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Four questions to help Australians manage the new $1.6m cap on pensions

$1.6 million sounds like a lot of money until you realise it needs to sustain you for, potentially, the rest of your life. However, as at 1 July 2017, Australian individuals could only begin their retirement-phase superannuation pension with a maximum of $1.6 million in the tax-free account.

Excess funds can remain in an accumulation account where the earnings will be taxed at 15 per cent.

It was initially expected that this cap would affect a tiny proportion of the population using superannuation-based pension funds to minimise tax and maximise wealth. However, this change will affect more Australians than initially anticipated.

This is because the average self-managed superannuation fund (SMSF) balance is just under $800,000 per member. While that seems to fall well and truly under the cap, many members don’t realise that the cap also applies to any death benefits the member may receive. Therefore, if a member has $800,000 in their pension fund and their spouse has, for example, $900,000 in their fund, they’ll exceed the $1.6 million cap if one spouse passes away and passes their benefit to the surviving spouse.

This creates an awkward situation in which members may need to remove value from their superannuation accounts before commencing a pension. If the amount is in cash, the transaction could be simple but, if an SMSF includes property such as farmland, business properties, or even residential property, then removing the assets could create complexity. Research has shown that 25 per cent of SMSFs own commercial property while a further 20 per cent include residential property. (1) This creates a significant risk that the SMSF won’t have cash to pay out a death benefit because the cash is tied up in the property.

Furthermore, if members haven’t conducted sufficient estate planning with the changes in mind, the property could end up with someone who wasn’t originally intended to benefit. The impact of this could be significant depending on whether the intended beneficiary was depending on that property for their income.

A key advantage of SMSFs is their ability to hold business property but these reforms mean SMSF members may need to reconsider how they structure their property ownership, along with how to take the property out of the SMSF at the right time without incurring a large tax burden.

There are four key questions Australians should consider in relation to their SMSFs to keep them under the $1.6 million cap:

1. Do you know where your super benefits will end up?

Many people think their superannuation benefits are covered by their will automatically. However, unless you explicitly state your preferences with regard to the beneficiary of your superannuation, this isn’t necessarily the case. If there are no clear instructions that specifically relate to the superannuation fund, it may be left up to the fund’s trustee to decide where the money goes. That could mean that the person you intended to receive your benefits, such as your offspring or partner, may not receive them. This can lead to protracted battles over money and property, which can be expensive and stressful, and the results are never guaranteed.

2. Should pensions automatically revert to living spouses?

If a couple both have $900,000 in superannuation pensions, they will exceed the $1.6 million cap when one passes away if the benefit is transferred to the spouse as is almost the case. It may be better to exercise some discretion on where the pension funds end up. Clever planning is required to make sure that the benefit goes to the right person, in the right format without giving away too much in tax.

3. How will you transfer your farming, investment, or other significant assets in SMSF to the next generation?

Converting physical assets such as farming or business properties to cash outside the SMSF can attract capital gains tax and stamp duty, so it’s important to address inheritance issues before the member dies. In some cases, it may be better tax-wise to transfer those assets earlier.

4. What impact will it have if you have to cash out part of your business premises?

Many people invest significant effort into setting up their SMSF and using it to purchase property. However, the ramifications and complications of getting that property back out of the fund are rarely considered, and they can be substantial. If the contract and loan documentation aren’t set up correctly, it may not be permissible to cash out just part of the business premises and it may become necessary to sell the property, which could cause losses.

It’s important for people who may reasonably expect to have a pension fund that exceeds $1.6 million, either as an individual or combined with their spouse, to consider ways to remove assets from the fund to avoid losses well before retiring.

Reference:
(1) Class Super December 2017 Benchmark Report

Katie Timms is national director, superannuation and SMSF services at RSM Australia

Four questions to help Australians manage the new $1.6m cap on pensions
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