Legacy pension commutation (Part 2)

Key points of the pension commutation reform

• To provide a 5-year window to allow legacy income streams (lifetime pensions, life expectancy pensions and market-linked pensions) to be fully commuted and the commutation payment either:

• paid to the income stream recipient as a lump sum super payment (“cashed out”);

• retained in the super fund as an accumulation interest for the recipient (“rolled back”);

• used (subject to transfer balance cap space) to commence an account-based pension for the recipient (“new pension”).

• The commutation will give rise to a transfer balance debit equal to the amount of the commutation payment.

• If cashed out commutation payment will be tax free (if the income stream recipient is aged 60 or more which is most likely to be the case since legacy pensions must have originally commenced before 20 September 2007).

• In the case of lifetime and life expectancy pensions – the commutation amount will usually be less than the amount in the fund which was used to support the pensions. This excess amount (the pension reserve) can be allocated to the member and will not constitute a concessional or non-concessional contribution of the member.

• If rolled back the commutation payment is treated as an internal rollover.

• If used to commence a new account based pension – the transfer balance credit arising on the commencement of the new pension will most likely be offset by the transfer balance debit arising on the commutation of the legacy pension.

When does the 5 year window commence?

• The 5 year window commences on the day after the regulations are registered.

Must legacy pensions be commuted?

• Whether the pension is commuted is entirely the choice of the pension recipient and the trustee. There is no requirement that legacy pensions be commuted.

• However, every SMSF trustee currently paying a legacy pension and any SMSF member currently receiving a legacy pension should consider taking advantage of the 5-year window for commutation.

What happens at the end of the 5-year commutation window?

• Any legacy pensions which have not then been commuted - cannot be commuted after the end of the window period.

Does the commutation window only apply if the pension is fully commuted?

• The draft legislation explicitly states that any commutation must be a full commutation of the legacy pension.

Does the commutation window apply to legacy annuities?

• The window does apply to the rollover annuity equivalents of lifetime, life expectancy and market linked pensions.

Does the commutation window apply to Centrelink assets test exempt income streams?

• There is no mention of how the commutation reforms will affect Asset Test Exempt income streams (under s9A (ATE lifetime); s9B (ATE life expectancy) and s9BA (ATE market linked) of the Social Security Act 1991 (and the service pension equivalents under the Veterans’ Entitlements Act 1986).

• These pensions will have either a 100% assets test exemption or a 50% assets test exemption.

• While the Social Security Act does not prohibit commutations of ATE pensions, there are adverse asset test consequences for a commutation of an ATE pension.

• Under current legislation a commutation of these income streams contrary to the conditions specified in those sections would cause the income streams to be non-ATE pensions and would trigger a retrospective reassessment of the pensioner’s age pension entitlement for the previous five years on the basis that the income streams were not asset text exempt. This will, in most cases, give rise to a material overpayment of the age pension during previous five years.  The position is similar for the commutation of ATE service pensions.

• Any change to this treatment would require changes to the Social Security Act (and the corresponding provisions of the Veterans’ Entitlements Act 1986 in respect of service pensions which are assets test exempt. Alternatively, any debt owing by the recipient of the commuted income stream to the Government arising because of the reassessment, could be waived by a statutory instrument of the relevant Minister/Secretary.

Can legacy pensions issued by APRA funds also be commuted?

• Despite the current name of the draft regulations – market linked pension issued by APRA funds could also be commuted.

• In relation to lifetime and life expectancy pensions, whether the commutation reform applies to these pensions depends entirely on whether the APRA fund which issued the pension only has income stream defined benefit interests. If the only defined benefit interests are pensions, then the commutation reform will apply to the fund.

• If the APRA fund has accumulation phase defined benefits interest, then the commutation reform will not apply to defined benefit legacy pensions issued by the fund.

Does the commutation reform apply to legacy pensions which have already ceased?

• No, as these pensions already have terminated. However, any reserves released by the prior termination of legacy pensions which remain in the fund will, however, be subject to the “reserve pension reforms”.

• Importantly, the reserve pension reform is not subject to a five-year window which is the case with the commutation reform.

Does the commutation reform apply to legacy pension which have transferred to a reversionary beneficiary?

Yes.