Julian Smith

The new simple account-based pension

From 1 July 2007, the Superannuation Industry (Supervision) Regulations (SISR) will provide for a simple form of account-based pension with five basic requirements¹:

• Each year, at least one payment must be made to the member.
• Each year, the total pension benefits paid to a member must satisfy minimum amounts based not on the pensioner's life expectancy (as used to be the case) but simply on the pensioner's current age. For instance, a pensioner aged 63 on 1 July during a year of the pension must be paid 4% of the pension's account balance and a pensioner aged 83 on the same day must be paid 7%.
• The pension may be transferred only on the death of the beneficiary (whether or not they are the original beneficiary or a reversionary).
• The pension's capital value, and the income from it, cannot be used for borrowing.
• The pension can only be commuted in certain circumstances, including on the death of the pensioner or if the minimum amount of pension payments for the year have been made.

Where's the catch?

"So that's it then. Seems simple as can be?"

Well, if someone is starting one of these new pensions on or after 1 July 2007 then it is relatively simple because all the trustee and the pensioner need to ensure is that the above conditions are met.

But it becomes a little more complex when any of the following factors are considered:

• Someone wants to commence a new pension before 1 July 2007
• Someone wants to commute an existing pension to commence a new pension, before 1 July 2007
• From 1 July 2007 to 19 September 2007, 3 forms of account based pensions will be available. First, the new pension; Second, the existing form of allocation pension; Third, the existing form of market-linked (or 'term allocated') pension;
• Planning for reversion of the pension; and
• Death benefits consequences (where there's no reversion), on death of the pensioner.

The transitional rules for account-based pensions - a snapshot

An advantage for market-linked pensions commencing before 20 September 2007

Starting a market-linked pension before 20 September 2007 will improve some people's chances of receiving a part or full aged pension. This is because market-linked pensions are 'complying pensions', and half of the capital used to fund the pension is excluded from the aged-pension assets test. From 20 September 2007, this assets test concession ends for pensions commenced on or after that date (along with the ability to pay a market-linked pension). So it may definitely be worth some people considering commencing a market-linked pension before 20 September 2007.

No advantage for allocated pensions commencing before 1 July 2007

However, it seems that the only reason to commence an allocated pension before 1 July 2007 would be that the pensioner is ready to retire. There are no advantages in starting a pension before the change.

If an allocated pension commences before 1 July 2007, then on that date it will be taken to be provided in accordance with the new rules - as long as it is provided in accordance with:

• the existing allocated pension rules and
• the relatively straightforward rules for commuting allocated pensions.

The benefit of commuting existing pensions before 1 July 2007

The background

Another matter to keep in mind is whether a person receiving more than one allocated pension may benefit from commuting those pensions and rolling them into a single allocated pension before 1 July 2007. Doing so may reduce taxation payable later. This is because even though a person over 60 will be able to take their superannuation benefits tax free, some superannuation benefits will still have components which are relevant to determining the taxation treatment of those superannuation benefits. For example:

• If a person takes a transition to retirement pension before their preservation age, then those benefits will be taxed and the amount of tax will be determined (in part) according to the components of the pension.
• If a person receives a death benefit on the death of the original pensioner, and the beneficiary is not entitled to take the benefit tax free (for instance, they are not an eligible dependant), then the components of the pension will be relevant for determining the tax treatment of the death benefit.

The components

The components are as follows:

• Tax free component: which includes the:
  • Contributions segment: generally, a person's post 1 July 2007 non-concessional contributions
  • Crystallised segment: these are existing components that are being crystallized on 1 July 2007 into the tax free component. These include the undeducted contributions, pre-1983 component, CGT exempt component, concessional component - the amount is calculated by assuming an ETP of the full superannuation interest is paid just before 1 July 2007.
• Taxable component: this is the combination of amounts taxed in the fund and amounts untaxed in the fund. It is calculated by deducting the tax free component from the total superannuation benefit.

