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ATO opens the way for lower tax on pensions (TTR)

Are you under 60 and thinking of retirement?

(or just need to access some extra funds from your SMSF)

Well the ATO has just done you a huge favour with it’s recent Private Binding Ruling (1).  This new ruling effectively allows a person (if implemented correctly) to treat a pension received from their superannuation fund as a lump sum for income tax purposes (even though it is still treated as an income stream for superannuation purposes).  As a consequence, you may be able to access the tax free lump sum benefit amount of up to $195,000 (applicable for the 2015 / 2016 financial year).

For anyone aged between 55 and 60 wanting to draw money from their superannuation fund this is potentially great news.

The old way of thinking…

Cast your mind back to 2005 when the then prime minister (The Honourable John Howard) was tackling an ageing population crisis.  His government wanted to help people who were approaching retirement to move to part time employment (possibly to spend more time with the grandchildren) but still maintain their standard of living.  Enter the “Transition To Retirement” strategy (or “TTR” as we like to call it).

The strategy was simple.  Once you turned 55 (ie. you had reached your “preservation age”) (2) you were now allowed to access up to 10{8c9c1ff2dd97e2d6259091c549649f3540ea2a8d186629f84b534d36b0353f14} of your superannuation nest egg to supplement your reduction in working hours.  Prior to this you had to actually “retire” from the workforce before you could start drawing a pension from your super.  So what was the catch?  The only downside to this strategy was if you were between 55 & 60, then the amount you drew as a pension would be included as income in your personal income tax return.  Once you turned 60, then the full amount would be tax free.  A pretty good deal if you ask me !

 So what’s the big change all about?

Strangely enough there hasn’t been a change to any of the regulations.

The Superannuation Industry (Supervision) Regulations 1994 (SIS Act)

The SIS Act is the legislation that all superannuation funds must abide by.

The SIS Act only allows a pension to be converted to a lump sum (commuted) in the very rare circumstance that the fund comprised of “Unrestricted, non-preserved benefits”.  The majority of people who have not yet retired from the workforce do not have this type of component within their superannuation fund, and as such it was generally accepted that TTR payments would need to be treated as income in the individuals hands.

Income Tax Assessment Regulations 1997 (ITAR) & Income Tax Assessment Act 1997 (ITAA)

On the other side of the legislation fence sits the ITAR & ITAA which dictates the income tax rules for individual taxpayers (and not superannuation funds).

Regulation 995.1.03 of ITAR states that:

“A payment from an interest that supports a superannuation income stream is not a superannuation income stream benefit if:

  (a)  the conditions to which the superannuation income stream is subject allow for the variation of the amount of the payments of benefit in a year in circumstances other than:

(i)  the indexation of the benefit under the rules of the product; or

(ii)  the application of the family law splitting provisions; or

(iii)  the commutation of the benefit (including commutation to pay a surcharge liability); or

(iv)  the payment of an assessment of excess contributions tax; and

(b)  the person to whom the payment is made elects, before a particular payment is made, that that payment is not to be treated as a superannuation income stream benefit.

Someone has simply argued with the ATO (successfully) that these 2 pieces of legislation are totally separate and in reality the SIS legislation has nothing to do with his personal income tax affairs.  The distinction was subtle. The taxpayer was not asking their superannuation fund to pay them a lump sum (which would not have been allowed under the SIS Act), but instead was simply asking the tax office to treat the amount he received as a lump sum for income tax purposes (something he was entitled to do under the income tax legislation).

In handing down it’s decision in the private ruling the ATO determined that:

“your client is able make an election pursuant to regulation 995-1.03 of the ITAR prior to the benefit being paid. The superannuation benefit will be taxed in accordance with section 301-20 of the ITAA 1997”. (1)

In this regard, section 301-20 of the ITAA 1997 Subsection (1) states that:

“If you are under 60 years but have reached your preservation age when you receive a superannuation lump sum, the taxable component of the lump sum is assessable income.”

Subsection (5) of the same section states that:

“The amount is so much of the total of the taxable components included in your assessable income for an income year under subsection (1) as exceeds your low rate cap amount for the income year.”

The end result was that the taxpayer only had to pay tax on the amount over and above the lump sum low rate cap of $195,000 and not the whole amount.

Will this change be beneficial to you?

Firstly, it must be stated that this is a private ruling only and not applicable to the public at large.  It does, however, pave the way for some new tax planning opportunities that weren’t previously thought possible.

This will be most noticeable for people between the ages of 55 and 60 that wish to access money from their superannuation fund.

A few words of warning:

  1. The ATO Ruling was a private Binding Ruling which means that it is not technically available for everyone to use.
  2. The member must make their election before the payment is made from the SMSF.
  3. The ATO has advised that “Electing for a TRIS (Transition to Retirement Income Stream) payment to be treated as a super lump sum for income tax purposes may affect the amount of the SMSF’s exempt current pension income for an income year and whether particular fund assets are segregated current pension assets”.
  4. Care must be taken to ensure that you do not exceed the 10{8c9c1ff2dd97e2d6259091c549649f3540ea2a8d186629f84b534d36b0353f14} maximum pension.  If payments are outside the allowable limits, your fund cannot claim a tax exemption on the income from the account supporting all the payments.
If you would like more information on this strategy and whether it is right for you please contact our office.

 

Notes:

(1) ATO Private Binding Ruling 1012925066548 issued 8 December 2015.

(2) If you were born before 1 July 1960, the preservation age is 55. The preservation age for those born on or after 1 July 1960 is higher.