Information for advisers only.
Defined benefit interests are difficult to value in accumulation phase, as final benefits depend on length of service, final salary and other factors. Defined benefit income streams have commutation restrictions imposed by legislation and quite often, by fund specific rules.
The following measures came into effect on 1 July 2017:
Contributions to defined benefit accounts, including contributions to constitutionally protected funds (CPFs), count towards a member’s concessional contributions cap, however modifications ensure that they won’t exceed the concessional contribution cap.
Deductions can’t be claimed for personal contributions to defined benefit Commonwealth public sector superannuation schemes, untaxed funds (generally CPFs), and other categories of funds that may be prescribed in the regulations.
The modified value of a retirement phase capped defined benefit income stream (special value) counts towards the member’s personal transfer balance.
Additional income tax applies to defined benefit income in excess of the defined benefit income cap ($118,750 per annum indexed).
Prior to 1 July 2017, notional taxed contributions, which are contributions that would have been required in a financial year to fund a member’s expected final benefit in a defined benefit fund, were classified as concessional contributions to the extent that these were funded. Contributions to CPFs and unfunded notional taxed contributions were excluded from the cap.
Since 1 July 2017, employer contributions to CPFs count towards a member’s concessional contributions cap, along with the following contributions to defined benefit interests:
employer contributions to a member’s accumulation account in a defined benefit fund
notional taxed contributions in respect of the member’s defined benefit interest (including those excluded under 2006 and 2009 arrangements)
the amount by which defined benefit contributions exceed the member’s notional taxed contributions.
Certain allocations from reserves to a member’s account by the trustee of a CPF or defined benefit fund will also count.
Where a member’s contributions to CPFs and defined benefit interests exceed the concessional cap ($27,500 in 2023/24) the member will be deemed to have contributed up to the concessional contributions cap. Where this is the case, a member’s concessional contributions to an accumulation super fund will be an excess concessional contribution.
In the 2023/24 year, Grace is a member of a CPF and she receives $10,000 in employer contributions. She is also a member of a defined benefit fund. Her defined benefit contributions total $25,000 ($20,000 of which are notional taxed contributions in respect of her defined benefit interest and $5,000 being contributions in respect of her unfunded defined benefit interest).
Grace’s capped amount (contributions to a CPF, notional taxed contributions, and defined benefit contributions exceeding her notional taxed contributions) for the financial year total $35,000, which is worked out as $10,000 + $20,000 + ($25,000 - $20,000).
As the total capped amount exceeds the general concessional contributions cap, her total concessional contributions will be equal to $27,500 (i.e. the general concessional cap). If Grace has an account in a retail super fund and receives any concessional contributions into that account, those contributions will be classified as excess concessional contributions, unless she is able to take advantage of the carry-forward concessional contribution rules (previously called ‘catch-up contributions) by utilising any unused concessional contribution cap amounts since 2018/19.
Members are no longer able to claim deductions for personal contributions made to defined benefit Commonwealth public sector superannuation schemes and CPFs. Members can make personal deductible contributions to an accumulation super fund without having to meet the earnings test (10% rule) which was also removed as part of the super reforms in 2017.
As at July 2023 George is a member of a defined benefit fund that is a CPF. He also has an account in a retail super fund. He sells some shares in the 2023/24 financial year and has a taxable capital gain of $15,000. He is on the 34.5 per cent marginal tax rate and wishes to make a personal deductible contribution to reduce his assessable income.
He cannot make a personal deductible contribution to the defined benefit fund. However, he can make a personal deductible contribution into his retail super fund. He doesn’t need to meet the 10% test as this was abolished from 1 July 2017. The contribution into the retail super fund will count towards his concessional contributions cap.
From 1 July 2017 superannuation interests used to commence a retirement phase income stream will count against a member’s transfer balance cap (TBC). Special values are calculated for capped defined benefit income streams that commenced just before 1 July 2017 and for non-commutable lifetime pensions and annuities commenced at any time.
Capped defined benefit income streams don’t just refer to defined benefit income streams. They also include non- commutable income streams such as lifetime pensions and annuities, life expectancy pensions and annuities, market-linked pensions and annuities, along with certain other income streams prescribed in the regulations. Commutable defined benefit pensions are excluded from these rules however.
A non-commutable lifetime income stream will have a special value for TBC purposes regardless of when it’s commenced. A special value will also be calculated for non-commutable life expectancy and term income streams including term allocated pensions that exist just before 1 July 2017. The special values will be a credit against the member’s transfer balance account. The calculation of the special value depends on the type of income stream as shown below.
|Type of capped defined benefit income stream
|Special value calculated as:
|Lifetime pensions and annuities commenced any time
|Annual entitlement* x 16
|Life expectancy and term pensions and annuities and market- linked pensions and annuities existing just before 1 July 2017
|Annual entitlemet* x remaining term
‘Annual entitlement’ is equal to:
First payment x 365 days / Days in payment period
First payment refers to the first payment just after the capped defined benefit income stream is valued.
