By Colin Lewis,
Head of Technical Services,
Fitzpatricks Private Wealth
July 2018

The introduction of the $1.6 million transfer balance cap (TBC) – part of the superannuation reforms that came into effect from 1 July last year – was the catalyst for many people to review their estate plans. The TBC limits the amount you can move into super’s tax-free retirement phase.

Superannuation death benefits must be paid as a lump sum and/or income stream, and the TBC limits the later. For beneficiaries eligible to receive a death benefit pension, this ‘cap’ now forces the withdrawal of benefits in excess their TBC.

So, while you may not have $1.6 million in super, if you exceed this amount when combined with your spouse’s balance, you may have a problem and should carefully consider your estate planning!

How the TBC works differs between reversionary pensions – income streams that automatically continue upon the member’s death to a nominated dependant beneficiary – and non-reversionary pensions. The value of the pension counting towards a beneficiary’s TBC and the timing of when it counts is different between these two types of pensions.

Thus, there’s been a renewed focus on ‘reversionary’ versus ‘non-reversionary’ income streams, with many people wishing to have the former in place due to the potential benefits under the TBC. However, changing from a non-reversionary to reversionary pension can have pitfalls, especially where you’re unable to change an existing account-based pension (ABP) and need to cease it and commence a new pension with the reversionary nomination. Where this occurs, there may be an adverse impact on the underlying components of the pension for tax purposes and result in loss of ‘grandfathering’ for social security / Department of Veterans’ Affairs (DVA) purposes.

For many with ‘grandfathered’ ABPs – pensions with the old income test applying – there is still confusion as to what can and cannot happen so as not to lose this status.

The balance of an ABP, including a transition to retirement pension, is counted under the social security / DVA assets test, and it is ‘deemed’ under the income tests for government income support payments, e.g. the Age Pension, and the Commonwealth Seniors Health Card (CSHC).

Deeming rules assume the market value of your financial assets earn a government-set rate of return to work out the income they create, no matter what they really earn.

However, if you have an ABP that was established before 1 January 2015 and you received and continue to receive income support payments, or held and continue to hold the CSHC, immediately before that date, then the income test rules that applied on 31 December 2014 continue to apply. That is, these ABPs are ‘grandfathered’ and a more generous income test treatment applies. For government income support payments, a non-assessable portion (deductible amount) offsets the ABP income, reducing the amount counted. For the CSHC, no income whatsoever from the ABP counts towards the card’s income test.

‘Grandfathering’ also applies to reversionary pensions where the original ABP member satisfies the above conditions until their death and the reversionary beneficiary receives and continues to receive income support payments, or holds and continues to hold the CSHC, from the date the pension reverts, i.e. the time they start receiving the deceased’s pension.

For self-funded retirees, having and retaining a CSHC is all-important as its main attraction is cheaper medicine under the Pharmaceutical Benefits Scheme. Other concessions for CSHC holders are not as extensive as those for Pensioner Concession Card holders. However, State and Territory governments and local councils may provide concessions, such as lower council rates, public transport fares and health care costs, including ambulance, dental and eye care, and cheaper electricity and gas bills, but these vary greatly depending on where you live.

The continued ‘grandfathering’ of an ABP is a two-limb test. First, you must maintain the ‘grandfathered’ ABP, however, you may reduce its balance via partial commutations, i.e. lump sum withdrawals. Second, you cannot lose government income support payments or the CSHC, even if you later re-qualify. If either occurs, ‘grandfathering’ is lost.

So, if you stop a ‘grandfathered’ ABP and start a new pension, maybe to include a reversionary nomination due to the TBC, you lose the ‘grandfathering’ and your new ABP is deemed.

There are many other ways ‘grandfathering’ can be lost. Most centre on making changes to the ABP, either deliberately or accidentally, without being aware of the implications.

For example, changing income stream providers. That is, moving your ABP from one super fund to another, including moving from a self-managed super fund (SMSF) to a retail or industry fund. However, people who have a ‘grandfathered’ ABP and no longer wish to run their SMSF but are locked in due to the CSHC may find a small APRA fund the solution. Handing control to a professional trustee does not change the fund or the ‘grandfathering’ of an ABP (nor trigger capital gains tax on fund assets).

The ‘grandfathered’ treatment of an ABP is also lost if it is stopped to add extra savings or to aggregate multiple ABPs, or a death benefit pension is paid to someone other than a reversionary beneficiary, or the minimum pension payment requirements are not met and the ABP ceases. In all these cases, the account balance of the new pension is deemed.

Circumstances where the CSHC is lost and consequently the ‘grandfathering’ of an ABP is also lost includes where the income threshold for the card is exceeded – currently $53,799 a year for singles, $86,076 a year for couples and $107,598 a year for couples separated by illness.

The CSHC can also be lost by going overseas for more than 19 weeks, which requires a card re-application on return and sees the ABP balance being deemed.

Losing ‘grandfathering’ on an ABP does not mean you automatically lose the CSHC – it may not be the end of the world! Only if the deemed income from the new ABP together with your adjusted taxable income pushes you over the income threshold for the card will you lose it.

So, if you ‘run the numbers’ including deeming on a new ABP and find you’re well within the relevant threshold, you may not be locked into your current ‘grandfathered’ ABP and enjoy the flexibility and options available to you, you didn’t know you had!