The Two Step Tango

Another interesting observation is that the ATO takes the view that a super interest in pension phase will immediately revert to taxable phase once the pensioner has requested the full commutation of the pension.

In contrast, if the pensioner member were to request only a partial commutation of the pension, then the super interest supporting the pension would continue to remain in pension phase (notwithstanding the partial commutation), as a pension (possibly now considerably reduced) will continue to be paid from that super interest.  Any asset disposals made in order to pay the partial commutation amount will still be tax exempt.

In short, any commutation of the pension should be effected in two steps: the first step is a partial commutation so that any assets with significant unrealised capital gains can be realised in a tax exempt environment.  The second step is the final commutation of the remaining pension.  The commutation for the final commutation will either produce a very manageable tax liability or even some capital losses.