The government continues to release its proposed super laws in draft form. Last week we saw the draft rules for the $1.6m pension cap and a couple of other measures.

There are several reasons for this approach – it allows the relevant Minister to say they have consulted widely even in situations where they have little or no intention of listening to anyone (I don’t think this is the case here) and it means they might iron out any problems that people identify before the legislation is introduced into Parliament.

To date we have been given a short review period to provide our thoughts on various measures announced in May’s budget.

How will the $1.6m cap work?

As I always expected, the assessment process is intended to work just like Reasonable Benefit Limits worked in the past.

Here are the basics of the proposed system:

1. You commence a pension – or you had a pension on 30 June 2017.
2. Your super fund reports this event to the ATO (how this will happen still hasn’t been worked out but it would appear that this will have to be done very promptly under changes the Tax Office will make to the reporting requirements applying to super funds).
3. The ATO assesses this pension against your Transfer Balance Cap or TBC.
4. If you have an excess amount – to be called a Crystallised Reduction Amount or CRA – then the ATO will send you a determination and demand that the excess be withdrawn from the pension; importantly under the current drafting of the rules, relatively severe tax penalties apply from the moment the ATO make its determination. In this determination, the ATO will nominate the fund and pension it thinks the CRA should be taken out of. This tax penalty will be payable in your personal name.
5. If you want to nominate another fund and/or pension for this CRA withdrawal, then you have to pass this information to the ATO within a short timeframe.
6. The ATO then informs the relevant super fund that a CRA amount needs to be taken out of the pension; the fund must react to this information promptly and if they don’t then your pension’s earnings will be taxed at 15% until this transaction is completed.

In reality, this is quite a complex process for super funds, the ATO and investors. Patient good record keeping is essential unless you want inadvertent errors to arise.

Some other rules you might be interested in

1. All investment value movements (growth and losses) and net investment earnings in your pensions are ignored for the purposes of the cap.
2. Death benefit pensions will be counted against the recipients cap – this will mean every estate plan involving super funds will have to be revisited and adjusted accordingly.
3. Indexation of $1.6m cap – in general this will be indexed by movements in consumer prices (but only in $100,000 lots) however only your unused cap will be indexed. For example suppose you started a pension with $800,000 and have therefore used 50% of your 1.6m cap. In time (about 5 years if inflation averages 2% per annum or 7 years with 1% annual inflation) the $1.6m pension is indexed to $1.7m. When this occurs, only your unused portion will be indexed. Your unused portion is $800,000, which is 50% of the original amount so it gets the same percentage of the $100,000 increase. That is, it will go up to $850,000. This means your next pension could have an initial account balance of this higher amount.
4. The tax penalties mentioned in point 4 above do not apply if your pension commences before July 2017 and the CRA is less than $100,000.
5. If your total monies in the super system are more than $1.6m then your SMSF cannot use the segregate assets approach to determining the fund’s accounts. This rule applies regardless of your account balance in your SMSF. It could be that you only have a small or nominal account balance. It would appear that this has been proposed to stop people moving money into the tax exempt pension part and selling the asset without incurring CGT. The ATO has long flagged that the general anti-avoidance provisions could be applied in these cases.

So is the $1.6m cap a problem looking for a disaster?

Some of you might recall that Joe Hockey had the job of legislating the Financial Services Reform measures in the early 2000s. Given that these reforms were not very successful then, I have been told that he doesn’t really like to be reminded about this part of his parliamentary legacy.

I’m sure Paul Keating feels the same way about Reasonable Benefit Limits.

I have a funny feeling Scott Morrison and Kelly O’Dwyer might feel the same way about this $1.6 million pension cap rule, if it survives for long.

What’s next in the super legislative changes timetable?

Well I can’t guarantee the process but I think we will see something like this:

• More draft rules – the most important of these will be the new Non-concessional contribution caps – might be released sometime in the middle of October with comments due late October or early November.
• Amending legislation will probably be introduced into Parliament at some stage before it finishes for the year in early December.
• When this occurs, the legislation will probably be referred to a Senate Committee, which will be asked to report in March or at the latest early April – this will be a very important point for those looking to derail the proposed rule changes.
• The government will seek to legislate the new rules sometime in late May or early June.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.