What you need to know about the pension transfer balance cap

Recent legislation has introduced several superannuation rule changes. Among them is a new “transfer balance account”, which each recipient of a superannuation pension will be required to have. In other words, individuals receiving superannuation income stream benefits will need to keep a transfer balance account.

The use of “accounts” for tax law purposes is not new. The best example, and a useful analogy, is the franking account that each company has. The franking account is used to track income tax paid by the company so that the company can pass to its shareholders the benefit of franking credits when a distribution is made. The “franking account” does not actually record anything for accounting purposes, but merely tracks an income tax attribute (which is why it does not appear on any financial statements).

Each individual receiving superannuation pensions will have a transfer balance account, which in general will be created when they start an account-based pension with all or part of their accumulated superannuation balance. But an important additional rule handed down by the government is that there is to be a cap placed on the total amount with which a pension can be commenced, with the cap for 2017-18 set at $1.6 million (it will be indexed for later years). The start date for these new measures is July 1, 2017.

The ultimate purpose of introducing the transfer balance account is to limit the total amount of an individual’s superannuation interests that receive an earnings tax exemption. While the transfer balance account mostly tracks how much superannuation savings an individual transferred into the retirement phase, it does not limit total transfers to the retirement phase. The transfer balance cap is used for this purpose.

However, the cap applies towards net transfers to the retirement phase and is not affected by earnings, losses or drawdowns that occur within the retirement phase. Note also that indexation of an individual’s transfer balance cap is done on a proportional basis – only an unused portion of the transfer balance cap is indexed.

In cases where there are excess funds above the cap placed into pension phase, the amount of excess will be required to be removed. Not only this, but notional earnings made on this amount will be taxed — at a rate of 15% for the first instance of a breach of the cap, but at 30% for subsequent breaches. Moreover, notional earnings are to be taxable regardless of whether the individual has rectified their breach and removed the notional earnings amount from the retirement phase.