Finally. About. Bloody. Time.
Draft regulations released yesterday provide – finally – the framework for unwinding legacy pensions cleanly and simply for members who choose to do so. It seems amazing that a mere 6 pages (plus one line) of legislation took this long to come about but...at least we have something to consult about now.
“Legacy pensions” is the generic term used for certain old style pensions that are generally no longer available in SMSFs. Some of these are market linked, lifetime complying or life expectancy complying pensions which carry strict restrictions. One of these restrictions is that they can’t be commuted and simply cashed out or turned into account-based pensions at will. Instead, they can only be commuted if the money is used to acquire another legacy pension or if the ATO forces the commutation (more on this later).
For years now, successive governments have promised to make life simpler for members who locked into these back at the turn of the century when tax rules were very different.
Yesterday’s draft regulations provide new rules which would allow that to happen. Essentially they remove the requirement that a commuted legacy pension must be turned into another legacy pension. (If you’re wondering why flexi pensions aren’t mentioned, it’s because they don’t need extra rules – they can already be commuted at any time, for any reason and the member can do anything with the commutation amount. Their particular challenge is that they generally release a lot of reserves which create other problems. Fortunately the Government is also proposing changes there – read our separate article here.)
There are of course some catches:
Why the time limit? Who knows. It seems odd that something so long in the making would have a deadline. And it will definitely create a class of people who “miss out” by not getting the right advice quickly enough to act on it. But at least this opens up some new opportunities for a lot of people.
Of course, commuting any pension and starting a new one has implications for the member’s transfer balance cap. Commuting a pension effectively adds back some or all of the amount of the transfer balance cap that’s been used in the past and starting a new one causes a new amount to be checked against the transfer balance cap.
Interestingly, the new regulations don’t propose any change to how the transfer balance cap works for unwinding legacy pensions.
In practice, that means someone with (say) a market linked pension won’t be able to simply turn it into an account-based pension. In fact, if the market linked pension is large enough, they will find if they commute the whole market linked pension they won’t be able to put even a single dollar back into an account-based pension. It will be a big decision. But for many people looking for more flexibility, or concerned about the estate planning implications of remaining locked into their legacy pension, it will be the right choice.
We have yet to see what changes the Government will make to the Social Security rules. This will be vital for anyone who started one of these pensions to allow some or all of their pension to be excluded from the assets test for the age pension. Significant consequences apply for people who commute these pensions without complying with all the rules (which, among other things, include moving the money to a new legacy pension). We assume the Government will also address this – it will be an essential extra step before anyone concerned about the age pension makes a change.
There is a lot more to unpack here in terms of what members with legacy pensions should actually do. People with large legacy pensions already have a mechanism to unwind them. For some time now, they’ve been able to do so as long as they’re willing to deliberately change their pensions to trigger an excess relative to their transfer balance cap. Taking that step effectively meant the ATO directed them to unwind their legacy pension – one of the few times it was possible to commute the pension without any restrictions on what the member did with the money. All this latest announcement will do for people in this position (assuming it’s enacted) is shorten the process and make it cheaper (they won’t have the tax cost of creating their temporary transfer balance cap excess).
For those potentially impacted by the proposed $3m cap, stopping their complying lifetime or life expectancy pension after 1 July 2025 could have adverse tax implications. Hopefully the draft Regulations will be finalised quickly so appropriate action can be taken in time.
And as mentioned earlier, those impacted by the age pension still need some further change.
But for others – whose legacy pension wasn’t large enough to enable them to create an excess relative to their transfer balance cap – this will provide a brand new opportunity to end their legacy pension.
All of this requires only a few lines of legislation.
The rest of the proposed regulations make extra changes to the way in which reserves are handled. Since reserves are often released when defined benefit pensions are commuted or simply end, making these changes at the same time makes sense. But the changes proposed actually do a whole lot more than just help unwind complying lifetime and complying life expectancy pensions – they are even relevant for the other type of legacy pension (flexi pensions) and even people whose pensions have simply ended rather than being formally commuted. We’ve got a whole separate article on that – click here to read it.
Looking for more information on this topic? Come along to next week's Quarterly Technical Webinar where Leigh Mansell and Lyn Formica will talk through the proposed changes. Click below to register.