As of 1 July 2017, the $1.6 million transfer balance cap has limited the total amount of superannuation benefits an individual can transfer into an income stream where earnings continue to be tax exempt (retirement phase).

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Previously, there was no tax on income and capital gains derived on assets supporting a superannuation income stream, irrespective of the type and the value of the pension.

Importantly, a transition to retirement (TTR) pension does not count towards the $1.6 million transfer balance cap whilst it is a TTR pension. However, as soon as the TTR recipient meets another condition of release that makes the pension unrestricted non-preserved (eg, retirement, permanent incapacity or reaching age 65), the value of the TTR pension will be included.

The value of a death benefit income stream also counts towards the recipient’s transfer balance cap. When and how much is counted depends on whether the pension is auto reversionary or not. Special rules apply to calculate how much transfer balance cap is available to commence a child account based pension.

A modified application of the transfer balance cap applies to non-commutable income streams, including lifetime pensions paid from defined benefit and constitutionally protected funds.

Key terminology

• The general transfer balance cap is $1.6 million for the 2017/18 year and will be indexed to CPI (in $100,000 increments) thereafter.
• The personal transfer balance cap is the amount an individual can transfer to retirement phase. In the first financial year of transfer, the individual’s personal transfer balance cap will be the same as the general transfer balance cap at that time (eg, $1.6 million for 2017/18).
• The transfer balance account tracks how much a person has transferred into and out of retirement income phase and allows a client to determine whether they have exceeded their transfer balance cap on any given day. Each transfer balance account will be maintained by the Australian Taxation Office (ATO) and must also be monitored by the individual and their adviser, if applicable.

The transfer balance account broadly operates on a system of credits and debits (eg, like a bank account).

Amounts credited to (counted towards or increasing) a person’s transfer balance account include:

• The value of all superannuation income streams in the retirement phase on 30 June 2017 (including most death benefit income streams);
• The commencement value of new superannuation income streams started on or after 1 July 2017 (including most death benefit income streams); and
• Notional earnings amounts that will accrue on excess transfer balance amounts.

The Government has proposed that a credit will also arise where the repayment of a Limited Recourse Borrowing Arrangement in an SMSF shifts value between accumulation phase interests and retirement phase interests. The amount of the credit that an individual member receives will equal the increase in the value of their retirement phase superannuation interests. At the time of writing, this proposal is not yet law.

An individual’s transfer balance account will be debited (reduced) when:

• They commute (in part or full) capital from the retirement income phase. The amount of the debit will be equivalent to the amount that is removed from the retirement phase, regardless of whether the amount is returned to the accumulation phase or is withdrawn completely from the superannuation system.
• Certain other transactions occur (eg, where the retirement income stream is commenced using the proceeds from a personal injury structured settlement, certain family law payment splits, fraud, and some transactions under the Bankruptcy Act).

Importantly, increases or decreases in the value of the income stream due to the investment earnings are not counted as debits or credits.

Strategic opportunity: Optimal drawdowns of pension

Additional amounts that a pension recipient can transfer into retirement phase (eg, add to their pension or start a death benefit pension with) depends on:

• if indexation is available¹ – their unused cap percentage; and
• their net transfer balance account position.

Regular pension income payments are not debits to an individual’s personal transfer balance account but lump sum commutations are.

Clients whose cash flow and capital requirements exceed the legislative minimum income drawdowns should consider only taking the minimum income from their account based pensions and supplementing their remaining needs from:

– their accumulation account (if they have one); or

– lump sum commutations from their pension (if they do not have an accumulation account). The commutation amount will result in a debit to the transfer balance account. If the client wishes to transfer additional money into retirement income phase, then a higher amount of personal transfer balance cap will be available as a result of these debits.

Breaching the personal transfer balance cap

If an individual’s transfer balance account exceeds their personal transfer balance cap, an excess transfer balance will arise. The two main consequences of this are:

1. The individual having to commute (back to accumulation phase or as a lump sum withdrawal) their retirement income stream to remove the excess capital plus a notional earnings amount; and
2. Excess transfer balance tax payable on the notional earnings.

Excess transfer balance earnings accrue on the excess balance daily and are generally credited towards an individual’s transfer balance account. These earnings compound daily until the earlier of the day:

• the breach is rectified; or
• the ATO issues an excess determination.

The rate at which excess transfer balance earnings accrue is based on the general interest charge. During the 2016-17 financial year, the general interest charge averaged 8.8 per cent per annum.

Excess transfer balance tax is payable on an individual’s accrued notional earnings over a financial year. These amounts are taxable, even if the breach has been rectified and the notional earnings removed from an individual’s retirement phase.