The opportunity to benefit from commuting before 1 July 2007

An opportunity exists for persons receiving more than one superannuation benefit to take advantage of the 30 June 2006 calculation of the Crystallised segment. On that date, existing components of a superannuation benefit will be crystallized, partly by reference to the amount of pre-1983 component. If a person is receiving 3 allocated pensions only one of which has a pre-1983 component, then:

• the crystallization will only occur in relation to the relevant amount funding that superannuation benefit (generally, all amounts other than amounts untaxed in the fund); but
• if all 3 were commuted into a single allocated pension, then the crystallization of the pre-1983 component would be applied to the relevant amount of the superannuation benefit, not just that part of the superannuation benefit that funded only 1 of the 3 previous allocated pensions. This is because the crystallization calculation is done by applying the period of a person's pre-1983 service against the relevant amount of the superannuation benefit.

For more detail on crystallizing the pre-1983 component of a superannuation benefit, see paragraphs 2.104 - 2.119, and 2.139 - 2.144 of the Tax Laws Amendments (Simplified Superannuation) Bill (and other bills) Explanatory Memorandum. Of course any such strategy must be assessed against any other implications, for instance RBL consequences which may still have an effect before 1 July 2007.

Choosing which pension to commence between 1 July 2007 and 19 September 2007

So there are three types of pensions which a person may commence to receive between 1 July 2007 and 19 September 2007. The new simpler pension and the old allocated and market linked pensions. The considerations are:

• There would be little point in commencing an allocated pension in preference to a new simple pension. This is because:
  • both are non-complying pensions for the purposes of the aged pension assets test and operate in similar ways; and
  • the simple pension is simpler to administer and (in contrast to the allocated pension) does not have a maximum amount which may be withdrawn each year.
• there is good reason to commence a market-linked pension before 20 September 2007 as a person may then be eligible for, or increase their eligibility for, a part or full aged pension. However, there are important disincentives for commencing a market-linked pension rather than a simple pension - they are more complex to understand and administer and, most importantly, they are not commutable to a lump sum except in limited circumstances.

Planning to make sure the reversion of the pension succeeds

From 1 July 2007, sub-regulation 6.21(2A) of SISR provides that a death benefit may only revert to a person in the form of a pension if:

• The person is a 'dependant' of the pensioner as defined by section 10 of the Superannuation Industry (Supervision) Act 1993 (SIS) (SIS dependant); and
• For a dependant who is a child, the child is:
  • less than 18;
  • between 18 and 25 and financially dependent; or
  • has a disability²; and
• The pension being paid to a child (other than to a child with a disability referred to above) is commuted to a lump sum when the child turns 25.

Therefore, the class of persons who are dependants for the purposes of receiving a pension is narrower than those who are generally considered as SIS dependants. This is because of the restrictive treatment of eligible children. We will call these people pension dependants.

SISR provides:

• that a death benefit in the form of a reversionary pension may only be paid as a pension to a pension dependant, and
• that rules for the provision of a pension do not meet the standards set out in SISR if 'the rules result in the pension being transferred to a person who would not be eligible to be paid a benefit in the form of a pension' - that is, to a person who is not a pension dependant.

Thankfully, the rules of the pension will only be deemed to not meet the standards if they 'result' in the pension being transferred to a non-pension dependant. So even if an existing pension provides that the pension is to revert to someone other than a pension dependant, the standards will still be met if the rules do not 'result' in the pension reverting to a non-pension-dependant. This may require an over-reaching clause in the pension payment agreement to the effect that the pension will be paid in accordance with superannuation law, or a specific amendment to the pension payment agreement.

Death benefits other than reversionary pensions

Next month's ClearLaw will examine the new rules concerning the payment of death benefits generally. As mentioned above, these rules affect pension planning because, if the pension does not or cannot revert to a pension dependant, then the tax free component and taxable component of the pension will be relevant to the amount of tax payable when the benefits are paid to any other eligible SIS dependant.

...but the Regulations are still in draft!

At the date this article went to publication, the regulations containing the new rules concerning pensions were still in draft, although the consultation period had ended. We will keep ClearLaw readers up to date with the progress of these changes.

More information

For more information:

• in relation to this article please contact Julian Smith on 03 9288 0555.
• on Simpler Super generally, please contact Maddocks on 03 9288 0555 or 02 8223 4100 and ask for a member of the Maddocks Superannuation Team.

¹ Amendments to the pension payment provisions are set out in the Superannuation Industry (Supervision) Amendment Regulations 2006 which are, as at 22 March 2007, still in draft form.
² As described in section 8(1) of the Disability Services Act 1986