What is the pension transfer balance cap and how does it operate?

By Julie Hartley, Townsends Business & Corporate Lawyers

November 15 2016
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The government has released a string of proposed changes to super – including amendments to the pensions transfer cap – over the last few months. But what does it mean for you?

In late September, the government released the second tranche of proposed superannuation changes covering the pension transfer balance cap, concessional contribution changes, catch-up concessional contributions and the removal of the earnings tax exemption for transition to retirement pensions. This article will focus on issues surrounding the pension transfer cap.

What is the pension transfer balance cap?

The draft legislation proposes to introduce a general pension transfer balance cap (being $1.6 million for the 2017-18 financial year) to limit the amount of super a member can transfer to pension phase and enjoy the earnings tax exemption which currently applies in pension phase. The cap will apply from 1 July 2017 and will be subject to CPI indexation in increments of $100,000.

The pension transfer balance cap will apply on a taxpayer by taxpayer basis in respect of all their super accounts (subject to one exception) which move into pension phase. The exception relates to transition to retirement pensions.

How will the cap be applied in practical terms?

The ATO will create a transfer balance account for each taxpayer who has super benefits in pension phase. As and when a pension is commenced, the ATO will credit the transfer balance account with the initial balance of the pension. If a member commences a pension which causes their transfer balance account to exceed the cap, the ATO will notify the trustee paying the pension that the pension is excessive and the amount of the excess. The trustee must then commute the excess, and the excess pension (or excess portion of the pension) can either be transferred back to accumulation phase or be paid as a lump sum super payment (provided the member has met a condition of release). If the excess pension is a pension subject to SIS commutation restrictions – such as defined benefit pensions or market-linked pensions – a different treatment will apply.

A special tax at the rate of 15 per cent, called the ‘excess transfer balance tax’, will apply on the notional earnings of the excess portion of the pension. This tax will be levied on the member, with the member having the choice to either pay the tax themselves or arrange for the super fund to pay the tax and to debit their pension balance.

How will the cap be calculated and tracked?

The exhaustion of the transfer cap will be measured in percentage terms and not dollar amounts. One reason for this approach is to diminish the advantage of the strategy that involves ‘saving’ a small portion of the transfer cap so that if and when the cap increases by indexation, the entire increase is retained.

While each new pension which is commenced will cause the ATO to credit the transfer account with the initial value of the pension, some events will give rise to a debit to the transfer account balance. Debits will arise if, after the pension commences, the pension is subsequently affected by trustee or investment manager fraud. Another situation where a debit will arise is where a portion of the pension balance has to be paid under a family law benefit split.

Once the pension commences, any increase in the pension account balance due to earnings will not affect the transfer balance account. Equally, any decrease in the pension account balance due to negative earnings will not affect the transfer balance account.

Once a taxpayer has exhausted their pension transfer balance, no new super capital can transfer to pension phase. However, super capital which is already in pension phase can move from one income stream to another income stream without exposing the growth in the pension account balance to assessment against the pension transfer cap balance.

Julie Hartley, solicitor, Townsends Business & Corporate Lawyers

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Retirement