is to be taxed as a superannuation lump sum benefit and to take advantage of the fact that the amount falls within her $185,000 low tax cap.
What if a TTR pension is fully preserved? Assume instead that Roma’s TTR account comprises only preserved benefits. In this case SIS generally does not permit a partial commutation cashing. However, under the governing rules of Roma’s fund, the terms of her TTR pension permit irregular pension payments so Roma arguably would be able to cash a $20,000 payment from the fund without it being classified as a partial commutation for the purposes of SIS. Would she be able to elect for such a payment to be treated as a superannuation lump sum benefit for tax purposes? There does not appear to be anything which expressly prevents her from doing this under the relevant provisions of the Income Tax Assessment Act 1997, but perhaps the fact that the payment could not be recognised as a partial commutation under SIS prevents this in some way. We await the ATO’s view on this remaining mystery.
Clients about to start a TTR pension: For SMSF clients about to commence a TTR pension with part of their super savings, the ATO website currently suggests that they can choose which classes of benefits they allocate to their TTR pension account for preservation purposes. For those who have URNP benefits, some thought needs to be given to whether or not the URNP benefits should be transferred to the pension account.
On the one hand, if they intend only to draw the minimum required each year, there may be some appeal in transferring URNP benefits into the pension account, as it may provide clear scope for some of the cashings to attract lump sum tax treatment.
On the other hand, the fact that any URNP benefits in a pension account must be drawn from that account before any other benefit may limit the scope to take them as lump sum benefits. In particular, clients who are likely to need to draw more than the minimum and who are keeping some of their super in accumulation phase may gain extra flexibility by keeping the URNP benefits out of a pension account since these will not be forced out of the fund but are available for cashing at any time.
Of course, some clients will transfer all their super savings into the TTR pension for tax and other reasons, in which case any URNP benefits will be allocated to the TTR account and be paid out first.
In many cases clients with ABPs aged 55 to 59 who are cashing only the minimum necessary to satisfy the SIS rules will have the scope for part of the cashings to be treated as a lump sum benefit for tax purposes. Recent ATO statements indicate that this may extend to TTR pensioners, although it is unclear whether that treatment is limited only to their URNP benefits.
* This is an updated version of a feature article that first ran in the December 2014 – January 2015 edition of Professional Planner.
