Understanding how the Transfer Balance Cap applies to death benefit pensions

It’s been around for a little over three years, but the introduction of the $1.6 million Transfer Balance Cap on 1 July 2017, which restricts the amount that can be used to commence a super pension, certainly whipped up a storm. The cap will have little or no impact on most, but for anyone with a sizable superannuation, or when a person becomes entitled to a death benefit pension, then close attention will help make sure no excess arises. Excesses may result in tax penalties and require an adjustment to the pension balance.

How does it work? Let’s look at a simple example of Andy who has an accumulation balance in super of $1.8 million. He has just retired at 65 years of age and wishes to commence an account-based pension with $1.3 million, which will be counted against Andy’s Transfer Balance Cap. As this is Andy’s only pension, and the commencement amount is less than $1.6 million, there is no excess.

In Andy’s situation, he has received pension payments monthly from his fund and the pension balance has increased to $1.4 million due to investment earnings. Any increase or decrease in Andy’s pension balance, due to pension payments or investment earnings or losses, will have no impact on his Transfer Balance Cap account balance and it remains at $1.3 million.

A few years later, Andy decides to start a second pension from the amount in his accumulation account, which has now increased to $600,000. However, as Andy has used up $1.3 million of his Transfer Balance Cap, he can only use $300,000 to commence the second pension. This means he will have used up all of the $1.6 million cap. If Andy was to use any more than $300,000 to commence his second pension an excess would arise. The ATO would notify him to reduce his pension balance by the excess plus any penalty applying.

It is possible for Andy to withdraw lump sums from his pension balance, which are called commutations, and they will reduce the amount counted against his Transfer Balance Cap. For example, let’s say that in future, Andy needs to withdraw a lump sum of $100,000 from one of his pensions. A commutation of a pension will reduce the amounts counted against his Transfer Balance Cap of $1.6 million by $100,000. This will result in Andy’s Transfer Balance Cap balance now being $1.5 million and at some time in future he may wish to start another pension up to his $1.6 million cap.

Indexation of the Transfer Balance Cap

The Transfer Balance Cap is indexed in amounts of $100,000. However, once a person has used 100% of their cap amount, like Andy in the example, they are unable to receive the benefits of any indexation. Andy’s has used up all of his Transfer Balance Cap of $1.6 million when he commenced the second pension. If the Transfer Balance Cap was indexed to $1.7 million, in Andy’s case the increase in the cap would not apply to him.

Death benefit pensions

In the unfortunate event where Andy was to pass away and his spouse became entitled to a death benefit pension, then the balance at the time it is payable to the spouse is counted against their Transfer Balance Cap. It is important to note that if the spouse is already in receipt of a pension then the aggregate balance of that pension, as counted for Transfer Balance Cap purposes plus the balance of the death benefit pension, needs to be within the cap.

For example, let’s assume the balance of Andy’s pensions at the time of his death had decreased to $1.1 million. At the time of Andy’s death his spouse was in receipt of an account-based pension which commenced with $900,000 and counted for Transfer Balance Cap purposes. If Andy’s spouse commenced a death benefit pension with his super balance at the time of his death, then an excess Transfer Balance Cap amount would arise. They would have the choice of reducing the death benefit pension and withdrawing a lump sum, or reducing the balance of the account-based pension and either transfer it to their accumulation account in the fund or withdrawing it as a lump sum.

Type of pension is important

Depending on the type of death benefit pension being received by Andy’s spouse, the balance is measured at different times against their Transfer Balance Cap. For example, if Andy’s pension was reversionary then his spouse would become entitled to it immediately at the time of Andy’s death. However, it will not be counted against the spouse’s Transfer Balance Cap until one year after Andy’s death. But if the pension was non-reversionary and Andy’s spouse decided to commence a new death benefit pension, the balance used to commence that pension is counted against the spouse’s Transfer Balance Cap at the time it commences.

There’s more to the Transfer Balance Cap story

The case study of Andy and how the Transfer Balance Cap impacts on the commencement of pensions provides a basic outline of how the rules work for many people. But the Transfer Balance Cap rules can be complicated depending on the type of pension commenced, the reason for payment, lump sum withdrawals and whether the person may have access to indexation. In the more complex cases, it can be worthwhile to obtain tax or financial planning advice to make sure no excess arises.