The Government has announced a long-awaited measure to allow superannuation members drawing legacy pensions to ‘get out’ of those more restrictive income streams.
The announcement comes as part of the 2021-22 Federal Budget, which provides a short-term opportunity for people with market-linked, life-expectancy and lifetime pensions (commencing prior to 20 September 2007) (“legacy pensions”) to access the capital supporting those accounts. Since the Government’s announcement, further commentary suggests that it will also apply for legacy pensions which commenced on or after 20 September 2007.
The commencement date and much of the detail of this opportunity has not yet been confirmed.
What’s the history?
Legacy pensions are largely a product of the historical superannuation regime. There are a number of different types which had the potential for benefits in the context of a now out of date reasonable benefits limits regime and in some cases, benefits in terms of not being means tested for Centrelink purposes. Alongside those benefits, the pensions typically had restrictions on access to the underlying capital, which often meant that capital could end up in the reserves of the relevant superannuation fund.
Since 2007, legacy pensions have been largely phased out but it has been possible for “old” pensions to convert into different types of legacy pensions.
The law has changed significantly over the last 20 years. Instead of reasonable benefits, we have the transfer balance cap regime, and the historical means testing exemption no longer applies.
Where legacy pensions were set up with reversionary beneficiaries nominated, the pension would continue to be paid to the person nominated. However, in cases where there is no reversion, or on the subsequent death of the reversionary beneficiary, the capital balance is locked up, and held in the reserves of the fund. That means it is not part of the death benefit of the member of the fund.
For those legacy pensions in an SMSF, reserves in a super fund are notoriously difficult to access, and by default will count towards the contribution cap of the member to whom the reserves are allocated. There are some exceptions to that position but it is fairly restrictive, – including a cap of 5% of the value of the member’s total balance in the fund – a nightmare for estate planning arrangements.
This creates a number of major issues:
- An inability to withdraw the balance, when the costs of running the legacy pension outweigh the income stream;
- Individuals having restricted access to capital or flexibility of drawdowns, which limited use of retirement savings for larger expenses such as relocation to retirement living or aged care; and
- Restrictions on estate planning and passing wealth to future generations (or at least accessing it).
What’s the change?
The Government has announced a two-year opportunity for people to commute the entire legacy pension (and any associated reserves) back to accumulation phase, to then:
- start a new retirement product (such as a more flexible account-based pension), which will be subject to the transfer balance caps;
- withdraw a lump sum out of the fund; or
- retain the funds in their accumulation account.
The two year period will begin at the start of the financial year following the law being passed (date to be confirmed).
If any reserves are commuted as part of this regime, the reserves will not be counted towards the member’s concessional contributions cap (which from 1 July 2021, will be $27,500 per year), and won’t be taxed as excess contributions. Instead they will be taxed at a rate of 15%.
The valuation methods that existing the superannuation legislation for legacy pensions, for the transfer balance cap purposes, will continue to apply.
As part of its announcement, the Government has confirmed that any existing social security treatment that may have been afforded by the legacy pension will not continue for any person who commutes out of their existing arrangement.
Until further detail of the changes are made available, it will be hard to definitively calculate whether a particular person is better off under these arrangements or not. The answer will likely be a combination of considering financial planning tax and estate planning objectives and outcomes of each option.
How we can help
If you find yourself stuck with a legacy pension you can’t get out of, a way forward is now in sight, but each person would need to consider whether the path out is better for their particular circumstances. For more information, please do not hesitate to contact us.