Do you have a client with an SMSF paying a capped defined benefit income stream?

The Australian Taxation Office (ATO) are concerned that a number of SMSFs paying capped defined benefit income streams haven’t met their Pay As You Go obligations and are writing to affected SMSFs (or their agent).

A “capped defined benefit income stream” is a concept which was introduced on 1 July 2017 and captures:

• lifetime pensions regardless of when they commenced
• lifetime annuities commenced prior to 1 July 2017
• life expectancy pensions and annuities commenced prior to 1 July 2017
• market linked pensions (otherwise known as term allocated pensions) and annuities commenced prior to 1 July 2017

Like any other retirement phase pension, a capped defined benefit income stream counts towards the recipient’s $1.6m Transfer Balance Cap. 

But unlike account based pensions, they cannot be partly or wholly commuted (eg rolled back to accumulation phase or cashed out as a lump sum) if they cause an individual to exceed that cap. This means they can create a problem (exceeding the cap) but can’t adopt the normal solution to that problem (commuting some or all of the pension).

For this reason there are special rules that allow recipients of capped defined benefit pensions to exceed their Transfer Balance Cap as long as the only income stream causing them to do so is their capped defined benefit pension.

In recognition of the fact that they are allowed to exceed their cap, people in this position have their tax concessions for these types of pensions limited in a different way. Individuals aged 60 years old or over (or receiving a reversionary defined benefit income stream and the deceased died at 60 years old or over) whose income from their capped defined benefit income stream exceeds $100,000 per annum (known as the defined benefit income cap), may have additional tax liabilities. For example, for pensions paid from a taxed source (which includes all SMSFs and virtually any other superannuation fund except certain public sector schemes), 50% of their annual income stream amount over the defined benefit income cap will be taxed at their marginal rate.

To allow the ATO to identify the individuals subject to this additional tax, a superannuation fund must issue a Payment Summary to any individual receiving a capped defined benefit pension if:

• the individual is aged 60 or over
• the individual is under age 60 but is receiving a reversionary pension and the deceased died age 60 or over

This rule applies to all superannuation funds, including SMSFs, regardless of the amount of pension paid. For example, a fund paying a pension of only $20,000 per annum from a capped defined benefit income stream would need to issue a Payment Summary to that individual.

In addition, if the amount paid will exceed the defined benefit income cap for a particular year, the fund trustee is also required to withhold tax using the usual tax tables.

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