Preparing for round two

Anthony Cullen provides a detailed summary of how the indexation of the transfer balance cap is determined and the implications the second implementation of it will have on pension-phase accounts and contribution thresholds.

Since 2017 we have had a transfer balance cap (TBC) regime that limits the amount that can be transferred from accumulation phase to retirement-phase pension accounts.

At the time of commencement, the cap was $1.6 million. A mechanism to index this amount in increments of $100,000 is covered in the Income Tax Assessment Act (ITAA). We saw the first increase of the general TBC to $1.7 million on 1 July 2021.

Based on recent inflation levels, an increase of $200,000 to $1.9 million is expected from 1 July 2023.

Why a $200,000 increase?

As per section 960-285 of the ITAA, the indexation factor is determined by:

indexation factor = Index number (December quarter) just before the start of the relevant income year / Index number for the base quarter (December 2016)

Where index number = All groups consumer price index (being the weighted average of the eight capital cities).

Subsequently, the formula produces the following calculation:

130.8 (December quarter 2022) / 110.0 (December quarter 2016) = 1.189 (rounded to three decimal places).

This figure is then multiplied by the base amount of $1.6 million, which produces a total of $1,902,400.

As this exceeds a multiple of $100,000, indexation will occur. This is rounded down to the nearest $100,000, being $1.9 million, representing a $200,000 increase from the current $1.7 million general TBC.

Proportional indexation

From 1 July 2023, your personal TBC (PTBC) could be anywhere from $1.6 million to $1.9 million. Proportional indexation is calculated in accordance with section 294-40 of the ITAA using the following formula:

Unused cap percentage

X Indexation amount

As mentioned above, the indexation amount will be a multiple of $100,000. To determine the unused cap, the steps below need to be followed:

(a) identify the highest-ever balance in a person’s transfer balance account (TBA), and

(b) identify the earliest day in which it occurs, and

(c) express the balance determined at (a) as a percentage (rounded down to the nearest whole number) of the TBC in question on the day identified in (b), and

(d) subtracting (c) from 100 per cent.

Example (see Table 1)

Larry, Curly and Moe are members of an SMSF. They all retired and commenced pensions on 1 July 2017.

• Larry started his pension with $1 million and has not commenced another since.

• Curly started his pension with $1 million. He commenced a second pension on 1 July 2022 with $330,000.

• Moe started his pension with $1.6 million and has not commenced any new pensions. He took a commutation of $400,000 on 1 January 2023.

Table 1: We can determine member's proportional indexation as follows:

1/7/2021 Indexation

Highest-ever TBA balance to 30/6/2021

Larry $1,000,000 -- Curly $1,000,000 -- Moe $1,600,000

Date of highest value

Larry 1/7/2017 -- Curly 1/7/2017 -- Moe 1/7/2017

PTBC on that date

Larry $1,600,000 -- Curly $1,600,000 -- Moe $1,600,000

Used cap

Larry $1m / $1.6m = 62% -- Curly $1m / $1.6m = 62% -- Moe $1.6m / $1.6m = 100%

Unused cap

Larry 38% -- Curly 38% -- Moe 0%

Proportional indexation 1/7/21

Larry 38% x $100,000 = $38,000 -- Curly 38% x $100,000 = $38,000 -- Moe $0

1/7/2023 indexation

Highest-ever TBA balance to 30/6/2023

Larry $1,000,000 -- Curly $1,330,000 -- Moe $1,600,000

Date of highest value

Larry 1/7/2017 -- Curly 1/7/2022 -- Moe 1/7/2017

PTBC on that date

Larry $1,600,000 -- Curly $1,638,000 -- Moe $1,600,000

Used cap

Larry $1m / $1.6m = 62% -- Curly $1.33m / $1.638m = 81% -- Moe $1.6m / $1.6m = 100%

Unused cap

Larry 38% -- Curly 19% -- Moe 0%

Proportional indexation 1/7/2023

Larry 38% x $200,000 = $76,000 -- Curly 19% x $200,000 = $38,000 -- Moe $0

PTBC on 1/7/2023

Larry $1,714,000 -- Curly $1,676,000 -- Moe $1,600,000

Death benefit pensions

A death benefit pension will result in a credit, or increase, to the TBA of the recipient. However, there is a difference in the timing of the credit, depending on whether it results from the reverting of an existing pension or the commencement of a new death benefit pension.

Example

Mike died on 5 February 2023 with $1.9 million in an account-based pension. Carol has $1.4 million in accumulation and has never had a retirement-phase pension.

If Mike’s pension was reversionary to Carol, she would receive the pension straightaway. However, the credit to her TBA will not occur until 5 February 2024.

On 1 July 2023, the highest-ever value in Carol’s TBA will be zero as the credit from the reverted pension is not yet included. This will give her a PTBC of $1.9 million, allowing her to retain the full reverted pension in super, should she so wish. As a side note, although not showing in Carol’s TBA, the value of the pension on 30 June will count towards her total super balance (TSB).

If Mike’s pension was non-reversionary, Carol will need to deal with the death benefit ‘as soon as practicable’. Although not legislated, it is widely accepted action taken within six months will rarely raise concerns around acting ‘as soon as practicable’.

If Carol were to start a death benefit pension prior to 1 July 2023, the credit will occur on that day. She will be limited to the current cap of $1.7 million and face the prospect of having to withdraw any excess death benefits from the superannuation system.

If the death benefit pension is not commenced until after 30 June 2023, this would delay the timing of the credit and provide Carol with access to the higher TBC.

When Carol starts the pension will also influence whether it will count towards her TSB on 30 June 2023 or not.

TSB

Indexation of the contribution cap is linked to average weekly ordinary time earnings. However, the required rate has not been reached this year for an increase to occur. On the other hand, an increase in the general TBC will see an adjustment in the thresholds for non-concessional contributions (NCC).

Based on the current contribution caps, Table 2 highlights the difference in thresholds for this year and next.

It is beyond the scope of this article to consider the implications of this further.

Table 2

Bring-forward rule -- NCC cap for the first year -- TSB - 30 June 2022 (current year) -- TSB - 30 June 2023 (next year)

3 years to use -- $330,000 -- Less than $1.48m -- Less than $1.68m

2 years to use -- $220,000 -- $1.48m to < than $1.59m -- $1.68m to < than $1.79m

1 year to use (no bring forward available) -- $110,000 -- $1.59m to < than $1.7m -- $1.79m to < than $1.9m

N/A -- Nil -- $1.7m or more -- $1.9m or more

Federal budget

The government has already indicated it wants to finalise and legislate the objective of superannuation. This will then set the tone for any future legislative changes and reforms for the super sector.

It is too early to say whether any potential changes will impact on the indexation process or consider a freezing of the cap.

Conclusion

As the law stands, we will see an increase in the general TBC. Any strategies linked to this should consider the current law, but be flexible enough to change, depending on the outcome of the budget.

It is not necessary to consolidate the benefits, however, in some situations this may be the most appropriate course of action. It will of course depend on the individual’s circumstances.