Now the $1.6m super cap kicks in

As investors prepare to do their taxes the reality of the biggest change to super we have seen in a generation will hit home.

As investors prepare to do their taxes the reality of the biggest change to superannuation we have seen in a generation will hit home.

The financial year just ended was the first in which the transfer balance cap of $1.6 million became applicable to all superannuants. The cap is the cumulative maximum a super fund member may transfer into retirement phase (tax-free pension) over their lifetime. It has been well-publicised in the industry and the media; at our own firm our clients were fully briefed about the cap and its implications before its introduction. Yet there still appear to be many questions about it — or understanding of planning opportunities and indeed, added complexities.

Despite all this attention, when I mentioned the transfer balance cap for superannuation to a prospective client at a meeting this month, there was little to no understanding of what it was. Investors have to get a grip on these new rules — here’s a guide.

Understand the cap

Essentially, the transfer balance account acts as a lifetime ledger, tracking transfers in and out of pension phase to identify when the transfer balance cap is reached. This is a very complex part of the new arrangements.

Notably, the transfer balance cap may be indexed in future years in increments of $100,000 to the consumer price index. If a person has not triggered a credit against their transfer balance cap they will benefit from the full increase of any indexation. The extent to which an individual benefits from indexation depends on whether that person has triggered a credit (or assessment) against their own transfer balance cap.

In addition, superannuants who have already commenced an income stream in pension phase but have not fully used the cap will have indexation applied only to the proportion of the unused transfer balance cap. Indexation is not available for those who have completely used their transfer balance cap.

This means that some superannuants will now need to track an additional two lifetime super amounts — the transfer balance cap and the transfer balance account effective from July 1, 2017.

The application of the transfer balance cap can also vary depending on whether it relates to an account-based pension, a defined benefit pension or a combination of the two. A transition to retirement pension doesn’t count towards the transfer balance cap as they no longer receive the earnings tax exemption from last year. Again, if readers believe they are affected with a combination of a defined benefit and account-based pension and are unsure where they stand I suggest they take separate advice.

Accumulation versus pension mode

Another incorrect assumption is that many superannuants seem to think that from July 1, 2017, you could only have $1.6 million ‘‘in super’’. You can have more; you just can’t have more underpinning a tax-free super income.

While you are in accumulation mode (saving pre-retirement) you can have balances over $1.6m and you are treated at 15 per cent on earnings on the total account ­balance.

Those in pension mode with amounts above the transfer balance cap have two choices. They are required to ‘‘roll back’’ the amounts above the transfer balance cap to either the super fund accumulation account, where earnings will be taxed at 15 per cent, while the balance in pension mode is taxed at zero.

The other option is that they withdraw the excess from the super system altogether.

The following example illustrates this scenario.

If you had $2m in a pension account on June 30, 2017, you either had to withdraw $400,000 from both the pension and the super system or commute $400,000 from the tax-free pension back into a taxable super fund accumulation account.

Rolling back is always the preferred option as the excess rolled back is taxed at a maximum of 15 per cent. It is for this reason that superannuants should avoid withdrawing the excess from the fund as accumulation super is still taxed advantageously.

As investors prepare tax returns for the tax year just ended — and find they have exceeded the transfer balance cap — the ATO will issue an excess transfer balance determination. This will come with a default commutation authority effectively requiring the excess amount to be commuted back to accumulation and excess transfer balance tax of 15 per cent be levied on notional earnings upon the excess amount for the first breach. If there are breaches in future years the ATO will levy 30 per cent for second and subsequent breaches.

This is a very new and expensive risk: I recommend the following moves to manage this new transfer balance cap regime.

Do’s:

● Know and understand your transfer account balance.

● Ensure you comply with the transfer balance cap for the 2018 financial year.

● Ensure your fund administrator understands the new regime and complies with it.

● If you have an SMSF, remember you — the trustee — are ultimately accountable for all SMSF activity.

Don’t:

● Withdraw money above the transfer balance cap from super — this money if left ‘‘in super’’ is still taxed at a maximum of 15 per cent under current legislation.

● Confirm whether you have a transfer balance cap excess.

● Wait to take remedial action if required.

Yes, superannuation has become even more complex. I hadn’t fully appreciated just how complicated transfer balance caps had become until I sat down to write this piece. Understanding your obligations and ensuring compliance is vital and if in doubt seek appropriate advice.

Will Hamilton is the managing partner of Hamilton Wealth Management, a Melbourne-based independent wealth manager.

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