12 minute read
INDEXATION IMPACT
The administration of an SMSF is about to become infinitely more complex and confusing with the indexation of the transfer balance cap and the contribution limits. Zoe Fielding assesses what these changes mean for the superannuation framework.
Indexation is about to be introduced to the superannuation system for the first time to allow super balances and contribution parameters to reflect the effects of inflation on living costs and wages.
This indexation process comes into effect on 1 July 2021 and from that date, the concessional contributions cap will be $27,500, up from $25,000. The nonconcessional contributions cap – set at four times the concessional contribution limit – will as such increase from $100,000 from $110,000.
In addition, for the first time since its introduction on 1 July 2017, the general transfer balance cap (TBC) will be lifted from $1.6 million to $1.7 million.
The basic details may seem straightforward, but Deloitte Private national SMSF leader Liz Westover says the way in which the indexation applies is far from intuitive.
“If the cap is going up, you would think that’s an opportunity. It’s not until you dig around that you realise it’s a lot more complicated,” Westover says.
TBCs limit the amount of super each fund member can move from an accumulation account into a tax-free retirement account.
When the system was introduced, each person’s TBC was set at $1.6 million: the general TBC amount. But after indexation is applied on 1 July, each fund member will have their own personal TBC, which will range from $1.6 million to $1.7 million, depending on individual circumstances.
People who start their first retirementphase income stream on or after 1 July will receive the full indexation and will have a personal TBC of $1.7 million.
But anyone who started a pension between 1 July 2017 and 30 June 2021 – triggering the creation of a transfer balance account (TBA) – will be subject to proportional indexation. And this is where complications arise.
“Unless you have a proactive adviser, unless you are reading the relevant articles that are coming out, you would not necessarily understand how proportional indexation works. Even advisers are challenged in getting their heads around how it works and explaining it to their clients,” Westover notes.
Crunching the numbers
According to SMSF Association deputy chief executive and policy and education director Peter Burgess, practitioners need to know how personal TBCs will be calculated on a proportional basis.
“The first step is to calculate how much of the cap the client has already used,” Burgess says.
To do this, advisers must identify the highest-ever balance in the client’s TBA history and divide that balance by $1.6 million, being the original TBC.
The result then has to be expressed as a percentage and rounded down to the nearest whole number.
“If you don’t round down, you will end up with the wrong answer. It’s not a big difference, but it will be the wrong answer,” Burgess warns.
The final step is to subtract the percentage value from 100 to give the unused cap percentage and then multiply that by $100,000 to find the dollar value of the proportional indexation to which the fund member is entitled.
A key point to note is the personal TBC is based on the highest-ever balance in their TBA, rather than the balance as at 30 June 2021.
“That’s to prevent people gaming the system by withdrawing amounts in the leadup to 1 July,” Burgess explains.
“There’s been discussion that you can commute your pension and qualify for a higher personal transfer balance cap. That’s not the way the rules work. It’s not the balance in their transfer balance account on 30 June that matters, it’s the highest-ever balance in their transfer balance account that matters.”
Simplicity is best
The SMSF Association is one of many voices in the industry that argue proportional indexation is too complicated.
“We certainly believe the proportional indexation is overly complex. Errors will be made and that will result in breaches of the cap, which will result in extra costs for everyone,” Burgess points out.
The association has discussed its concerns with Treasury and put forward three alternatives to proportional indexation in its 2021/22 budget submission.
One option is to simplify the proportional indexation method by reducing the number of bands of indexation. The industry body argues in its submission that this would be “easier for members to understand and apply in practice” than the existing system.
The other two options would remove proportional indexation altogether.
Either everyone could receive the full amount of indexation regardless of whether they had previously used some of the cap, or each member’s TBC could be locked in when they start their first retirement-phase income stream.
“The second approach of locking in the TBC at pension commencement might sound harsh, but it might not affect many clients,” Burgess says.
The SMSF Association favours removing proportional indexation and is hopeful of a last-minute reprieve.
“There’s a chance that the government will look at this and look for ways to make it simpler for people to work with,” Burgess predicts.
“They could switch off proportional indexation before 1 July this year or defer it for a few years. From what we understand, the ATO systems have all been updated, so they are ready to go, but it would not be the first time this has happened.”
Accurium SMSF technical services manager Melanie Dunn doubts the system will be changed at this late stage.
“Any new system takes time to bed down, but any change now could be more disruptive when we are so close to the indexation deadline. We have to deal with the legislation we have at hand,” Dunn says.
She concedes the way in which indexation is being applied should not come as a surprise to anyone. The legislation that established TBCs on 1 July 2017 spelled out how indexation would work. However, practitioners have been lax in their preparation.
A quick survey at an Accurium technical webinar in March revealed 63 per cent of delegates had not yet determined how many of their clients would be eligible for a higher TBC after indexation. A further 29 per cent were going through the exercise of identifying which clients would enjoy some benefit. Only 8 per cent of advisers had completed the process.
“The good news is that once we get past the initial difference phase, it’s not going to change again until the next round of indexation. So it is not something we are going to have to assess every month or every year,” Dunn explains.
Report early
In the lead-up to 1 July the ATO is urging advisers, trustees and SMSF members to report all events that affect the TBA – such as pension commencements and commutations – as early possible to ensure their records are up to date and accurate. ATO Online will be the primary store of information on an individual’s TBA and personal TBC.
“The ATO can only calculate a transfer balance cap based on information reported to us,” ATO assistant commissioner Justin Micale explains.
