Options for Complying Pensions within an SMSF

When setting up income streams for clients today you can generally ignore the concept of “complying pensions” as this relates to concessions available under previous legislation. But you can’t so easily ignore the issues for the many retirees who may already have one in place.

As time progresses, needs may change, new opportunities emerge and markets can take their toll on asset values and you may come across clients with a complying income stream who want to make changes. 

So what options exist for advice today?

Background – what is a complying pension?

A complying pension (or annuity) is a non-commutable income stream commenced with superannuation money that met specific requirements to access Centrelink and reasonable benefit limit (RBL) concessions. This includes non-commutable lifetime, fixed term and term allocated pensions (TAPs).

Once started, a complying pension is non-commutable, except:

• within the first six months*
• to rollover to another complying income stream (subject to policy restrictions)
• under a divorce payment split, or
• to give effect to a release authority (eg. surcharge payment).

* If the income stream was started with a commutation and rollover from another complying income stream this six month period does not apply.

A complying pension commenced before 20 September 2004 receives a full Centrelink/Veterans’ Affairs (DVA) assets test exemption. If commenced between 20 September 2004 and 19 September 2007 (inclusive) only 50% of the asset value is exempt. 

Can a complying pension in an SMSF be commuted? 

Circumstances may have changed since purchasing the original income stream and clients with a self-managed super fund (SMSF) or small APRA fund (SAF) may no longer need the assets test exemption or the assets supporting a lifetime pension may have fallen to a level that can no longer support the income guarantees or they may no longer wish to operate a defined benefit pension. 

So what happens when a client with an SMSF/SAF wants to commute their complying pension?

The legislative rules for a complying pension do not allow lump sum withdrawals. If a lump sum payment is made:

• the pension may no longer meet the definition of an income stream for taxation purposes and any earnings (including capital gains) within the pension would become taxable income to the super fund
• the super fund may be deemed to be non-complying for allowing a member to illegally access money
• the super fund trustee could be penalised
• the pension would no longer receive an assets test exemption under the Centrelink/DVA rules and benefits paid in previous years may be clawed back.

Under previous rules, non-allowable commutations triggered a Centrelink/DVA reassessment that assumed the assets test exemption never applied. This generally raised a debt through an effective clawback of Centrelink benefits paid in previous years due to the exemption. 

Example On 1 July 2007, at age 65, George (a single homeowner) commenced a term allocated pension (TAP) for $600,000. As the TAP was a complying pension for Centrelink purposes, only 50% of the account balance counts as an asset. If he had not commenced the TAP he would not have been eligible for any age pension because the assets test cut-out threshold for a single homeowner was $343,750. Between 1 July 2007 and 1 July 2011, George received a part age pension, with approximately $30,000 received in total. Since he commenced the TAP, the cut-off asset thresholds have significantly increased (up to $673,000) so he is no longer so concerned about the assets test exemption and wants to know if he can commute the TAP and roll it to an ordinary account-based pension. If he receives a lump sum withdrawal from the TAP now, Centrelink will deem the pension to be fully asset tested and may consider that it was never complying. Centrelink could claw back payments up to the $30,000 received as overpaid benefits.

New rules allow choices

Social security/DVA rules allowed a complying pension to be commuted and rolled over to an equivalent complying income stream, within specific limitations as outlined in section 4.9.2.17 of the Guide to Social Security Law at www.fahcsia.gov.au. But this did not allow the commutation of a lifetime or term certain pension to start a TAP. 

However, these rules were recently changed to allow a waiver of debt when a complying lifetime or term certain pension is commuted.

The new rules provide the following options for clients with complying pensions in an SMSF or SAF.

* The ATE can be retained only if the commutation occurs due to divorce or death of a reversionary who had a longer life expectancy at commencement or the circumstances meet the requirements of section 4.9.2.17 of the Guide to Social Security Law.

Lump sum withdrawals are still not allowed. The new rules may benefit a client who:

• No longer wants the burden of administering a defined benefit pension in an SMSF or SAF
• Has a lifetime pension inside an SMSF that no longer meets the ongoing actuarial requirements due to falls in market performance
• Wants to change income levels by starting a new TAP with a different term.

Example George (from above example) commenced a TAP on 1 July 2007 with $600,000. At that point he did not need much income and his main aim was to receive at least $1 of age pension so he selected the maximum term of 35 years. The balance of the TAP on 1 July 2011 is $490,000 and it has a remaining term of 31 years. The maximum annual income he can draw for 2011/12 is $28,762. Under the current Centrelink rates, he is entitled to an age pension amount of $600.33* per fortnight or $15,608 per annum. George would like to increase his income payments from the TAP and doesn’t mind if the TAP now counts as an asset for Centrelink purposes as he has no other assets and will still receive some age pension even if it is assessable. Increasing his income payments George could roll over the TAP and commence a new TAP with a new commencement date and a shorter term. However, under previous Centrelink rules, this would mean that he would have to repay most of the previous Centrelink benefits he has received.  George is now able to rollover the existing TAP into a new TAP. It will be an assessable asset but he will not owe anything to Centrelink.  Assuming he selects the minimum term for the new TAP of 16 years, the maximum annual income for 2011/12 is $44,582.   Despite the fact that the TAP now fully counts as an assessable asset, George is still entitled to receive an age pension amount of $293.93* per fortnight or $7,642.18 per annum. Summary If George continues the existing TAP he would receive $44,370 in estimated income for 2011/12. If commutes and starts a new TAP with a shorter term, he will receive $52,224 in income payments. This creates an additional $7,854 in income and he is still entitled to the pensioner concession card.  *Based on rates effective 20 September to 31 December 2011.

It is important to look at the circumstances of each case individually. A focus on Centrelink and how changes affect the age pension might be important for some clients, but you also need to ensure you do not breach the SIS rules if clients want to rollover complying pensions.