The standard rate of excess transfer balance tax is 15 per cent. For a subsequent breach, the rate is 30 per cent (applicable from 2018/19 onwards). This is designed as an intentional deterrent.

The ATO issues a taxpayer with an assessment notice which has the total notional earnings and the tax. The individual has to pay the tax within 21 days of receiving the notice.

Transitional provisions
Transitional provisions provide that an individual will not have an excess transfer balance in the transitional period from 1 July 2017 to 31 December 2017 if:

• the only credits in their transfer balance account are from existing superannuation income streams as at the end of 30 June 2017;
• their transfer balance is more than $1.6 million only by an amount equal to or less than $100,000; and
• their transfer balance is reduced below $1.6 million by 31 December 2017.

Some clients eligible for transitional provisions should still consider removing the excess amount from retirement phase prior to 1 July 2017.

To qualify for transitional CGT relief, assets broadly must be re-allocated from ‘pension phase’ to the ‘accumulation phase’ prior to 1 July 2017 to comply with the transfer balance cap changes.

Clients waiting to move the assets to the accumulation phase after 1 July 2017 will be ineligible to make the election to apply for CGT relief.

Practical considerations

Where an excess personal transfer balance cap is identified, the adviser should proactively work with the client to rectify the breach as soon as possible.

In determining the amount to commute, advisers should take into account not only the original excess transfer balance, but also the excess transfer earnings and the time required for the superannuation provider to action a commutation.

Deciding on whether to remove the excess from super or retain in the accumulation phase
The appropriate course of action depends on the clients’ circumstances including:

• whether their spouse is eligible to contribute the withdrawn amount into their super to even out the account balances.
• the tax implications (eg, funds retained in accumulation phase are taxed a maximum of 15 per cent. Funds withdrawn and invested outside of super are taxed at personal tax rates, including relevant offsets. Due to the application of the Seniors and Pensioners Tax Offset, singles with ‘rebate’ income of up to $32,279 per annum or couples with income of up to $28,974 per annum each, pay no tax outside of super. This means that some people will pay less tax by investing the excess outside of super).
• estate planning considerations, such as intended beneficiaries and tax impacts of receiving the funds inside or outside of super.

Excess determination from the ATO

The best course of action for clients who have exceeded their transfer balance cap is to rectify the breach as soon as possible, and ideally, prior to the ATO issuing them with an excess transfer balance determination.

However, if an excess determination is received, it will state the ‘crystallised reduction amount’, which is the individual’s excess transfer balance (the excess amount plus the notional earnings on this amount to the date of the determination). This is the amount that must be debited from the individual’s transfer balance account. Excess transfer balance tax is imposed on the earnings from the date of the breach until the date the excess transfer balance is removed.

The determination will also include the details of the superannuation provider the ATO will issue a default commutation notice to.

Typically, this will be the income stream which caused the excess transfer balance, except where this superannuation income stream is subject to commutation restrictions. This commutation notice will effectively require the super fund to reduce the pension by the amount specified in the notice. The individual will also have an opportunity to make an election to nominate a different provider to the ATO.

What advisers need to do

Before 1 July 2017
Advisers should identify clients who are in excess (or are very close to being in excess) of the transfer balance cap before 1 July 2017.

If the clients are a couple, there may be an opportunity to even out account balances, so that each person is within the $1.6 million transfer balance cap by 1 July 2017. This may involve making a withdrawal from the superannuation of the partner with a higher balance and recontributing it into the name of the spouse with a lower balance.

This is particularly important up to 1 July 2017, as it may allow the clients to take advantage of the higher bring-forward provisions and the higher general non-concessional cap.

If this is not available, advisers should consider these clients’ circumstances to determine the most appropriate way to reduce their personal transfer balance amount to $1.6 million by 30 June 2017. When determining the appropriate strategy, consideration should be given to:

• If multiple pensions are in place, which pension should be commuted, given the tax components of each pension, Centrelink/aged care considerations and the estate planning objectives?
• Whether the excess should be retained in super or invested outside of super.
• Where relevant, whether electing to apply the CGT rollover relief is available and beneficial.

After 1 July 2017
Ongoing contribution splitting and spouse contributions to a partner with a lower total superannuation balance should be considered for couples.

To avoid penalties, advisers should ensure that the new pensions commenced after 1 July 2017 do not exceed the client’s personal transfer balance cap.

Many clients will benefit from considering the best way to structure the receipt of income from superannuation (eg, only receive the legislative minimum and make commutations for the remainder).

1. The general transfer balance cap will be indexed to CPI (in $100,000 increments). Once an individual has used up their cap, they will not have their personal transfer balance cap indexed.