“Until all events are reported and processed by the ATO, an individual should not rely on their transfer balance cap calculation to make financial decisions.
“If the ATO later receives information that would impact the calculation of the cap, we will recalculate the transfer balance cap and apply it to an individual’s circumstances.”
Fund members who start a pension or make other fund decisions based on personal TBCs that are later revised may inadvertently exceed their limits and be liable to pay penalty taxes.
“Indexation does not change an SMSF’s, or any other super fund’s, legal reporting obligations or what happens if a member exceeds their transfer balance cap,” Micale notes.
Keep track
Fund members and their tax agents can check now if the ATO holds the correct information and whether, based on that information, they will be entitled to have their personal TBC indexed.
Unfortunately, SMSF advisers and administrators who are not registered tax agents cannot directly access their clients’ data via the ATO Portal and must instead rely on clients accessing the information through their myGov account, and passing it to their adviser.
Perhaps as a result of this challenge, only about one-third of SMSF practitioners plan to use the fund member’s myGov account to keep track of their clients’ personal TBAs after 1 July 2021, Accurium’s March survey found.
Some 44 per cent of respondents planned to use their current fund administration platform, while 11 per cent said they would rely on spreadsheets to monitor personal TBAs.
Dunn says SMSF administration platforms will be able to keep track of SMSF information and also record events in other super funds that the SMSF member may have. This can be reconciled with information held by the ATO.
“Anything that you do with retail or notfor-profit funds, they will report. Where you are missing things, it’s most likely to be from the SMSF,” Dunn suggests.
Any gaps would probably be due to the timing of reporting requirements.
SMSFs are required to lodge transfer balance account reports (TBAR) notifying the ATO of reporting events within their fund, such as pension commencements and commutations, but they may not have to submit the TBAR for several months after the event, Dunn says.
“If they have an event that occurs in the last quarter of 2021, the fund would not normally report that until the July deadline,” she says
Westover recognises SMSF trustees may need to get ahead of their reporting responsibilities to ensure members’ TBCs can be calculated accurately on 1 July.
“The key to a lot of this is: do not rely on the longer period of time you have got to report commencements of income streams,” she says.
“Get into the habit of real-time reporting. It’s not always practical, but to the extent that you can do it, that’s accurate information that the tax office is going to hold.”
SMSF advisers need to be mindful their clients may not provide them with all the information they need, she warns.
“If you take on a new client you may not have all the right information. You can’t know that they have lodged all the TBARs if there are multiple funds involved,” she says.
To get all the details, advisers should be prepared to ask a lot of different questions and the same question in a lot of different ways.
Rather than simply asking: Do you have other super funds? advisers may have to add questions like: Have you had any super funds from a previous employer? Have you ever worked for government? Do you have a defined benefit fund from that work?
“Do not make assumptions. You have to ask relevant questions to make sure you get all the information together,” Westover stresses.
Strategy and timing
Amid the complexity, indexation can provide an opportunity for SMSF practitioners to initiate conversations with SMSF clients about timing and strategy.
For SMSF members who are looking to start a retirement income stream and are eligible for the full TBC increase, it could be beneficial to delay starting the pension until after 1 July. Then, they will be able to add $100,000 more into their tax-free retirement stream than if they started the pension on or before 30 June.
Indexation of the concessional contribution caps will allow fund members to contribute more to their accumulation accounts than in previous years. Some clients who have been salary sacrificing up to the $25,000 limit may want to revisit their arrangements to take advantage of the $2500 increase to that cap.
The increase to the concessional contribution limit has a knock-on effect to the non-concessional contribution cap, which is set at four times the concessional contribution cap. The non-concessional contribution cap is therefore rising from $100,000 to $110,000, or $330,000 over three years under the bring-forward provisions.
Eligibility to make non-concessional contributions is based on a member’s total super balance (TSB). Until June 30 this year, fund members can only make non-concessional contributions if their TSB is below $1.6 million. This threshold will be lifted to $1.7 million from 1 July, allowing SMSF members with a TSB of between $1.6 million and $1.7 million to make non-concessional contributions when they currently cannot.
SMSF members who are planning to make large non-concessional contributions might consider waiting to trigger the bringforward provisions in the new financial year so they can add a larger sum overall, Westover advises.
“If you sold an investment property, you might contribute $100,000 this year and wait until next financial year to trigger bring-forward provisions after the caps have been indexed, so you could contribute $330,000 over the next three years. If you triggered the bring-forward provisions this year, you would be held to $100,000 this year and the same amount in the next two years,” she says.
The trap to watch for here is ensuring the TSB does not go over the $1.7 million threshold for making non-concessional contributions, she adds.
Confusion to come
Burgess acknowledges the index increases may bring advantages to some SMSF members this year, but he expects further confusion down the track.
“The complexity is that the concessional contributions cap is indexed differently to the transfer balance cap,” he says.
Increases in the TBC are linked to the consumer price index, while concessional contributions caps are indexed to average weekly ordinary time earnings.
“This year it turns out that both caps are increasing at the same time. But at some point they won’t and that will lead to confusion,” Burgess explains.
Add to this the fact not all limits that apply to SMSFs are changing. The $500,000 TSB for catch-up contributions, for instance, will remain unchanged.
The fact the indexed thresholds are interconnected, but based on different indexation, could even set up some perverse outcomes in future where the bring-forward thresholds will be less than in previous years, Burgess warns.
“It comes back to the formula that they use to determine how much you can bring forward. You would expect that all caps increase over time, but that’s not what happens in reality,” he concludes.
