The ATO has announced that the transfer balance cap will increase from July 1, 2021. The increase in the general cap from $1.6 million to $1.7 million represents the first increase in the cap since it was introduced in 2017/18.

The increase in the cap will unleash a number of complex rules that have lain dormant until now. Financial planners and their clients will need to understand these rules in detail to ensure they don’t exceed, or fall unnecessarily short of, the client’s transfer balance cap.

The cap itself

The transfer balance cap is, in a nutshell, a set of rules that limit the amount of money any individual can have backing investment tax-free superannuation income streams. That said, all clients are not subject to the same cap number.

While the general cap is increasing by $100,000, it is important to understand the difference between the general transfer balance cap and your client’s personal transfer balance cap. Many clients’ personal transfer balance caps may increase by less, or nothing at all.

The starting point in understanding the rules is to look at those for whom the increase in the general cap will be simple.

Those who have not yet commenced a pension

Those clients who have yet to commence a superannuation pension in retirement phase will have the general cap amount at the date of their first pension’s purchase as the starting point for their personal caps.

Put simply, if a client starts their first retirement phase pension (that excludes transition to retirement pensions) after the cap has increased to $1.7 million, their personal cap will be $1.7 million.

Those who have had an account balance in excess of the general cap before July 1

At the other end of the scale are those clients who have had a transfer account balance at, or in excess of, the general cap at any point since the cap was created. Such clients will have no increase in their personal transfer balance caps at any point in the future.

It is important to note that it doesn’t matter when the client’s transfer balance account reached or exceeded the general cap. Having brought the account balance back below the general cap also does not help the client have their personal cap increased. From the moment the client’s account balance met or exceeded their personal cap, they were excluded from any future increase in their personal cap.

Those with an existing personal cap who have never reached the general cap

It is for those clients who already have a personal transfer balance cap, but who have never reached or exceeded the general cap, that things will get more complex from July 1.

The increase in their personal transfer balance cap will be applied proportionately to the increase in the general transfer balance cap. The following formula is used to index a client’s personal transfer balance cap:

Unused cap percentage x increase to the general cap (in this case, $100,000)

Where:

• The unused cap percentage is the highest balance at the end of any day in or before the previous financial year, divided by the client’s personal transfer balance cap at that time (which will be $1.6 million for all clients at this point in time).
• The number provided by this formula will be added to the client’s existing personal cap (again, $1.6 million) to give their new personal cap.

Example 1: One historical transfer account balance

On July 1, 2017, Frances retired and commenced an account-based pension worth $1 million.

As Frances commenced her pension in 2017/18, her personal transfer balance cap is equal to the general transfer balance cap applicable in that year – $1.6 million.

Frances used 62.5 per cent (i.e. $1 million / $1.6 million) of her personal transfer balance cap and has an unused cap percentage of 37.5 per cent. 

The July 1, 2021 general transfer balance cap increase will be $100,000 (taking the general cap to $1.7 million).

As a result, Frances’ personal transfer balance cap will increase by: 

Her unused cap percentage x increase to the general cap =

37.5% x $100,000 =

$37,500

This will take Frances’ personal transfer balance cap to $1.6375 million. This means that Frances will have $637,500 ($1.6375 million – $1 million) of her cap remaining. 

One important feature of this indexation formula is that it looks at the client’s highest previous transfer account balance – not the current transfer account balance. As such, the client will have a smaller increase in their personal cap if their account balance has been higher in the past.

Example 2: Multiple transfer account balances over time

On September 1, 2017, Graeme retired and commenced an account-based pension worth $1 million.

As Graeme commenced his pension in 2017/18, his personal transfer balance cap is equal to the general transfer balance cap applicable in that year – $1.6 million.

In October 2019, Graeme commuted $100,000 from his account-based pension to pay for a cruising holiday in Europe. This commutation applied a debit to his transfer balance account, bringing his balance back from $1 million to $900,000. 

The July 1, 2021 general transfer balance cap increase will be $100,000 (taking the general cap to $1.7 million). Graeme’s unused cap percentage will be based on his highest transfer account balance ($1 million), rather than his current balance ($900,000). This makes Graeme’s unused cap percentage 37.5 per cent ($600,000 / $1.6 million).

As a result, Graeme’s personal transfer balance cap will increase by:

His unused cap percentage x increase to the general cap =

37.5% x $100,000 =

$37,500

This will take Graeme’s personal transfer balance cap to $1.6375 million. This means that Graeme will have $737,500 of his cap remaining ($1.6375 million less his current account balance of $900,000). 

Where to find cap information

A client’s transfer balance account and cap information is available through the ATO section of the MyGov portal. The MyGov data for each individual should include all the figures relevant to their transfer balance cap, including their current account balance, their highest historical balance and their personal cap.

Other impacts of the increase

There are a number of other rules governing benefits and taxation that are linked to the transfer balance cap. It is important to note that these rules all refer to the general transfer balance cap (i.e. $1.7 million from July 1, 2021), not the client’s personal cap.

Non-concessional contribution cap

The non-concessional contribution cap’s eligibility rules look at a client’s total superannuation balance on June 30 of the preceding financial year. The client’s total superannuation balance must be below the general transfer balance cap, in order for non-concessional contributions to be made.

In 2021/22, the general transfer balance cap against which the client’s June 30 total superannuation balance will be tested will be $1.7 million. This is in spite of the fact that the general transfer balance cap on June 30, 2021 will be only $1.6 million.

