Reserves Trap for Complying Pensions

Reserves Trap for Complying Pensions

Complying pensions, in the good old days, were used to achieve two significant planning objectives. The first was to minimise the adverse tax consequences of having excessive benefits – excess as measured by the reasonable benefit limits (RBLs).  The other was to qualify for the age pension and Centrelink benefits as complying pensions had either a 100% (or 50%) asset test exempt status.

RBLs were removed from the superannuation landscape in July 2007.  Asset test exempt pensions departed soon after.  From September 2007 no new pensions would have asset test exempt status but existing pensions with such status could continue and retain that status on a grandfathered basis.

A recent ATO Interpretative Decision has highlighted both an opportunity and a danger in relation to complying pensions issued for RBL purposes.   The Interpretative Decision confirms that complying pensions can be restructured to market linked pensions and any associated pensions reserves can be applied as part of the initial pension account balance of the market linked pension.

Restructuring complying pensions in this manner is consistent with the SIS Regulations, does not trigger a contribution cap assessment and, best of all, it precludes the pension reserves from being locked into a general reserve on the death of the pensioner.

If a complying pension is not restructured then on the death of the member (or reversionary beneficiary, if applicable) any pension reserve supporting that pension cannot be paid out but will become part of the general reserve of the fund.  The problem is that once an amount has been transferred to the general reserve if it is subsequently allocated to a member account, the allocation will be treated as a concessional contribution of that member and thereby will be subject to the concessional contributions cap.  There is the exception provided by the 5% member account balance allocation rule - but to exhaust the pension reserve using this method may take many years.

By contrast on the death of the member receiving a market linked pension, the account balance must be paid out as a final benefit payment.  Consequently, the unused pension account balance is not locked up in the fund.

Restructuring a complying pension which has had asset test exempt status will generally give rise to significant adverse Centrelink issues.  Subject to some exceptions, if an assets test exempt pension is restructured, Centrelink will generally retrospectively assess the pension as having nil asset test exempt status and recalculate the entitlement of the member to age pension payments.  This will generally result in Centrelink determining that there has been a net overpayment of pension with the consequence that Centrelink will seek to recover the overpayment.