For a member to be permitted to commute an amount from their Account Based Pension (ABP), certain commutation rules apply which may require a pro rata pension payment to be received prior to commuting or for any remaining balance to be more than a specific amount.
These commutation rules vary depending on when the member commenced their ABP and whether they are fully or partially commuting.
Full commutation of an account based pension
Where a member wishes to fully commute their ABP part way through a financial year, the commutation will only be permitted where the member has already received a pro rata minimum payment for the financial year prior to the commutation occurring.
The required pro rata minimum payment is calculated in accordance with the following formula:
Minimum annual payment x days in payment period / days in financial year
For ABPs that were in place on 1 July of that year:
- Minimum annual payment is the balance at 1 July multiplied by percentage factor determined by recipient's age at 1 July in that year, rounded to the nearest $10
- Days in payment period is the number of days in the period that begins on 1 July and ends on the day the commutation takes place
- Days in financial year is the number of days in the financial year of commutation.
Alternatively, for ABPs that commenced after 1 July of that year:
- Minimum annual payment is the initial purchase price multiplied by percentage factor determined by recipient's age at commencement pro-rated by the number of days in the financial year since commencement, rounded to the nearest $10
- Days in payment period is the number of days in the period that begins on commencement day and ends on the day the commutation takes place
- Days in financial year is the number of days in the financial year of commutation.
The following case studies provide examples of how these rules operate where a member fully commutes their pension in a financial year. This could be due to the client wishing to rollover their pension account to another fund or because they wish to fully withdraw and payout their benefits as a lump sum member benefit.
Example: Full commutation of pension in existence at start of financial year
Jerry is aged 67. His account based pension balance at 1 July (in a non-leap year) was $600,000, and his minimum annual payment for the financial year was $600,000 x 5%. Jerry plans to fully commute his account based pension on 1 March in that year.
Prior to the commutation, Jerry must have received at least a pro rata minimum pension payment as follows:
Minimum annual payment ($600,000 x 5%1, rounded to the nearest $10) x days in payment period (244 days from 1 July to 1 March inclusive) / days in financial year (365)
= $20,055.
Example: Full commutation of pension commenced during the financial year
Elaine is aged 67. She commences a $600,000 account based pension on 1 August (in a non-leap year).
As her pension commenced during the financial year, the minimum pension payment Elaine is required to receive is pro-rated to $27,450 ($600,000 x 5% x 334 days from 1 August to 30 June / 365 days in financial year, rounded to nearest $10) if the pension remains in place at 30 June.
Elaine then decides to fully commute her account based pension on 1 March in the same year.
Prior to the commutation, Elaine must have received a pro rata minimum pension payment based on the number of days from commencement to date of commutation:
Minimum annual payment2 ($27,450) x days in payment period (213 days from 1 August to 1 March inclusive) / days in financial year (365)
= $16,019.
Partial commutation of an account based pension
Where an account based pension is partially commuted during a financial year, it is important to note that as the pension does not cease when the commutation occurs, the minimum annual payment requirement must be met for the full financial year (note - partial commutations don’t count towards meeting the minimum payment requirement).
In addition, where an account based pension is partially commuted during a financial year, either of the following requirements must be met:
Option 1: A pro rata minimum payment must have been paid during the financial year prior to the commutation occurring. The required pro rata minimum payment is calculated in accordance with the following formula:
Minimum annual payment x days in payment period / days in financial year
For ABPs that were in place on 1 July of that year:
- Minimum annual payment is the balance at 1 July multiplied by percentage factor determined by recipient's age at 1 July in that year, rounded to the nearest $10
- Days in payment period is the number of days in the period that begins on 1 July and ends on the day the commutation takes place
- Days in financial year is the number of days in the financial year of commutation
Alternatively, for ABPs that commenced after 1 July of that year:
- Minimum annual payment is the initial purchase price multiplied by percentage factor determined by recipient's age at commencement pro-rated by the number of days in the financial year since commencement, rounded to the nearest $10
- Days in payment period is the number of days in the period that begins on commencement day and ends on the day the commutation takes place
- Days in financial year is the number of days in the financial year of commutation.
Option 2: The account balance immediately after the commutation is equal to or greater than the minimum payment amount required for the pension for the financial year (reduced by any pension payments already made during the financial year).
Example: Partial commutation of pension in existence at start of financial year
George is aged 67. His account based pension balance at 1 July (in a non-leap year) was $600,000. George plans to make a partial commutation from his account based pension on 1 March in the same year. He has already received $20,000 in pension payments during the financial year.
At the time of the partial commutation, one of the following two options must be met.
Option 1: Prior to the commutation, George must have received at least a pro rata minimum pension payment:
Minimum annual payment ($600,000 x 5%, rounded to the nearest $10) x days in payment period (244 days from 1 July to 1 March inclusive) / days in financial year (365)
= $20,055
Option 2: George’s account balance immediately after the commutation must be equal to or greater than the minimum payment amount required for the pension for the financial year (reduced by any pension payments already made during the financial year). As George has already received $20,000 in pension payments during the financial year, this requirement is met if his balance immediately after the partial commutation is at least $10,000 ($30,000 - $20,000).
Importantly, in addition to meeting one of the above options, George must ensure that he receives $30,000 in pension payments throughout the full financial year to satisfy the general minimum payment requirements for his account based pension.
Exemptions from additional requirements
The additional requirements of receiving a pro rate minimum payment prior to a commutation (or alternatively in the case of a partial commutation the requirement to have a balance of at least the minimum payment requirement less pension payments already received) do not apply to the following commutation situations:
- Commutations due to the death of the pensioner.
- Commutations for the sole purpose of paying contributions surcharge, a family law payment split or the right of a client to return a financial product under the Corporations Act 2001
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Disclaimer
The information contained in this update is based on the understanding Avanteos Investments Limited ABN 20 096 259 979, AFSL 245531 (AIL) and Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (CFSIL) has of the relevant Australian laws as at the article date. As these laws are subject to change you should refer to our website at www.cfs.com.au or talk to a professional adviser for the most up-to-date information. The information is for adviser use only and is not a substitute for investors seeking advice. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), no person, including AIL, nor CFSIL, accepts responsibility for any loss suffered by any person arising from reliance on this information. This update is not financial product advice and does not take into account any individual’s objectives, financial situation or needs. Any examples are for illustrative purposes only and actual risks and benefits will vary depending on each investor’s individual circumstances. You should form your own opinion and take your own legal, taxation and financial advice on the application of the information to your business and your clients.
Taxation considerations are general and based on present taxation laws and may be subject to change. You should seek independent, professional tax advice before making any decision based on this information.
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