Michelle Bromley CFP®, Director – Strategy & Advice
On 7 December 2024, significant regulatory changes were enacted, addressing long-standing complexities surrounding legacy pensions and fund reserves. The new regulations are a welcome relief for superannuation trustees and members who:
- Have a lifetime defined benefit pension, life-expectancy pension, or market-linked pension they would prefer to commute
- SMSFs with an unallocated reserve arising from a previously restructured legacy pension, or where the member in receipt of the legacy pension has passed away
Temporary Changes for Legacy Pensions
For five years, starting from 7 December 2024, the new rules allow legacy pensions—such as complying lifetime, life expectancy, and market-linked pensions — to be fully commuted without the need to roll over into another legacy pension. This marks a pivotal shift for individuals seeking greater flexibility in accessing capital or the ability to pay a future death benefit as part of their estate plan.
Key highlights:
- Time-sensitive opportunity: As the 5-year window of opportunity closes on 6 December 2029, members wishing to cease their legacy pension should seek advice promptly.
- Flexibility with commutations: Members can now commute these pensions fully to the accumulation phase, or withdraw the funds. Partial commutations are not available.
- Transfer Balance Cap considerations: Using commutation proceeds to commence an account-based pension may be possible to the extent the member has sufficient space within their Transfer Balance Cap.
Legacy pensions can be time-consuming and costly to administer, and traditionally, they have restricted the supporting capital to remain within the superannuation environment even beyond the death of the pensioner. These new regulations allow members to simplify their SMSFs, reduce costs associated with legacy pensions and flexibly withdraw benefits and wind up their SMSF in future.
Social Security Implications
For clients who established assets test exempt legacy pensions, further changes to the legislation governing social security are required to ensure the pensioner does not incur a retrospective 5-year clawback of social security entitlements because of the commutation.
These further changes are expected to be enacted in the first half of 2025.
Updated Reserve Management Rules
Previously, reserve allocations made to members were generally counted against the individual’s concessional contribution cap, giving rise to 15% tax on the amount allocated within the cap and up to 47% tax on the excess above the cap.
This rule potentially resulted in a significant tax liability for members wishing to restructure existing legacy pensions, or where the member in receipt of a legacy pension had passed away, and where a reserve arose relating to those benefits.
As a result, it may not have been possible to fully allocate reserve amounts and close an SMSF post the death of a member.
These welcome changes provide more flexibility to make reserve allocations to members, by redefining how reserve allocations interact with contribution caps:
- Fully Exempt: Where the allocation is made from a reserve used solely to enable the super fund to discharge its income stream liabilities, and that allocation is made to the recipient of an income stream related to the reserve, the allocation will not count toward the individual’s concessional or non-concessional contribution caps.
- Non-concessional cap alignment: Where allocations are not exempt, they will be measured against the recipient’s non-concessional contributions cap, rather than the concessional cap
The regulations apply to allocations made from 7 December 2024 providing the opportunity for SMSF trustees to tax-effectively make larger reserve allocations to members, which can then be rolled over to another fund and clearing the way to close an SMSF that is no longer wanted.
Unlike the temporary nature of the legacy pension provisions, the reserve management changes are permanent and not subject to the 5-year window.
Next Steps
Given the complexity and significance of these changes, expert advice is essential.
SMSF Trustees and pensioners holding a lifetime defined benefit pension, life-expectancy pension, or market-linked pension should contact their Financial Adviser to review whether commuting their pension and allocating reserves may be in their best interest for flexibility in accessing capital and enabling payment of death benefits as part of estate planning strategies.
SMSF Trustees will need to involve their Accountant and an Actuary to calculate commutation values and tax and transfer balance account consequences of the various restructuring options.
Contact
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