Commute Pension Meaning

What does it mean to commute a pension?

A pension commutation is a lump sum withdrawal from the theoretical capital supporting the pension.

The theoretical capital is not exactly calculated as the pension balance itself.

Basically, if a lump sum withdrawal is made from a pension it is classified as a commutation, unless that lump sum withdrawal was a pension payment.

The pension commutation meaning is much less relevant these days, yet still important to understand.
 

Commute Pension Meaning & History

 
Prior to the Simpler Super reforms, superannuation pensions were different.

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The current account-based pension was referred to as an allocated pension.

The owner of an allocated pension was required to draw an income between a minimum and maximum amount.

The minimum and maximum amount was calculated based on your age, account balance and life-expectancy.

If you needed more money, you would need to make a pension commutation.

The pension commutation would reduce the theoretical capital value of your pension.

A commutation would then affect the calculation of the minimum and maximum payments, as well as the income assessment for Centrelink purposes.

After the simpler super reforms, the calculation of the minimum and maximum pension payments was removed and replaced with a minimum pension income factor.

The minimum pension income factor is a percentage of your total pension balance, based on your age.

It determines how much pension income you must withdrawal for the financial year as an absolute minimum.

There is no longer a maximum pension income threshold for standard account based pensions.

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Therefore, a pension owner can now nominate how much income they want to receive each year, provided it is above the minimum amount.

In most cases, you can simply take an increased pension payment, rather than partially commute your pension, if you need additional money.

A maximum income threshold of 10% does apply to Transition to Retirement (TTR) Pensions.

Transition to retirement pensions are also known as non-commutable account based pensions.

As the name suggests, commutations cannot be made on TTR pensions.
 

Types of Pension Commutations and Their Meanings

 
There are four types of pension commutations that can be made.

These include a partial rollback commutation, full rollback commutation, partial withdrawal commutation and full withdrawal commutation.

The meaning of each of these types of pension commutations is detailed below:

Commutation Type Meaning
Partial Rollback Commutation Rolling part of your pension capital balance back to a super accumulation account
Full Rollback Commutation Rolling your total pension balance back to a super accumulation account
Partial Withdrawal Commutation Withdrawing part of your pension capital balance out of the superannuation environment altogether
Full Withdrawal Commutation Withdrawing your total pension balance from the superannuation environment altogether

 

Transfer Balance Cap Pension Commutation

 
The introduction of the Transfer Balance Cap from the 1 July 2017 super changes brought in the need for some people to make compulsory commutations.

The Transfer Balance Cap limits the amount of superannuation savings that can be held in pension phase.

The current Transfer Balance Cap is $1.6 million.

If you had a total pension balance in excess of $1.6 million on 30 June 2017, the excess amount above $1.6 million had to be partially commuted.

The partial commutation could be a partial rollback or a partial withdrawal, as defined in the table above.

A formula, which can be found here, was used to calculate the capital value of a defined benefit pension for Transfer Balance Cap purposes.
 

Pre-1 January 2015 Pension Commutations

 
A non-grandfathered account based pension is assessed using the deeming provisions for Centrelink income test and aged care means tested purposes.

However, a pre-January 2015 grandfathered pension is assessed using the deductible amount for Centrelink and social security purposes.

The reason this is important is because partial commutations will affect the calculation of the deductible amount, which can affect Centrelink entitlements and aged care fees.

A full pension commutation, including a pension refresh, will result in a pre-1 January 2015 grandfathered pension no longer being grandfathered.
 

Should I Commute My Pension?

 
Whether you should commute your pension or not depends on what you are trying to achieve.
 

Commuting Pension to Lump Sum

 
If you need a lump sum for a one-off purpose, such as a new car, you may consider making a lump sum withdrawal pension commutation.

However, a one-off increased pension payment can have the same outcome.

If you have a post-1 January 2015 pension, there is no real difference between an increased pension payment or a commutation.

If you have a pre-1 January 2015 grandfathered pension, you need to calculate the implications of a commutation on the future deductible amount, compared to the immediate consequences of a one-off increased pension payment.

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Commute Pension Back To Accumulation Phase

 
If you have too much in pension phase and required to draw an income more than you need, you may decide to commute part of your pension back to accumulation phase.

The benefit of a partial rollback commutation is that it can reduce the amount of income you have to withdraw and preserve the amount held within super.

The downside of a partial rollback commutation is that earnings within a super accumulation account are taxed at up to 15%; whereas earnings within a standard pension account are taxed at 0%.
 

Pension Commutation Example

 
Let’s say you have a pension that you started on 1 July with a balance of $500,000.

By 1 December of the same year, the balance had earned income (e.g. dividends) of $8,000, had capital growth of $20,000 and paid pension payments of $12,000 and fees of $1,000.

The balance at 1 December would be $515,000.

If you made a lump sum commutation on 1 December of $30,000, the balance would reduce to $485,000.

For standard account based pensions, this is no different to if you had simply opted to make an increased pension payment of $30,000.

However, for a grandfathered pension, this commutation would affect the deductible amount calculation.

The deductible amount calculation = (Original Pension Purchase Price – Any Commutations Since Inception) / Relevant Number At Commencement.

You can now see how a commutation will reduce the Centrelink deductible amount and therefore increase the assessable income for income test purposes.

If you have a grandfathered pension, you can ask your superannuation provider for your Centrelink Schedule which provides you with all the information you need to calculate your deductible amount.

Chris Strano

Chris Strano created SuperGuy to help the average punter navigate through the complex and ever-changing super rules. It has since become one of Australia's leading digital super resources. If you’re looking for more personalised advice, have a chat with one of our experts at www.superguy.com.au/need-advice

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8 Comments

  1. Michael

    Income Stream partial Commutations

    Hi Chris
    For DHS/Centrelink purposes , when reporting the total commutations since commencement, is the value of commutations from a purchased income stream treated as Gross or Net

    Reply
  2. Marion Haworth

    If I want to move from one account based pension product to another, do I have to fully commute my investments?

    Reply
    • Chris Strano

      Hi Marion, not always. It depends on what your investments are and if the super fund that you intend on moving to is willing to accept your existing investments as an ‘in-specie’ transfer. Your existing super fund would also need to agree to in-specie transfer them out. There may be a cost for this.

      Reply
  3. Michael

    Hi Chris
    Can I roll over my allocated pension to a better performing fund my pension started post 01/01/2015. Are there any pitfalls I should be aware of. Thanking you in anticipation
    Regards
    Michael

    Reply
    • Chris Strano

      G’day Michael,
      The main pitfall would be transaction costs.
      Transaction costs include brokerage for shares or buy/sell spread costs for managed funds, or even investment switching costs charged by your super fund. All of these should be considered, as it could run into the thousands depending on your balance.
      Another thing, be careful of chasing returns. It’s not impossible for the ‘best’ performing super fund over the past 5 years to be the worst performing over the next 5 years and vice versa. Super funds have legal ways of smoothing investment returns through their reserve accounts, which can allow them to put earnings away in really good years and then use them to bump up their returns in future years.

      Reply
  4. Tim

    Hi Chris,

    My parents have qualified for the state pension and have a nominal amount in super. Would there be any considerations if withdrawing “commuting?” the entire balance? I understand the underlying amount is “deemed” by Centrelink as income whether it is cash, super, shares, etc anyway.

    cheers

    Reply
    • Chris Strano

      Hi Tim, the things to consider would be potential income tax on the super withdrawal, particularly if they are under age 60, as well as possible CGT within super. Also, any life insurances within super that are being funded by the super balance. These policies would lapse if the account was closed.
      Chris
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      Reply

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