Explanatory Statement
Issued by authority of the Minister for Revenue and Assistant TreasurerExplanatory Statement
Superannuation Industry (Supervision) Act 1993
Superannuation Industry (Supervision) Amendment Regulation 2003 (No. 3)
Section 353 of the Superannuation Industry (Supervision) Act 1993 (the Act) provides that the Governor-General may make regulations prescribing matters required or permitted by the Act to be prescribed, or necessary or convenient to be prescribed for carrying out or giving effect to the Act.
Retirement income policy aims to encourage the accumulation of superannuation savings so that these savings may be drawn on to provide income in retirement. Consistent with this aim, regulation 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (the Principal Regulations) requires the withdrawal of superannuation savings from the superannuation system once an individual has retired and reached a certain age, in the form of a lump sum or income stream.
Some strategies attempt to avoid the withdrawal of superannuation after retirement, thereby utilising superannuation tax concessions for purposes other than retirement income, such as wealth creation and estate planning. A common element of these strategies is to avoid making pension or annuity payments by the repeated commutation of one income stream and subsequent roll-over into another. Because the Principal Regulations allow some leeway in the timing of the first income payment, a repeated commutation strategy can avoid the need to make an income payment. This is achieved by never allowing an income stream to run long enough to require the first payment.
The purpose of these regulations is to strengthen the standards for the provision of annuities and pensions to ensure that these products are used to provide genuine retirement income.
The regulations:
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- require a minimum payment to be made from a superannuation annuity or pension prior to the commutation of that annuity or pension;
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- tighten the rules allowing the deferral of the first income payment from an allocated annuity or pension that commences in the last quarter of a financial year; and
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- clarify that the six month commutation period for a complying annuity or pension is a once only 'cooling off' period that cannot be extended through a roll-over to another complying annuity or pension.
Details of the regulations are set out in the Attachment.
The Regulations commence on 1 October 2003.
The regulations only apply to income streams that commence after 1 October 2003. The prospective application of the new rules does not prevent providers who already pay an amount of income on the commutation of income streams under the pre-existing rules from continuing to make these payments. That is, because the Principal Regulations are permissive in nature, these income stream providers are not required or expected to change pre-existing arrangements for income streams that started before the commencement of these regulations.
However, some income stream providers may decide to exercise their option, where available, to align their payment of income on commutation with the new rules.
Superannuation Industry (Supervision) Amendment Regulations 2003 (No. 3)
Regulation 1 - Name of Regulations
This clause is a formal provision specifying the mode of citation of the Regulations.
The Regulations commence on 1 October 2003.
Regulation 3 - Amendment of the Superannuation Industry (Supervision) Regulations 1994
This clause provides that the Superannuation Industry (Supervision) Regulations 1994 are amended as set out in Schedule 1.
The amendments made by Schedule 1 apply to an annuity or pension with a commencement date on or after 1 October 2003.
Schedule 1 - Amendments
These items require contracts for the provision of annuity benefits to meet certain conditions for the commutation of benefits. Benefits arising under contracts for allocated annuities that meet the standards of Subregulation 1.05(4) must also meet the conditions for commutation set out in Regulation 1.07A (see item 11). Benefits arising under contracts for annuities that meet the standards of Subregulation 1.05(2), (6), (7), or (9) must also meet conditions for commutation set out in Regulation 1.07E (see item 11). Benefits arising under contracts for annuities that meet the standards of Subregulation 1.05(8) are taken to consist of two benefits. An annuity that arises from the part of the contract that provides for payments that are not fixed in size, and an annuity arising from the part that provides for fixed payments. The annuity of non-fixed payments must meet conditions for commutation set out in Regulation 1.07A, and the annuity of fixed payments must meet the conditions for commutation set out in regulation 1.07B.
