$1.6m Transfer Balance Cap
Retirees with + $1.6m in super face changes to their tax treatment from 1 July 2017
One of the biggest proposed super changes brought down in the 2016-17 federal budget was the $1.6 million transfer balance cap. Since the announcement, the legislation has been passed and we now have certainty on the details for this change.
The changes are included in the three bills given Royal Assent last week:
- Superannuation (Objective) Bill 2016
- Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016
- Superannuation (Excess Transfer Balance tax) Imposition Bill 2016
The concept of the $1.6 million balance transfer cap appears simple, however the devil is in the details when it comes to implementation.
What is the $1.6 million transfer balance cap?
Broadly speaking, the $1.6 million transfer balance cap is a limit on how much an individual can transfer into a tax-free pension phase account. This will be effective from 1 July 2017.
The transfer balance cap is per individual.
How does it work?
The transfer balance cap is established at the time an individual moves from accumulation phase into pension phase.
If the individual is already in receipt of a pension on 1 July 2017, the transfer balance cap will be applied at that time.
The transfer balance cap will be tracked like an account or ledger, whereby amounts transferred into pension phase are credits and amounts commuted or rolled over are debits.
Earnings and capital growth on assets supporting the pension are ignored when calculating the cap usage. There is no limitation on the appreciation of value and no requirement to remove the excess earned over $1.6 million.
Conversely, if the pension balance falls below the $1.6 million cap due to poor investment returns, there is no ability to “top up” the shortfall to the cap.
Indexation of the transfer balance cap
The transfer balance cap is indexed in increments of $100,000 on an annual basis in line with Consumer Price Index.
If an individual has not fully utilised their transfer balance cap and chooses to transfer after an indexation increase has occurred, the balance cap amount will be subject to a proportioning formula.
Julie commences a pension with a balance of $1.2 million in the 2017/18 financial year. At that time, she has utilised 75% of her $1.6 million transfer balance cap.
Let’s say the cap was indexed to $1.7 million in the 2019/20 year, her cap has also increased by $25,000, being 25% x $100,000 increase. Accordingly, Julie can commence another pension with $425,000 without breaching her transfer balance cap.
What happens to the individuals already in pension phase before 1 July 2017?
For those who are already in retirement phase and have pension balances totalling to more than $1.6 million, they will need to take action. They have 2 choices:
- Commute/Transfer the excess above $1.6 million into an accumulation account within the existing superfund or rollover to another; or
- Withdraw the excess above $1.6 million out of superannuation.
If the excess amount is not dealt with, the tax office will issue a directive to commute the excess amount (plus notional earnings) from the retirement phase and issue an Excess Transfer Balance Tax assessment. The imposed tax is on the notional earnings on the excess amount. The tax rate will be 15% for the first notice which is aimed to equalise the tax had it been in the accumulation account. If the first directive is not complied with, the tax office may issue additional assessments which carry a 30% tax rate.
The notional earning amount is based on the 90 Days Bank Accepted Bill Yield plus 7% and compounds daily (similar to the General Interest Charge).
There are some individuals who still have defined benefit lifetime pension such as Life expectancy or Market-linked pensions which have commutation restrictions. Due to these restrictions, the pensions count towards the transfer balance cap, but the individuals cannot reduce the balance to $1.6 million using the methods above. To comply with the cap, there are special valuation arrangements and additional rules relating to Excess Transfer Balance Tax.
Transitional CGT Relief – Resetting Cost Bases
The legislation provides Capital Gains Tax (CGT) relief to those individuals that comply with the transfer balance cap and transition to retirement income stream changes, allowing the cost base of assets reallocated from pension to accumulation phase to be reset. Effectively, if a superfund elects to use this CGT Relief, the superfund is taken to have sold and then reacquire the asset. It is important to note that by applying the CGT Relief, the 12 month eligibility period for the purpose of the CGT discount also resets.
Under this relief, the deemed sale triggers a CGT event. The superfund can choose to include the assessable portion of the capital gain in the tax return or elect to have the gain deferred when the asset is sold.
The elections to utilise the CGT Relief and capital gains deferral, are irrevocable and must be done by the due date of the superfund’s 2016/17 Income Tax Return.
What to do next?
Talk to us and start planning.
We have a planning program for our existing clients which will start from 1 January 2017.
Although this measure theoretically comes into effect from 1 July 2017, it is clear from the detail that action is required much earlier.
Everyone’s circumstances are different and factors such as fund structure, investment types and values, will play a crucial part in determining what choices are the right choices for you.