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Defined benefit pensions: new super rules change the game

Einfeld says there are very few people with total super balances of more than $1.6 million and a defined benefit pension in their SMSF.



Under new superannuation rules that started on 1 July, super fund members are no longer allowed to start an account-based pensions if they have exceeded the $1.6 million transfer balance cap.  

This means self-managed super fund (SMSF) trustees must be able to accurately value the assets in the fund, to ensure they don’t inadvertently breach the rules when paying pensions.

For most SMSF members, working out how much money is in pension phase is straight forward because the balance is shown on the annual member statement, says Greg Einfeld, a director of SMSF specialists Lime Super.  

“The exception is members with defined benefit pensions and certain market-linked pensions, which are old-style pensions that pay a pre-defined member benefit each year,” he adds.  

A defined benefit pension scheme – which is typically untaxed – is paid from a Commonwealth or public service superannuation scheme.  

AMP financial planner Mark Borg says it is important to note that a person who exceeds the $1.6 million cap won’t be forced to commute their pension. 

Should the value exceed $1.6 million then the income stream will be taxed differently and all other funds the member has in superannuation will be ineligible to move to a superannuation pension.

“This means that the contributions and earnings were not taxed. A taxed defined benefit scheme means that contributions made attracted 15% contribution tax and the earnings of the fund were taxed as a normal superannuation fund,” says Borg.

“It is important to note the pension paid from a taxed scheme to a member over the age of 60 is paid tax free while a member of the same age of a taxed scheme would pay tax at their marginal tax, rate less a 10% offset,” he adds. 
 
Where income from a defined benefit scheme exceeds $100,000 a year the income above this will attract additional tax.

Einfeld says there are very few people with total super balances of more than $1.6 million and a defined benefit pension in their SMSF.  

“What’s more common is when a member has a defined benefit pension from a previous employer-sponsored super fund, in addition to their SMSF. Where this is the case, the member needs to take into account the size of the defined benefit pension in calculating their transfer balance cap,” he explains.

Where the pension has a fixed term, then its value is deemed to be the annual pension entitlement multiplied by the remaining term of the pension. A multiple of 16 is used where the pension is payable for life. Einfeld says this multiple is arbitrary and in many cases is unfair.  

“Consider an 85 year old with a life expectancy of six years, receiving a defined benefit pension of $75,000 a year. The member would expect to receive future pension income of $450,000. However, this pension will absorb $1.2 million of their transfer balance cap, leaving only $400,000 for account-based pensions,” he says.

Many SMSF trustees overlook their defined benefit pensions in performing their transfer balance cap calculations, but it is important to consider all your superannuation interests when working out the value of assets in the fund.  

“If in doubt, the ATO web site allows you to identify all your super fund balances. The next step is to ensure you understand exactly what type of pensions you have, and how those pensions are treated for transfer balance cap purposes,” says Einfeld.

Borg notes the $1.6 million cap must be administered at the member level.  

“As such it is not the trustee’s responsibility. Should someone make a non-concessional contribution above the cap the ATO will instruct them to withdraw the funds and direct the trustee to release the monies plus earnings of these funds.” 

“The earnings will be taxed at the member’s marginal tax rate less 15%. Failure to have the funds released in the prescribed ATO time will result in higher taxation. Trustees need to be mindful of this and ensure liquidity is not an issue,” he adds.
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