A 'complying' annuity or pension is an annuity that meets the standards set out in Subregulation 1.05(2) or 1.05(9), or a pension that meets the standards set out in Subregulation 1.06(2) or 1.06(7). Items 3 and 5 amend the conditions under which a ´complying' annuity can be commuted. Rather than allowing all commutations within six months of the commencement of the annuity, items 3 and 5 impose the further requirement that the annuity is not funded from the commutation of another annuity or pension.
Subregulation 1.05(5) contains an exception from the requirement that an allocated annuity make an annual payment in the financial year that the annuity commences. Item 4 reduces the period covered by this exception. The exception only applies to allocated annuities that commence on or after 1 June in a financial year rather than to allocated annuities that commence on or after 1 April in a financial year.
These items require the rules of superannuation funds providing pensions to meet certain conditions for the commutation of pensions. The rules of superannuation funds providing allocated pensions that meet the standards of Subregulation 1.06(4) must also meet the conditions for commutation set out in Regulation 1.07A (see item 11). The rules of superannuation funds providing other pensions that meet the standards of Subregulation 1.06 (2), (6), or (7) must also meet conditions for commutation set out in Regulation 1.078 (see item 11).
A 'complying' annuity or pension is an annuity that meets the standards set out in Subregulation 1.05(2) or 1.05(9), or a pension that meets the standards set out in Subregulation 1.06(2) or 1.06(7). Items 8 and 10 amend the conditions under which a ´complying' pension can be commuted. Rather than allowing all commutations within six months of the commencement of the pension, items 8 and 10 impose the further requirement that the pension is not funded from the commutation of an annuity or another pension.
Subregulation 1.06(5) contains an exception from the requirement that an allocated pension make an annual payment in the financial year that the pension commences. Item 9 reduces the period covered by this exception. The exception only applies to allocated pensions that commence on or after 1 June in a financial year rather than to allocated pensions that commence on or after 1 April in a financial year.
This item inserts Regulation 1.07A - condition for commutation of allocated annuities and pensions and Regulation 1.07B - condition for commutation of other pensions or annuities.
Condition for commutation of allocated annuities or pensions
Regulation 1.07A sets out a minimum payment condition that must be satisfied prior to the commutation, in whole or part, of an allocated annuity or pension including the allocated part of an annuity provided under Subregulation 1.05(8). Under the condition the annuity or pension must pay an amount, in the financial year in which the commutation is to take place, of at least the pro-rata of the minimum annual payment that would be required under Schedule 1A of the Regulations.
The condition that the pension or annuity pay a minimum amount prior to commutation prevents commutations from taking place when there are insufficient funds in the account balance to meet the minimum requirement. In these situations pensions or annuities can end by exhaustion rather than commutation, paying the entire account balance out as income. Subregulations 1.05(5) and 1.06(5) excuse pensions and annuities from meeting the requirement to pay a minimum amount of income in the financial year that they end, permitting pensions and annuities that end by exhaustion to meet the standards in Subregulation 1.05(4) and 1.06(4). However, the effect of Subregulations 1.05(5) and 1.06(5) is not to excuse allocated pensions and annuities from meeting the minimum payment conditions in Regulation 1.07A in cases of commutation.
The minimum payment condition in Regulation 1.07A does not apply to a commutation resulting from the death of an annuitant or pensioner or a reversionary annuitant or pensioner. Similarly, it does not apply to a commutation for the sole purpose of paying a superannuation contributions surcharge, giving effect to an entitlement of a non-member spouse under a payment split, or meeting the rights of a client to return a financial product under the cooling-off period provisions in the Corporations Act 2001.
The formula for calculating the pro-rata amount is as follows:
Minimum annual amount * (Days in payment period / Days in financial year)
The minimum annual amount for the pro-rata calculation is worked out in accordance with the formula for determining minimum limits in clause 2 of Schedule 1A of the Regulations and rounded to the nearest ten dollars.
For allocated pensions or annuities that commence in the year that they are commuted the pro-rata amount is calculated using the number of days in the payment period from the commencement day of the annuity or pension until the day on which the commutation takes place. For subsequent year commutations the pro-rata amount is calculated using the number of days in the payment period from 1 July in the financial year in which the commutation is to take place until the day on which the commutation takes place. The financial year used for the purposes of the pro-rata calculation is the year in which the commutation takes place.
