Commutation of complying lifetime pensions - ATO ID 2015/22

The ATO has confirmed that complying lifetime pensions can be commuted and converted into market linked pensions.  Lifetime pensions are defined benefit pensions which are payable for the life of the member. Often these pensions were indexed and also had a spouse survivor pension.  These pensions can no longer be commenced in SMSFs.  However, complying lifetime pensions which commenced before 11 May 2004 or commenced (subject to satisfying certain conditions) within the grandfathered period from 11 May 2004 to 1 July 2006 can continue to be paid.

Complying lifetime pensions were issued for either Centrelink purposes (the pension has favourable asset test treatment) or reasonable benefit limit purposes (taking the benefit in defined benefit pension form avoided tax which was payable on excess superannuation benefits).  

If there is no Centrelink reason to continue with the pension (or if the pension has failed the Centrelink adequacy requirements) the pension can be converted into a market linked pension.  

Interpretative Decision 2015/22 confirms that both the commutation value of the lifetime complying pension, as well as the pension reserve amount which was supporting the pension, can be applied as the purchase price of a market linked pension.  Whether the commutation value and the pension reserve amount are applied towards the same or different market linked pensions is an issue for the member and trustee.  As market linked pensions can have different durations (which affect the minimum and maximum pension amounts) the member may wish to have two or more market linked pensions.

The Interpretative Decision also confirms that if either the commutation amount or the pension reserve amount is applied to the purchase of an account-based pension, those amounts will be treated as being concessional contributions of the member.  To the extent that those amounts cause the member to have excess concessional contributions, the excess will be taxed to the member albeit with an entitlement to a 15% offset of the amount of the excess: refer s291-15 of the Income Tax Assessment Act 1997.  The member can then elect to have the SMSF pay 85% of the tax on the member’s behalf by using a release authority to debit the member’s account in the SMSF.

While the Interpretative Decision seems to suggest a means by which pension reserves could be released (by having the amount of the pension reserve applied to commence an account-based pension) at the cost of incurring tax at the member’s marginal tax rate (less 15% rebate), two points need to be considered.

First, such a strategy would involve a breach of SIS Reg 6.17C.  A breach of Reg 6.17C gives rise to a maximum penalty of 20 units ($3,600 per trustee).  However, as such a breach is likely to be considered intentional then the maximum penalty will be 100 units ($18,000 per trustee) rather than 20 units.  

Secondly, a breach of Reg 6.17C constitutes a breach of a regulatory provision which permits the ATO to revoke the compliance status of the SMSF and given the circumstances of the breach the ATO is unlikely to be inclined to overlook the breach as “non-material” or “inadvertent”.