Meg Heffron
Managing Director
The big challenge with reserves under current law is that unless they are allocated in quite small amounts (less than 5% of each member’s balance each year), they are generally checked against the receiving member’s concessional contributions cap and excesses are subject to additional tax.
The new draft regulations proposed to allow people to more easily unwind legacy pensions (see our separate article here), if enacted, would also make big changes to how reserves are managed.
Firstly, they would move the “5% rule” to the regulations dealing with non-concessional contributions caps. In other words, larger allocations would be checked against the non-concessional contributions cap instead of the concessional cap. For some people this is a game changer:
- non-concessional caps are usually much bigger – $120,000 pa (or more if a bring forward is available) rather than $30,000, and
- exceeding them doesn’t have to result in much additional tax – instead the members can choose to release the excess from super and tax is paid on a notional earnings amount calculated for the excess. Big taxes do apply, however, if the excess is left in superannuation.
For many people this will be a good result – it will allow them to deal with reserves more quickly and at a lower tax cost.
But there’s a catch. Non-concessional contribution caps are linked to the size of a member’s super balance. Someone with more than $1.9m at 30 June 2024, for example, has a non-concessional contributions cap of $nil for 2024/25. That means if their fund strays outside the “less than 5% rule”, every dollar of reserve allocation would exceed the cap. That could mean a large excess – and a lot of money to be removed from super.
But fortunately sanity has prevailed when it comes to commuting legacy pensions.
Special new regulations would treat any reserves allocated as part of unwinding a legacy pension entirely separately. Importantly, they wouldn’t be checked against any cap.
Not only will these changes apply for people actively unwinding (say) their own complying lifetime or complying life expectancy pension, it will also extend to:
- reserves freed up when someone who is a reversionary beneficiary under one of these pensions winds it up,
- pensions that have ended (for example a life expectancy pension that has reached the end of its term), or
- all those same events for a flexi pension.
Now that makes sense. And it will be a very significant improvement. This particular change has no 5 year deadline (unlike the new freedom to commute certain legacy pensions).
To be honest, with reserves so rare (and difficult to create) in SMSFs these days, I do wonder why the Government wouldn’t just make it possible to allocate any reserve, no matter where it comes from, to a member outside the contribution caps.
As it stands, the new regulations will create two classes of super members:
- those releasing their reserves now by winding up their (say) lifetime pension – who will get generous treatment, and
- those who didn't manage to do this before they died and whose beneficiaries are in the process of drip feeding the amounts out slowly – where whoever receives the reserve allocation will have it checked against their non-concessional cap.
There is much more to say here – we’ll wait to see how the changes unfold and whether they do actually become law.
If you need support regarding legacy pensions, our Technical Support Desk are available to answer your questions here.
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