While public attention focuses on whether the $500,000 lifetime non-concessional super cap will be legislated, defined benefit fund members are yet to learn precisely how the budget changes will affect them.
The greatest area of uncertainty is how the proposed $1.6 million cap on pension fund accounts will be applied to defined benefit pensions.
The proposed arrangements for taxing defined benefit pension income were set out clearly in the budget. The 10 per cent tax offset for unfunded pensions after age 60 will be capped at a maximum annual income of $100,000, increasing the income tax payable on pensions in excess of this amount.
Recipients of tax-free funded pensions will be subject to income tax on 50 per cent of their annual pension in excess of $100,000. What's not yet clear is how the changes set to apply from July 1, 2017, will treat people with both tax-free and taxable defined benefit pensions as well as account based pensions from private super accumulations.
The major question is how the new $1.6 million cap on pension accounts will be applied when there's both a defined benefit pension and a private pension account.
Depending on how the capital value of the defined benefit pension is calculated, there's a real possibility that higher income defined benefit pension recipients will have limited opportunities to receive tax-free account based pensions when the new rules apply.
Given today's low interest rates and increased longevity, as well as generous surviving spouse benefits, the actuarial values of indexed defined benefit pensions have increased over the past decade.
For the tax arrangements for defined benefit pensions, the budget used a multiple of 16 to link the $1.6 million cap on account based pension accounts to the $100,000 annual income threshold for changes to defined benefit pension taxation accounts.
For younger defined benefit pension recipients this is a generous valuation factor, with private sector lifetime annuities costing 20 or more times the annual pension. However, at later ages such as 75, the capital value of a defined benefit pension is much lower. Thus, in introducing changes affecting all retirees the government needs to err on the generous side in valuing existing defined benefit pensions.
There's also the issue of whether the same valuation factor should be applied to tax-free funded and taxable unfunded defined benefit pensions. If it is, the legislation would favour funded pension recipients over those whose equivalent pensions are taxed.
To be consistent, the valuations should accurately allow for the different tax arrangements. Fortunately, most defined benefit pension recipients won't be affected by the budget changes. But those with larger pensions plus private account based pensions will need to study the fine print
when the legislation is presented in parliament.