Example 1: Allocated pension commuted in the same financial year that the pension commences
Ellen commences an allocated pension on 15 July 2007. Her opening account balance is $100,000 and her age on commencement is 65. Shortly thereafter she decides that she does not want the pension and decides to commute out of the pension on 10 August 2007.
The pro-rata calculation is as follows:
The minimum annual amount calculated under Schedule 1A clause 2 is $100, 000/15.7 = $6, 370 (rounded to nearest $10). Since there are 27 days between 15 July and 10 August (inclusive), the pro-rata minimum amount for Ellen's pension is $6, 370 x 27/366 = $469.92. Ellen therefore must take $469.92 in pension payments before commuting her pension.
Example 2: Allocated pension commuted in a financial year subsequent to the financial year that the pension commences
Greg commences an allocated pension after 1 October 2003. On 1 July 2009 Greg is aged 70 and has a pension account balance of $100,000. After a pension payment of $2,000 on 1 September 2009 Greg decides to commute the pension in full on 1 November 2009.
The pro-rata calculation is as follows:
The minimum annual amount is $100, 000/13.5 = $7, 410 (rounded to nearest $10). There are 124 days between 1 July and 1 November (inclusive) and 2010 is not a leap year, so the pro-rata minimum amount is $7,410x124/365 = $2,517.37. To comply with the new Regulations Greg must draw at least this amount after 1 July 2009 from the pension before he can commute. Greg therefore must take a further payment of $517.37 before commuting the pension.
Condition for commutation of other pensions or annuities
Regulation 1.07B sets out a minimum payment condition that must be satisfied prior to the commutation, in whole or part, of an annuity or pension. Under the condition an annuity or pension must pay an amount, in the payment year that the commutation is to take place, of at least the pro-rata of the minimum payment amount for that year. The Regulation applies to all annuities and pensions provided under the annuity and pension standards in Part 1A of the Regulations other than allocated annuities and pensions provided under Subregulations 1.05(4) and 1.06(4) and the allocated part of an annuity provided under Subregulation 1.05(8).
The minimum payment condition in Regulation 1.07B does not apply to a commutation resulting from the death of an annuitant or pensioner or a reversionary annuitant or pensioner. Similarly, it does not apply to a commutation for the sole purpose of paying a superannuation contributions surcharge, giving effect to an entitlement of a non-member spouse under a payment split, or meeting the rights of a client to return a financial product under the cooling-off period provisions in the Corporations Act 2001.
The formula for calculating the pro-rata amount is as follows:
Minimum annual amount * (Days in payment period / Days in payment year)
The minimum annual amount, other than for an annuity provided under Subregulation 1.05(8), is the minimum amount that the annuity or pension would have to pay in the payment year if the annuity or pension were not commuted. For an annuity provided under Subregulation 1.05(8), the minimum annual amount is the minimum fixed-size amount that the annuity would pay in the payment year if the annuity were not commuted. If, to calculate the minimum annual amount, it is necessary to use a future unknown value of the Consumer Price Index (CPI), that value is taken to equal the CPI for the last known quarter.
Subregulation 1.07B(2) defines the payment year, other than where Subregulation 1.07B(5) applies, for the purposes of the regulation as the period of 12 months that begins on the day after: the commencement day; or the anniversary of the commencement day of the pension or annuity. Where an annuity or pension is commuted on the same day that it commences Subregulation 1.07B(5) provides that the payment year commences on the commencement day and ends on the day before the anniversary of the commencement day.
The number of days in the payment period begins on the day after the commencement day of the annuity, or where reached, the day after the anniversary of the commencement day that occurs before the day on which the commutation is to take place. The payment period ends on the day that the commutation is to take place. Where Subregulation 1.07B(5) applies there is one day in the payment period for the purposes of calculating the pro-rata minimum amount.
