Are you wondering how the Transfer Balance Cap applies to your defined benefit pension and defined benefits payments in excess of the cap are taxed?
With an account based pension, a maximum of $1.6 Million can be used to commence the pension (indexed in line with CPI from 1 July 2017 in increments of $100,00). Any remaining superannuation benefits must remain in accumulation phase.
An account based pension commenced prior to 1 July 2017 must be reduced to $1.6 Million prior to 1 July 2017 (transitional rules apply) by rolling any excess back to accumulation phase before this date.
But what about Defined Benefit Pensions?
How do the new superannuation changes affect defined benefit pensions and what happens if a defined benefit pension exceeds the Income Cap or Transfer Balance Cap?
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Defined Benefit Transfer Balance Cap Formula
Lifetime defined benefit pensions do not have a capital value. They are simply an income stream for life. So how do they apply to the Transfer Balance Cap?
For existing defined benefit pensions, the effective value of the pension for Transfer Balance Cap purposes is calculated by multiplying the annual income by 16. The amount that will be counted towards the cap is the calculated value at 30 June 2017.
For defined benefit pensions commenced from 1 July 2017, the value of the income stream for Transfer Balance Cap purposes is also calculated by multiplying the annual income at commencement by 16. If the defined benefit pension commences part way through a financial year, it is the income that would be received over a full year.
Defined Benefit Superannuation Changes
So, what happens if you are in receipt of a defined benefit pension and an account based pension. Or what about if you have a defined benefit pension and are looking to commence an account based pension (or vice-versa)?
Here’s what you need to do.
Firstly, you need to determine the value of your defined benefit pension for Transfer Balance Cap purposes. You then need to ensure that your account based pension value, when added to the defined benefit pension value, does not cause the Transfer Balance Cap of $1.6 Million to be breached.
For example, if you have a defined benefit pension income of $60,000 p.a., then the value that will be counted towards the Transfer Balance Cap is $960,000 ($60,000 x 16). Therefore, the maximum amount that you can hold in an account based pension is $640,000 ($640,000 + $960,000 = $1.6M).
Because a defined benefit pension is unable to be commuted or reduced in capital value, the only lever you have available to get under the cap is to reduce the account based pension by rolling some or all of it back to accumulation phase of superannuation. Accumulation accounts do not count towards the Transfer Balance Cap.
So, if you were receiving a defined benefit pension of $100,000 p.a., the value for Transfer Balance Cap purposes would be $1.6M. In this instance, you would not be able to commence an account based pension. Any existing account based pensions would need to be closed down or rolled back to accumulation phase prior to 1 July 2017.
Defined Benefit Pension Tax Modifications
From 1 July 2017, modifications have been made for the way lifetime defined benefit pension income streams are treated for tax for people over the age of 60. This is known as the capped defined benefit pension modifications and applies to income that are unable to be commuted (commuted means making a lump sum withdrawal to reduce the capital value of the pension).
If the value of your defined benefit income streams exceeds the Transfer Balance Cap, you will not incur Excess Transfer Balance Tax. Rather, the income received from such income streams will be subject to additional income tax rules.
Taxed Source Capped Defined Benefit Pension
Specifically, in relation to taxed source defined benefit income streams, half of the income received that exceeds $100,000 will be included in your tax return as assessable income. The taxed source consists of the tax-free and taxable (taxed) component of your pension.
For example, if your defined benefit income stream was $120,000 p.a., made up entirely of tax-free and taxable elements, half of the amount above $100,000, being $10,000 (i.e. $20,000 / 2 = $10,000), will be included as assessable income and taxed at your marginal tax rate.
Untaxed Source Capped Defined Benefit Pension
The tax offset associated with income received from a defined benefit pension derived from an untaxed source is limited to 10% of the first $100,000 p.a. Therefore, if you are receiving a pension of $150,000, the ordinary 10% offset ($15,000) will be reduced to $10,000, as the 10% only applies to the first $100,000.
Combination Taxed and Untaxed Source Defined Benefit Pension
Where you pension is made up of a combination of taxed and untaxed sources (i.e. Taxable (untaxed) Element AND Taxable (taxed)/Tax-Free Elements), the taxable component is first applied to the $100,000 defined benefit pension income cap.
For example, if you are receiving a pension of $150,000 p.a. consisting of $100,000 taxable (untaxed) component and $50,000 tax free component, the $50,000 is not included in your assessable income as it does not exceed the $100,000 income cap. However, the full $100,000 from the untaxed source will be included as assessable income, subject to a 10% offset.
Defined Benefit Pension Income Assessment for Centrelink
The tax free component is used to calculate the deductible amount of a defined benefit income stream for Centrelink purposes. Click here to read more.