The amount of bring-forward non-concessional contributions a client may make in the first year of a bring-forward period also uses a total superannuation balance test. The client must have a total superannuation balance of less than the general transfer balance cap minus the non-concessional contribution cap in order to bring-forward a future year’s non-concessional contributions cap. The limit is the general transfer balance cap minus two times the non-concessional contribution cap in order to bring-forward two years’ worth of non-concessional contribution cap.

The non-concessional contribution cap is also set to increase to $110,000 on July 1, 2021. That will make these bring-forward total superannuation balance limits $1.59 million and $1.48 million respectively in 2021/22.

Example 3

Harriette (57) wishes to make $250,000 in non-concessional contribution in 2021/22. She has never before triggered a bring-forward period.

At the close of June 30, 2021, Harriette’s total superannuation balance is $1.51 million. This is below the 2021/22 general transfer balance cap ($1.7 million), so she can make a non-concessional contribution up to the cap ($110,000).

Her total superannuation balance is also below the general transfer balance cap minus the non-concessional contribution cap ($1.59 million), so she can bring-forward an additional year’s worth of non-concessional contributions ($220,000 total).

Her total superannuation balance is, however, greater than the general transfer balance cap minus two years’ worth of non-concessional contribution cap ($1.48 million). As such, she cannot bring-forward two years’ worth of the cap.

Co-contributions and spouse contribution tax offsets

The Government co-contribution’s eligibility rules, as well as those of the spouse contribution tax offset, look at a client’s total superannuation balance on June 30 of the preceding financial year. The client’s total superannuation balance must be below the general transfer balance cap, in order to qualify for either of these benefits.

In 2021/22, the general transfer balance cap against which the client’s June 30 total superannuation balance will be tested will be $1.7 million.

Tax on capped defined benefit income streams

As certain defined benefit pensions cannot generally be commuted to meet the transfer balance cap, excess defined benefit income is subject to additional tax rules. The defined benefit income cap is only relevant for clients 60 or older, or those younger than 60 receiving a death benefit pension where the deceased was 60 or older when they died.

The defined benefit income cap for a financial year is equal to the general transfer balance cap for the financial year divided by 16. From 2017/18 until 2020/21, the cap has been $100,000. From 2021/22 it will increase to $106,250.

Payments that exceed the cap are subject to specific rules that restrict how much is tax-free or subject to a tax offset. As such, clients subject to these rules may find less tax is withheld on their pension payments from July 1, 2021.

Example 4

Kai, 63, commenced a defined benefit income stream on July 1, 2016. The income stream paid him annual income of $120,000, which was all tax-free and taxable (taxed element) components.

In 2016/17, Kai paid no tax on his income stream payments, as they were considered non-assessable non-exempt income.

From 2017/18 to 2020/21, Kai’s defined benefit income cap was $100,000. Kai continued to receive $120,000 in payments each year and therefore, his excess was $20,000 ($120,000 minus $100,000). Fifty per cent of this excess, or $10,000, was included in Kai’s assessable income each year. It was subject to Kai’s marginal tax rate and any applicable levies. 

In 2021/22, Kai’s defined benefit income cap increases to $106,250. Kai continues to receive $120,000 in payments for the year, but his excess has reduced to $13,750 ($120,000 minus $106,250). Fifty per cent of this excess, or $6,875, will be included in Kai’s assessable income in 2021/22. It will be subject to Kai’s marginal tax rate and any applicable levies.

Prepare for the complexity

The transfer balance cap rules have always been complex. That said, the complexity has largely been theoretical to date. Financial planners need to prepare for the new, practical complexities that will come with the cap’s first indexation in July and ensure their strategic approaches remain robust in the face of the changes.

Rob Lavery is Technical Manager at KnowIt Group.

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QUESTIONS:

To answer the following questions, go to the Learn tab at moneyandlife.com.au/professionals

1. Which of the following thresholds will be $1.7 million in 2021/22?

1. The general transfer balance cap for all clients.
2. The personal transfer balance cap for all clients.
3. The total superannuation balance for all clients.
4. The non-concessional contribution cap for all clients.

2. Which of the following statements is true?

1. The general transfer balance cap and the personal transfer balance cap are the same for all clients.
2. The unused cap percentage looks at the client’s transfer account balance immediately before the indexation of the transfer balance cap.
3. Clients who commence their first income stream in retirement phase in 2021/22 will have a personal transfer balance cap of $1.7 million at the commencement date.
4. Exceeding the general transfer cap does not preclude a client from having their personal transfer balance cap increased in future.

3. Ingrid commences her first income stream in retirement phase in 2020/21. $800,000 is added to her transfer account balance at commencement. She has had no subsequent credits or debits in her transfer account before July 1, 2021. By how much will Ingrid’s personal transfer balance cap increase on July 1, 2021?

1. $0.
2. $50,000.
3. $100,000.
4. None of the above.

4. Which of the following benefits’ or strategies’ qualification criteria will be impacted by the increase in the general transfer balance cap?

1. The Government co-contribution.
2. The ability to use non-concessional bring-forward periods.
3. The spouse contribution tax offset.
4. All of the above.

5. What is the defined benefit income cap in 2021/22?

1. $100,000.
2. $106,250.
3. $1.7 million.
4. The increase in the defined benefit income cap multiplied by the client’s unused defined benefit income cap.