Five common questions about the transfer balance cap answered

By Graeme Colley
Executive Manager, SMSF Technical and Private Wealth - SuperConcepts Sydney, Australia

The commencement of the transfer balance cap on 1 July 2017 certainly sparked a storm, by limiting the amount you could transfer to the pension phase to $1.6 million. Here, we clear up some common questions and misunderstandings.

What sounds like a simple cap can end up being complicated and confusing if you don’t know the intricacies of how the cap operates. In this article I’ve covered some of the misunderstandings about the transfer balance cap, to iron out any confusion.

1. Can my transfer balance cap be more than $1.6 million?

Yes, it is possible for your transfer balance cap to be more than $1.6 million in some limited situations. The amount you use to commence an account-based pension or its balance as at 30 June 2017 are counted as a credit against your transfer balance cap.

Also, if you are receiving a transition to retirement income stream (TRIS) and move into retirement phase or reach age 65 the balance at that time will be counted against your transfer balance cap. The total of these pensions that can be counted when they commence is limited to $1.6 million.

Example 1

Mark commenced an account-based pension on 1 August 2019 with $1.3 million. If he is not receiving any other account-based pensions his transfer balance account will have a credit of $1.3 million and there will be no excess as it is less than his transfer balance cap of $1.6 million.

Example 2

Dina reached age 58 and commenced a TRIS but continues to work. The balance of her TRIS at commencement was $1.1 million but as she has continued working. The value of the TRIS will not be counted against her transfer balance cap until she has ‘retired’ as defined for superannuation purposes or reached age 65, whichever comes first. If Dina decided to retire at 61 and the balance of her TRIS at retirement was $900,000 it would be counted as a credit against her Transfer Balance Account. If that was her only pension, then there would be no excess as the value counted is less than $1.6 million.

A transfer balance cap of more than $1.6 million?

It is possible to have a transfer balance cap of more than $1.6 million if you are receiving a special type of pension called a defined benefit pension. A defined benefit pension is usually paid for your lifetime or for a fixed period such as your estimated life expectancy. In most cases defined benefit pensions are paid by a small number of public company funds, some public sector funds and some SMSFs that have been in existence for many years. Once a defined benefit pension has commenced it can only be converted to a lump sum in very limited circumstances.

The value of the defined benefit pension counted against your transfer balance cap is calculated by using the first pension payment you receive. That amount is multiplied by a factor to work out a value which is counted against your transfer balance cap. If this value of the defined benefit pension is greater than $1.6 million it will be your transfer balance cap.

If you are receiving a number of different types of pensions including a defined benefit pension and the combined value is greater than $1.6 million you may be required to reduce the value of any account based pension or TRIS in retirement phase you are receiving so you don’t end up with an excess.

Example 3

Rob is in receipt of a defined benefit pension because he worked in the public service. The value of his pension is $1.7 million as calculated under the transfer balance cap legislation will become his transfer balance cap.

Example 4

Sue has retired as an executive of a multinational company which pays her a defined benefit pension valued for transfer balance cap purposes at $1.3 million. The balance in the accumulation account of her SMSF is $500,000 and she would like to use the whole balance to commence an account-based pension. In her situation, she can only use $200,000 of her accumulation account to commence the pension otherwise she will exceed her transfer balance cap of $1.6 million.

Example 5

Emily commenced a TRIS at age 58 while she was working. She has now retired at age 61 which means the value of her TRIS of $600,000 at that time will now be measured against her transfer balance cap. At retirement Emily is also entitled to a defined benefit pension which is valued at $1.4 million.

As the combined value of Emily’s pensions exceed $1.6 million, she will be required to reduce the balance of her TRIS to $200,000 to avoid exceeding her transfer balance cap of $1.6 million. It is not possible to reduce the amount of her defined benefit pension in view of the special rules that apply.

2. What if my pension balance(s) go above $1.6 million?

One misunderstanding about pensions and your transfer balance cap is that once your pension balance(s) go beyond $1.6 million any excess is required to be withdrawn from the fund or transferred to your accumulation account. This is not correct because once the value used to commence your pension has been counted against your transfer balance cap any movements in the pension balance due to investment income or pension payments are not taken into account.

Example 6

Stephen commenced an account-based pension with $1.2 million which is counted against his transfer balance cap. During the year his pension balance increases to $1.3 million due to investment income including capital gains but after his pension has been paid to him.

The amount counted against Stephen’s transfer balance cap will not change as the income earned as well as the pension payments are not counted.

3. Can I end up with a negative transfer balance account?

Yes, you can end up with a negative transfer balance account. The reason is that if you decide to stop (commute) your pension in full or in part the amount commuted will result in an adjustment to your transfer balance account.

Example 7

Frank commenced an account-based pension with $1.3 million which is counted against his transfer balance cap. During the financial year his balance after allowing for pension payments and increases due to investment income has grown to $1.4 million.

If Frank decides to commute the balance of his pension in full his transfer balance account will be reduced by the amount commuted ($1.4 million). As Frank commenced his account-based pension with $1.3 million which has been counted for transfer balance cap purposes it will now be reduced by the commuted amount of the pension ($1.4 million) which will result in a transfer balance account of -$100,000. In future, if Frank wishes to commence a new pension then the negative balance in Frank’s transfer balance account would be taken into account in the calculation.

4. What if I belong to more than one fund – are there transfer balance cap issues associated with this?

There are no limits to the number of superannuation funds you can join. However, if you commence an account-based pension in more than one fund, each pension will be reported to the ATO and measured against your transfer balance cap. You will need to take care to ensure that the total value counted stays within your transfer balance cap, otherwise you may end up with a tax penalty being imposed.

A good source of information concerning what has been counted against your transfer balance cap is your MyGov account. However, you will still need to keep an eye out for other amounts that may have been counted because of a delay by funds reporting of amounts that impact on your transfer balance account.

Example 8

Jessie commenced an account-based pension in her SMSF on 23 February 2019 and in July 2019 commenced another account-based pension in an industry fund of which she was a member. Because of timing differences in reporting Transfer Balance Cap amounts by an industry fund and SMSF she finds that her industry fund has reported the pension in the next month after it commenced but the SMSF is not required to report the pension until the end of the current quarter.

5. What if I take a lump sum from my super – what’s the best way for transfer balance account purposes?

A strategy that can work well is to withdraw the minimum pension amount and top up your pension from your accumulation account in the fund. The main benefit you get from this strategy is that over the longer term the amount you will have in pension phase will increase proportionately. Any income on investments used to support a pension in the fund are tax exempt. Therefore the higher the proportion of your superannuation in pension phase the greater the taxation advantages.

Example 9

Raylene is drawing an account-based pension of $60,000 which is equal to 5% of the pension’s account balance at the commencement of the financial year. She has decided to go on an overseas trip for six months and requires an additional $40,000 for estimated expenses. As she has an accumulation account in the fund, she may find it better to withdraw a lump sum from that account which will help maximise the amount in her pension account and the income on pension account investments that will be tax exempt.

If Raylene had only a pension account in the fund any additional amounts required for living expenses or to travel could be paid to her by commuting the pension. The effect of a commutation of the pension would be to reduce the amount counted against her Transfer Balance Cap as discussed above.

Conclusion: lessons learned

Your transfer balance account and strategies you can use, mean that every time you commence or commute a pension you should check to see which option provides you with the best tax advantages. This will also help ensure that you stay within your transfer balance cap and are not faced with penalties because an excess has occurred.  

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Graeme Colley, Executive Manager, SMSF technical and private wealth- Super Concepts
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While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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