A member with an Account Based Pension must meet their annual minimum pension payment requirements. This minimum amount is determined by the member’s pension balance as well as their age as at 1 July of the relevant year as specified under r.1.06(9A) of the Superannuation Industry (Supervision) Regulations 1994.
In today’s blog we will consider questions such as what if a member wishes to pay an asset out of the fund (in specie)? or what if they pay themselves more than their annual minimum pension? Below we will discuss how a partial commutation can be implemented to benefit your clients.
What is a Partial Commutation?
A benefit payment arising from the partial commutation of a member’s account-based pension is a lump sum for superannuation purposes. However, prior to 1 July 2017 such a payment constituted a superannuation income stream benefit for tax purposes unless the member elected under reg 995‑1.03 of the Income Tax Assessment Regulations 1997 (Cth) (‘ITAR’) to treat it as a lump sum for tax purposes.
Therefore a lump sum payment arising from a partial commutation counted towards the annual minimum pension payment requirements as outlined in the ATO’s view as per SMSFD 2013/2 and SMSFD 2014/1.
From 1 July 2017 the law was changed to align the super and tax law treatment of a partially commutated amount of a superannuation income stream paid to constitute a superannuation lump sum.
Why Should a Partial Commutation be used?
In-Specie Partial Commutations
The ATO have confirmed on numerous occasions that pension payments must be ‘cashed’ and cannot be paid by transfer of assets to a member (i.e. in-specie).
This view was reinforced in SMSFD 2013/2 the ATO stated:
Further, the partial commutation payment is a lump sum for the purposes of the SISR 1994 and counts regardless of whether the payment is made in cash or in specie.
Therefore, if a member wishes to make an in-specie payment out of the fund (as opposed to a cash payment), a partial commutation is an option that is available to a member (the other option being a regular lump sum from the members accumulation account)
Reduction of SMSF Taxation Liability
One benefit of using a partial commutation is the fact that the member’s pension never has to be commuted to accumulation phase in order for the payment to be made. Unlike a lump sum payment that can only be made from a members accumulation account, a partial commutation is made from a members pension account which avoids the need to roll back a specific balance to accumulation phase.
By avoiding the step of rolling back to accumulation phase, the member’s time in pension phase as opposed to accumulation phase is maximised therefore keeping the fund’s exempt current pension income as high as possible (meaning less tax to pay).
Furthermore, this may also avoid the cost of the fund having to purchase an actuarial certificate (proving the members of the fund had no other accumulation balances throughout the year). Where a lump sum is used and a member is required to roll back a part of their balance to accumulation phase, an actuarial certificate will be required in some circumstances.
Strategy for Members Under 60
A partial commutation can be important for members under 60 as they are able to take advantage of their low rate cap. If a lump sum payment is made from a superannuation fund for someone under 60, the payment is generally tax free up to the amount of their unused low rate cap.
The current low rate cap is $210,000.
It should also be noted that only the taxable portion of the lump sum payment is counted towards the members low rate cap. All tax free components will always be tax free, regardless of the member’s age.
Once a member is over 60, all lump sum payments are tax free, regardless of the taxable and tax free components.
Partial Commutation for a TRIS
Prior to 1 July 2017 there was ambiguity regarding whether a partial commutation could be used for a TRIS. Many leading SMSF providers were promoting this as a viable strategy, even though there was clearly uncertainty regarding whether or not the ATO would allow such strategy to be used.
From 1 July 2017, the ATO has made it very clear in that a partial commutation can only be used where the member has unrestricted non-preserved components. Where a member has reached preservation age and commenced a TRIS, their member components will still be classified as preserved. It is only where the member satisfies a condition of release with a nil cashing restriction, such as retirement that will cause the members components to be classified as unrestricted non-preserved, thus giving access to being able to make a partial commutation lump sum.
Transfer Balance Cap Considerations
Partial commutation strategies undertaken post 1 July 2017 may become more significant as a result of the introduction of a members $1.6m transfer balance cap.
Upon a member commencing an account based pension, they need to consider the effect this will have on their $1.6m transfer balance cap as any pension commencement results in a credit of the members cap (i.e. the members remaining cap balance cap increases). However, what should be noted is a partial commutation results in a debit of the members transfer balance cap, meaning that using a partial commutation will reduce the balance of the members transfer balance cap, allowing commencement of future account based pensions.
This generally means that fund members who take more than their prescribed minimum pension payment as an ordinary pension payment will generally want to take any additional drawdowns in the form of a lump sum benefit payment arising from a partial commutation from 1 July 2017 to maximise their unused TBC. If they do not take this course of action, the additional pension payments they receive will reduce their pension capital without a corresponding reduction in their transfer balance account.
Documenting Partial Commutation Strategies
In TR 2013/5 it is the ATO’s view that a member must “consciously exercise their right” to make a lump sum partial commutation payment. Without any documentation existing, it is very difficult to prove the member has in fact opted to make a partial commutation payment as opposed to a regular pension payment.
Furthermore, due to a partial commutation affecting a members TBC, this forces documentation to be prepared either before or at the time the payment is being made. Failure to do so could result in the ATO deeming the partial commutation payment as a regular pension payment for the member.
Should you require assistance in documenting any future partial commutation payments made by your SMSF clients, we can assist you by providing the necessary documentation to support such transactions.
Please contact us, if you would like to access our comprehensive suite of SMSF documents.