Jenny is aged 65 and has the following superannuation income streams just before 1 July 2017:
1. A life expectancy annuity (taxed fund) paying $40,000 pa that has a remaining term of 13 years.
a. The special value is calculated as: $40,000 x 13 years = $520,000
2. A lifetime defined benefit pension (untaxed fund) which pays $1,000 per fortnight.
a. The annual entitlement is calculated as: $1,000/14 days x 365 days = $26,071
b. The special value is calculated as: $26,071 x 16 = $417,143
Where the balance of capped defined benefit income streams exceeds the TBC, the excess caused by these interests alone will not cause the member to exceed their TBC or trigger excess transfer balance earnings.
A commutation from the defined benefit income stream will not be required. However, where the member also has an account-based pension, the excess is the lesser of the amount that exceeds the TBC or the capped defined benefit(s).
Jane is aged 67 and commenced holding the following as at 1 July 2023:
Without realising the consequences Jane decides to commence a new pension on 1 September 2023:
The special values of Jane’s lifetime and life expectancy defined benefit pensions total $1,948,286. While the capped defined benefit sub-account exceeds Jane’s TBC, there is no requirement to commute the defined benefit pensions.
Jane’s excess TBC will be $700,000, calculated as the lesser of the amount exceeding:
Jane will be required to commute $700,000 plus any related excess TBC earnings from her account based pension. She may choose to commute the amount to accumulation phase where earnings are taxed at up to 15 per cent.
To avoid excess TBC amounts, check whether the special value/s of the member’s capped defined benefit income stream/s exceed the TBC before recommending the commencement of an account-based income stream.
While there is no requirement to commute the capped defined benefit income streams where the TBC is exceeded, tax concessions on income from capped defined benefit income streams (capped defined benefit income) are limited to an annual defined benefit income cap (cap). Defined benefit income in excess of that cap will be subject to additional tax. The cap is one-sixteenth of the general transfer balance cap for the financial year, i.e. $118,750 for 2023/24.
A member’s defined benefit income cap reduces if part way in the financial year, the member receives defined benefit income that is subject to concessional tax treatment. For example, where the member is age 60 or over, or starts to receive a death benefit income where the deceased member died age 60 or over. The reduced cap is calculated on a pro-rata basis, based on how many days they’ve received the income at the concessionally taxed rate.
Tax concessions apply to defined benefit income of members aged 60 or over, or death benefit beneficiaries of members who died at or over age 60. These tax concessions allow defined benefit income to be received tax-free if a tax-free or taxable (taxed) component exists, or assessed at marginal tax rates with a 10 per cent tax offset if a taxable (untaxed) component exists.
These tax concessions continue to apply but are now limited to defined benefit income within the cap.
The cap only applies to income that receives concessional treatment. This means the tax treatment of member benefits will remain the same for those under age 60.
Excess capped defined benefit income will be subject to additional tax depending on the tax components as shown below:
|Defined benefit income stream paid from
|Special value calculation
|50% of the amount exceeding the defined benefit income cap is taxed at marginal tax rates.
|100% of the defined benefit income is taxed at marginal tax rates, and the 10% tax offset does not apply to the taxable untaxed component exceeding the defined benefit cap.
When applying capped defined benefit income against the cap, the taxed source and tax-free component is considered before the untaxed source.
Jose, aged 63 receives the following defined benefit income:
The $80,000 from the taxed source will count towards the $118,750 defined benefit income cap first and is non-assessable non-exempt income (tax free) as he is over age 60. The $50,000 from the untaxed source is considered next, and results in him exceeding the cap by $11,250. The $50,000 is assessed as taxable income for Jose because it is from an untaxed fund. As he is over age 60, he is entitled to a 10% tax offset based on the amount of $38,750 within the cap ($3,875). No tax offset is available for the excess income of $11,250.
Where a member is offered different options in taking their defined benefit interest such as a lump sum, part lump sum + part pension or pension only, the defined benefit income cap should be considered.
There are still opportunities to make concessional contributions to CPFs and defined benefit accounts. While tax concessions on defined benefit income are limited, capped defined benefit income streams are advantageous for members with balances in excess of the TBC, as these alone will not cause an excess TBC situation. Members will be allowed to keep excess benefits in an accumulation account.
Download "The transfer balance cap".
FOR ADVISER USE ONLY
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