What happens when a market linked pension ends?

Market linked pensions are quite different to normal account-based pensions in that they are paid for a specific number of years (the term). At the end of the term, the pension has to stop.

The factors that drive how much has to be paid out of these pensions in any given year are designed with that end in mind. For a start, they are based on the number of years remaining rather than the pensioner’s age. Secondly, the factors require a bigger and bigger proportion of the pension balance to be paid out each year as the remaining term goes down.

This is easiest to explain using an example. 

Let’s say Jim’s market linked pension is due to end on 31 December 2024. At 1 July 2023, it will have 1 year and 6 months left (which is rounded down to 1 year). The payment normally required from a market linked pension in that position is between 90% and 110% of the entire account balance at 1 July 2023.

That alone should be enough to see the vast majority of Jim’s pension balance paid out in 2023/24 and it might very well be $Nil by 1 July 2024. But what if there’s still some money left? The pension has 6 months left to run so Jim will need to take that remaining balance (and any subsequent earnings) early in the new financial year. In fact, there are special rules that give Jim 28 days’ grace after the end of the term but one way or another he needs to have withdrawn the full balance before 28 January 2025 (28 days after the end of the term).

There are a few important points to note here.

For starters, Jim doesn’t have the entire financial year to get his pension payments right – he needs to withdraw the whole thing before 28 January 2025. Not doing so is just like failing to pay the minimum for an account-based pension over the financial year. It is a breach of the superannuation rules and will mean his fund loses the tax exemption on investment income for that pension.

Secondly, the fact that minimum payments for these pensions can currently be halved (and this will continue for 2022/23) can be slightly tricky. 

Imagine Jim’s pension was due to end on 31 December 2022 instead.

The minimum payment he has to take in 2021/22 will actually only be 45% of his full account balance at 1 July 2021. If that’s all he takes, it’s likely he will still have a reasonable balance at 1 July 2022. He still has to make sure he withdraws everything that remains before 28 January 2023. Even though minimum pensions for market linked pensions are allowed to be halved in 2022/23 for everyone else, nothing changes for Jim in that final year. This requirement to extinguish his pension balance within 28 days of the end of the term overrides the normal halving.

And finally, pension payments for market linked pensions can get extremely large in those final few years. If we ignore the temporary rule that allows minimum payments to be halved at the moment, the normal minimum for a market linked pension with (say) 3 years to run at the start of the year is around 33% of the balance. This increases to 47% when the pension has 2 years left and then 90% if there is only 1 year left. And remember that some people receiving these pensions pay some personal income tax if their market linked pension payments exceed $106,250. We’re seeing plenty of cases where people who have never had to pay tax before are suddenly paying significant amounts of tax in those final few years.

There are plenty of strategies to consider for clients with market linked pensions at the moment – whether it’s about minimising tax as they come to an end or restructuring to improve flexibility. We’ll be covering these and much more in our legacy pensions masterclass on 27 April.

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