The Transfer Balance Cap and CSS/PSS Pensions

It has been almost 18 months (from 1 July 2017) since the Federal Government imposed a $1.6 million cap on the total amount that a member can transfer into the tax-free pension phase (known as the “Transfer Balance Cap”).

Now that some time has passed, certain irregularities have been brought to light with regard to the treatment of reversionary Commonwealth Superannuation Scheme (CSS) and Public Sector Superannuation Scheme (PSS) pensions and the Transfer Balance Cap.

This article looks at the current law regarding the Transfer Balance Cap generally and how the Transfer Balance Cap is affected when a “reversionary pensioner” is in receipt of a reversionary CSS or PSS pension. Some of the principles raised in this article will also apply to other defined benefit pension but for this article, we will examine only the CSS and PSS scheme.

The Transfer Balance Cap System – a Recap

The Transfer Balance Cap system operates via a “credits and debits” system – a credit is an assessment against the cap and a debit arises to reduce the assessment against the cap.

The following “ledger” provides some examples of credits and debits against the Transfer Balance Cap:

Transfer Balance Cap Ledger – $1.6 Million
Credit
(assessment against cap)
Debit
(reduction of assessment against cap)
  • When an income stream commences (from 1 July 2017)
  • The value of super interest supporting income streams on 30 June 2017
  • When person has other types of superannuation income streams (eg Transition to Retirement income stream) and they either reach 65 years or notify the fund trustee that they have satisfied another condition of release
  • Commutations (or lump sums) taken from income stream
  • Adjustments to meet family law settlements
  • “Replenishment debits” approved by the ATO. Replenishment debits apply in limited circumstances where the value of an income stream has been impacted by bankruptcy, fraud or dishonest

 

Division 294 of the Income Tax Assessment Act 1997 (“The Act“) deals with the calculation of Transfer Balance Caps and section 294-25 of the Act provides the general rule for credits to the Transfer Balance Account.

It is important to note that investment gains and losses do not alter the transfer balance cap. Income stream payments also will not change the transfer balance cap either.

Defined Benefit Pensions

CSS and PSS pensions are both examples of defined benefit pensions – that is, a type of pension plan based on a predetermined formula.

Defined benefit pensions have special rules which recognise their non-commutable nature. These types of pensions receive a credit to the Transfer Balance Cap by their “Special Value, which is determined by multiplying the “annual entitlement” by a factor of 16.

An example

Consider the case of Joseph and Mary. Joseph becomes entitled to a CSS pension of $100,000 per annum as at 1 July 2018 when he permanently retires from the Public Service and claims his benefits.

Joseph will have reached his Transfer Balance Cap limit ($100,000 x 16 = $1.6 million).  One of the great benefits of the CSS is that Joseph’s pension is indexed and will increase every 6 months. In January 2019, the CSS/PSS indexed pension increase was set at 0.8%[1]. Fortunately for Joseph, any subsequent increases to his defined benefit pension will not affect his Transfer Balance Cap.

Reversionary Pension Recipient – Mary

In the example above, what happens to Mary and her Transfer Balance Cap if Joseph subsequently dies?

The rules of the CSS entitle Mary to a reversionary pension equating to 67% of Joseph’s indexed pension at the time of his death if she satisfies the definition of an “eligible spouse”.  Let us assume at the time of Joseph’s death, his CSS pension has been indexed such that the pension as at the date of his death is valued at $110,000 per annum. As we saw above, the subsequent indexation to Joseph’s pension would not affect his Transfer Balance Cap.

Assuming Mary is entitled to receive 67% of Joseph’s CSS pension value as at the date of his death, what would be the credit to Mary’s Transfer Balance Cap. Would it be (a) or (b) below:

  1. a credit of $1,179,200 (being 16 x (67% of $110,000) – keeping Mary is within her Transfer Balanced Cap allowance
  2. a credit of $1,760,000 (being 16 x 110,000) – meaning Mary has exceeded her Transfer Balance Cap allowance

From a logical point of view, one would assume the answer is (a) – the credit to Mary’s Transfer Balance Cap would be based on the value of the reversionary pension she receives.

Reversionary Benefits paid to a Spouse

Unfortunately the torturous and arcane provisions of the Superannuation Act 1976 (and in particular, section 94) make more than one interpretation of the Special Value possible in the above example. The Commonwealth Superannuation Corporation have adopted an interpretation which severely prejudices Reversionary Pension recipients.

That view is as follows – based on section 94, the spouse of a deceased pensioner is entitled to receive the first 7 pension payments at the original pension rate (that is, at the same rate the deceased pensioner was receiving). As we saw above, the “Special Value” of a superannuation interest is determined by multiplying the “annual entitlement by a factor of 16. The annual entitlement is worked out taking the “first superannuation income stream” to which the recipient is entitled.

The first superannuation income stream the spouse is entitled to receive is at the original pension rate and as a result, the spouse’s Transfer Balance Cap is assessed as if the spouse was in receipt of the original pension rate. No allowance is made for the fact that after the after 7 pension payments, the spouse’s pension is deceased.

In the above example, Mary’s Transfer Balance Cap would be assessed on her receiving a pension of $110,000 per annum, meaning she would have exceeded her Transfer Balance Cap allowance.

Due to increased queries from the public and financial advisors alike, the Commonwealth Superannuation Corporation has released a Fact Sheet which outlines the interpretation of the current rules regarding reversionary pensions and their Special Value. The Fact Sheet can be found here (document CSF33).

Recent Media Release

Thankfully, the Federal Government has recognised the unintended consequence arising from the introduction of the Transfer Balance Cap on reversionary defined benefit pensions.

On 31 October 2018 Assistant Treasurer Stuart Robert issued a Media Release titled “Retirement income covenant and ensuring a fair and effective superannuation system”  which can be found here. Among other things, the Media Release mentioned the following:

Finally, the valuation of defined benefit pensions under the transfer balance cap will be amended to reflect when pensions are permanently reduced following an initial higher payment, such as for some public sector defined benefit reversionary pensions or reclassification of invalidity pensions. This will ensure that holders of these pensions are not disadvantaged when reductions occur”

While the Media Release is a promising step in the right direction, until legislative changes are drafted and come into force, the current law stands to assess reversionary pensioners unfairly.

Written by Golnar Nekoee, Director, Wills and Estate Planning

 

[1] (following the Australian Bureau of Statistics release of the CPI data for the Section 2018 quarter)