Example 3: Commutation of a quarterly pension in a payment year subsequent to the anniversary of the commencement of the pension
Iris receives a superannuation pension that commences on 15 January 2004. The pension pays Iris four equal income payments each year on 1 March, 1 June, 1 September and 1 December. Each year the size of the payments is increased by 3%, with an initial payment size of $2,500, totalling $10,000 for the first year. On 10 February 2009 Iris decides to commute the pension to move to a new annuity provider. Over the period 16 January 2009 to 15 January 2010 but for the commutation the pension would have paid Iris $11,592.72 (in four payments of $2,898.18).
The pro-rata calculation is as follows:
Since there are 26 days between 16 January 2009 and 10 February 2009 (inclusive), the pro-rata minimum payment amount for the pension is $11, 592.72 x 26/365 = $825.78. If Iris commuted the pension on 20 May 2009 instead, the pro-rata minimum amount would be $11, 592.72 x 125/365 = $3, 970.11, subtracting the payment on 1 March 2009 the pension would still need to pay Iris $1,071.93 in income before the commutation.
Item 12 This item amends clause 4 of Schedule 1A of the Regulations to clarify that an amount determined by the payment limits specified in clauses 1 or 2 of Schedule 1A is rounded to the nearest ten whole dollars.
Policy objective
The objective of this measure is to ensure that income streams can not be managed to avoid the requirement to pay income. The requirement that income streams pay regular amounts of income to recipients is a key feature of the retirement income system that prevents the superannuation tax concessions from being used for wealth accumulation or estate planning rather than to provide retirement income.
While the pre-existing pension and annuity standards require income streams to make annual payments, income streams can be manipulated through commutation so that they do not pay any income. This is achieved by repeatedly commuting an income stream and rolling over the commutation amount to start a new income stream. By doing this annually, this strategy creates a series of income streams, none of which run for more than a year, thereby avoiding the requirement to pay out income. Overall the series of income streams does not pay any income to the owner.
Implementation options
Require minimum payments on commutation of new income streams. This option requires that any commuted income stream pay an amount of income based on the amount of time that the income stream ran.
Restrict commutations for new income streams. This option would prevent commutations from taking place, except in particular circumstances such as to pay a death benefit after the death of the original recipient.
Require more frequent payments from new income streams. This option would make it more difficult to avoid the requirement to pay income from income streams.
Assessment of impacts
Each of these options will potentially affect income stream providers, which are either superannuation funds or life companies.
According to Australian Prudential Regulation Authority statistics there are around 254,000 superannuation funds in Australia, of which around 252,000 are small funds with less than five members. There are around 40 registered life insurance companies. The options will only affect those funds and life companies that issue new income streams after the implementation date. Many small funds will not be affected because they only have a single member who has already started drawing a pension. Small business in general is not expected to be affected by these changes.
The individual recipients of new income streams will also be affected to some extent by options 2 and 3, and will be affected by option 1 if they decide to commute their income stream.
While it is not feasible to quantify the costs and benefits of each of the options it is possible to compare the options and, based on their effect on income stream recipients or providers, rank them in an order.
From the perspective of income stream recipients, option 2 would be the most restrictive. There are a number of situations where it would be desirable from the recipient's point of view to commute an income stream. These situations would include changing income stream providers or to use the commutation lump sum to pay a large unforseen expense. By preventing individuals from commuting their income streams the attractiveness of income streams and the superannuation system would be reduced.
Neither option 1 or 3 has any great effect on individuals. Option 1 results in individuals possibly receiving an extra income payment if they choose to commute an income stream. Under option 3, affected individuals would receive their income through more frequent smaller payments than previously.
Income stream providers, on the other hand, would be least affected by option 2, as it would have almost no ongoing compliance costs. Income stream providers would simply be prevented from commuting income streams in some cases that the preexisting rules allow. While the reduced attractiveness of income streams may affect the business conditions that income stream providers face, this is a secondary effect which is difficult to quantify.
