How not to restructure defined benefit pensions

Defined benefit pensions were used to address RBL problems – that is removing RBL problems.  However, with the changes to super in 2007, the RBL justification for defined benefit pensions ceased to apply.  Also, with the lacklustre investment returns of recent years, many SMSF investors, who have defined benefit pensions are facing stress as the reserves established to support the pensions have been much reduced, possibly placing the pensions in a parlous financial state.

In these circumstances, the pension must be re-structured.  A defined benefit pension is re-structured by commuting the pension and rolling over the commutation amount into a market linked pension (sometimes called a term allocated pension) for the relevant member.

This re-structuring is permitted, as there is an express exception to the non-commutation of a complying pension, where the commutation is rolled over into a market linked pension.  Further, a new market linked pension can be commenced as there is an exception to the general rule against commencing new market-linked pensions after 20 September 2007 – the exception applies if the purchase price of the pension can be traced back to a complying pension which commenced before 20 September 2007.

Commuting the defined pension benefit also releases the pension reserve. The value of the pension reserve could be used for a number of different purposes – such as payment to a general reserve of the fund or being used to finance a pension for the relevant member.

If the pension reserve is used to commence a market linked pension for the relevant member, the value of the pension reserve is not treated as a concessional contribution and counted against the concessional contributions cap of the relevant member.  Also, it is not treated as a non-concessional contribution of the relevant member.

However, if the value of the pension reserve is used to commence an account-based pension for the relevant member, the value of the pension reserve will be treated as a concessional contribution and counted against the relevant member’s contribution cap.

If the value of the pension reserve is credited to a general reserve of the fund, then it will generally be counted as a concessional contribution as and when it is transferred to a member account (there is one limited exception).

ATO ID 2012/84 has confirmed that defined benefit pension re-structure will not have adverse contribution cap implications for the relevant member, so long as the commutation value of the pension is rolled over into a market linked pension for the relevant member.  Additionally, any pension reserve can be rolled over into a market linked pension for the relevant member will  not have any adverse contribution cap implications.  However, rolling the pension reserve into an account-based pension will have adverse contribution cap implications for the relevant member.

The moral is: only rollover into market linked pensions.  This will avoid excess contribution cap issues as well as not infringing the SIS operating standard of commutating a pension in breach of the pension standards (SIS Reg 6.17C).

Interestingly, the ATO in the Interpretative Decision, suggests that only one market linked pension needs to be issued rather than two: one in respect of the commutation value and a second in respect of the pension reserve.

Where a complying pension was used to gain Centrelink benefits (as the value of the pension was  either not counted for asset test purposes or reduced by 50%, depending on the commencement date of the pension), re-structuring the pension will generally have adverse Centrelink consequences.