Pension commutations

Are there limits to the amount which can be commuted?

One of the most significant features of account-based pensions is the ability to commute the pension, whether in full (also known as a 100% commutation) or in part (a partial commutation ie. less than 100%).

This ability to commute the pension is vital for management of your super balance when in pension phase.  The ability to commute permits the pension to be “rolled over” to another superannuation entity (to avoid being locked into a particular superannuation fund) and can assist in estate planning in relation to your super balances.

The legislation governing account-based pensions imposes only one limitation on pension commutations the purpose of which is to ensure that commutations cannot be used to by-pass the pension drawdown rule. 

The limitation where the pension is partially commuted, is that the balance of the pension account after the partial commutation must be sufficient to satisfy the minimum drawdown requirement (taking into account any pension payments already made in that financial year prior to the partial commutation). 

The limitation where the pension is fully commuted, is that sufficient pension payments must have been made at or before the full commutation to satisfy the minimum drawdown rule pro-rated to the date of commutation (after taking into account any pension payments already made in that financial year prior to the full commutation).

The operation of these limitations can be illustrated in the following examples relating to Peter who commenced an account-based pension on 1 July 2023 with a $300,000 balance where the minimum drawdown requirement is $15,000 (given that the prescribed percentage is 5% given Peter’s attained age at 1 July 2023).

Partial Commutation

The maximum Peter can commute his pension is expressed as a percentage is 95% and expressed as a dollar amount is $285,000.  This is because there must be at least $15,000 retained in the pension account to satisfy the minimum drawdown requirement. 

If $6,000 in pension payment has been made before the partial commutation, then the maximum commutation amount would be $285,000 or about 97% of the account balance before commutation.  The slight increase in the percentage amount arises because the pension account balance prior to the partial commutation is $294,000 (as $6,000 had already been made).  Only $9,000 in pension payments needs to be made in respect of the balance of the financial year as these future pension payments and together with the pension payments already made will equal $15,000.

Full Commutation

This depends on the period from the 1 July 2023 to the date of commutation compared to the entire financial year.  If the commutation occurred on 30 September 2023 (so the pension was payable for one-quarter of the financial year) then maximum commutation amount would be $296,250, or about 98.75% of the pension account balance prior to the full commutation.

The significance of the date of the full commutation is that where a pension is fully commuted during a financial year the minimum drawdown requirement is pro-rated for the number of days the pension was payable (including the date of commutation).  So as the pension was payable for only 25% of the financial year, the minimum drawdown requirement which applies is 25% of the full year requirement which is $3,750.  

If $3,500 in pension payments was made before 30 September 2023, then the maximum commutation amount to be paid would be $296,250 or about 99.91% of the pension account balance immediately before the full commutation.  Given the pro-rated drawdown requirement is $3,750 and already $3,500 of pension payments have been made, then only another $250 in pension payments need to be made to satisfy the (pro-rated) minimum drawdown requirement.  The slight increase in percentage is due to the fact that only another $250 in pension payments has to be made given the pension account balance has been reduced by the previous pension payments.

Conclusion

So while there is no formal limit on the ability to partially or fully commute an account-based pension, there is an implicit limit created by the minimum drawdown requirement.

Important Point

In the above illustrations no account has been made for increase in the pension account during the financial year due to investment earnings.  Additionally, when determining the pro-rated pension drawdown amount the calculation is done is days not complete months.  This was done for ease of illustration.

NOTE:  This article was prepared as at November 2023.  The article has not been updated in light of subsequent developments.