Option 1 is a more complex regime for income stream providers compared with option 3, as the minimum amount that must be paid has to be calculated on commutation. However, income stream providers will retain the option of paying income annually, and will only need to make the minimum payment calculations required by option 1 when commutations are made. Further, they will only be required to pay the shortfall between the minimum required amount and the amount of any income that was paid as part of the normal operation of the income stream.
Income stream providers may face some costs in complying with option 1. These costs may be due to the need to amend fund rules or annuity contracts to reflect the requirements for new income streams or the need to make system changes to ensure that the required payments are made. These costs would be borne on implementation, rather than on an ongoing basis. The fact that many income stream providers already provide income streams with conditions that mirror those proscribed by the regulations lowers the expected compliance costs. The calculation of the required income payments will also be similar to the calculation that is currently required to determine the income that an allocated pension or annuity must pay if it starts on a day other than 1 July.
Under option 1 small superannuation funds that do not have automated payment systems will face comparatively lower implementation costs but may have to manually calculate the required minimum income payment if one of their income streams is commuted.
Option 3 has the added drawback that it would not fully meet the policy objective because there is still some scope to avoid the requirement to pay income from income streams by commuting more often than annually. For instance a quarterly payment requirement could be circumvented through quarterly commutations.
Confidential consultations with industry on the Regulations and Explanatory Statement were held prior to their finalisation. As a result of these consultations some minor changes were made. Consultations were not held prior to the announcement of these changes, as they are integrity measures.
Conclusion and recommended option
Option 1 is preferred. Of the identified implementation options, only option 1 achieves the full policy objective without significantly reducing the attractiveness of income streams. While the costs associated with this option are difficult to quantify, they are not expected to be significant.
Policy objective
The income stream regulations do not permit the commutation of income streams that qualify for concessional Reasonable Benefit Limit (RBL) treatment ('complying' income streams). However, there are a limited number of exceptions to this rule. These exceptions include commutation where the resulting Eligible Termination Payment (ETP) is transferred directly to the purchase of another 'complying' income stream, or within six months of the commencement of the income stream.
The objective of this measure is to clarify the operation of these rules to prevent the commutation of 'complying' income streams to a lump sum after the expiry of the original six month window by commuting into a new 'complying' income stream and then commuting to a lump sum within six months of the commencement of the second income stream.
Implementation options
Apply the six month exception from the commencement of the original 'complying' income stream rather than the commencement of the new income stream.
Limit the use of the six month exception to only the original income stream.
Assessment of impacts
Each of these options will potentially affect 'complying' income stream providers, which are either superannuation funds or life companies.
According to Australian Prudential Regulation Authority statistics there are around 254,000 superannuation funds in Australia, of which around 252,000 are small funds with less than five members. There are around 40 registered life insurance companies. Small business in general is not expected to be affected by these changes.
Consistent with the policy objective, recipients of 'complying' income streams will be affected, since they will be unable to commute their income streams to lump sums outside the six month window.
Option 1 requires income stream providers to record the commencement date of the original income stream. Option 2 requires that income stream providers record whether the income stream arose through the transfer of an ETP from another income stream. Each of these actions can be expected to have a similar cost.
However, the Social Security Act 1991 contains a provision in the form of option 2 to determine whether an income stream is exempt from the social security assets test. Adopting option 2 would allow income stream providers to rely on a single check for both tax and social security purposes, implying that option 2 entails lower compliance costs.
From the perspective of income stream recipients, option 1 provides some extra flexibility. While both options maintain the right of pensioners or annuitants to change their minds about taking a 'complying' income stream within six months of commencement, option 1 also retains this right in cases where the income stream has been commuted and transferred to a new provider in that time.
Confidential consultations with industry on the Regulations and Explanatory Statement were held prior to their finalisation. Industry representatives expressed their preference for option 2 over option 1. Consultations were not held prior to the announcement of these changes, as they are integrity measures.
Conclusion and recommended option
Option 2 is preferred on the basis that it results in lower implementation costs and less system complexity.
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