Three super changes that will impact defined benefit pensions from 1 July
Although there is a lot of talk about the government’s sweeping changes to super, what has taken defined benefit fund members (including retired public servants, judges and parliamentarians) by surprise is the significant impact the changes are having on their retirement and contribution strategies.
So, if you’re a member of a defined benefit fund or receive a pension from one, you need to consider the key changes that come into effect from 1 July carefully, as you only have a small window of opportunity to make the most of your retirement plans under the current rules. Here’s what we think you need to know.
Your annual defined benefit pension will convert into a special lump sum value
To understand how your defined benefit pension is impacted by these new rules, you need to know that your annual pension will now be converted to a ‘special lump sum value’. This value is calculated by multiplying your annual gross defined benefit pension by a factor of 16. For example, retired public servant Jane’s annual pension is $60,000, so from 1 July it will have a defined benefit pension special value of $960,000 ($60,000 multiplied by 16).
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This special value may limit your ability to make non-concessional contributions, hold money in a tax-free retirement pension and if you’re a current defined benefit fund member it could also impact your member contributions. So what does this all mean?
1. Existing retirement pensions may need to be rolled out of their tax-free environment
From 1 July, if you’re a retiree, you can hold a maximum of $1.6 million in the tax-free phase of super. And the special defined benefit pension lump sum value will be included within this limit. This may require you to adjust the amounts you hold in your private tax-free retirement pensions, such as within a self managed super fund. For example, Jane’s $960,000 defined benefit pension special value means she’ll now only be able to have a total maximum balance of $640,000 in any tax-free retirement pensions she holds.
The good news is that if you’re a retiree, you don’t need to take excess amounts out of super altogether. These could still be held in an account in the accumulation phase where income is taxed at 15 per cent and capital gains at 10 per cent (if the investment is held for at least 12 months).
2. You may not be able to make further contributions to super after 1 July
You should consider the option of bringing forward any planned lump sum contributions before 30 June because after this date, the ability to make non-concessional contributions will be governed by how much money you already have in the super system. Put simply, if the value of your total super exceeds $1.6 million then non-concessional contributions are not allowable. Again, the special value of defined benefit pensions (for example, Jane’s $960,000) will be counted within this limit plus the balance of any other pension accounts – as well as super accounts in the accumulation phase and defined benefit fund accounts still in the contributing phase.
If you’re a retiree or close to retirement, then you’re most likely to be affected by this rule change, but young executives in a strong financial position should also consider the benefits of bringing forward contributions into this financial year while the more generous contribution limits still apply. It’s especially important to re-assess the timing around asset sales and leave payouts that are often not used to boost super until after retirement.
For defined benefit fund members in particular, making contributions before retirement is expected to become a high priority because as soon as the defined benefit pension is claimed upon retirement, the special value will apply and may exclude you from making further contributions, whereas the value of the defined benefit fund account before it is converted to a pension is generally assessed more favourably.
3. Your member contributions may incur penalty tax
Most defined benefit schemes require member contributions to be made to maximise the final entitlement payable on retirement. However, this may become problematic if you have more than $1.6 million in total super and your member contributions are made on an after-tax basis. In this scenario, from 1 July your member contributions would be considered excess contributions and will incur a tax penalty.
However, because member contributions help maximise your final payout, the long-term benefits far outweigh the tax penalties incurred, so it’s important to consider the overall impact of doing so before stopping or reducing member contributions.
There’s still time to review your retirement strategies in line with the new rules
While for many people the impact of the changes on defined benefit fund members was unexpected, you still have until 30 June to review your financial strategies and optimise your retirement savings under the new rules.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.
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