(August-2003) SIS Changes may stop pension commutation strategies

29 September 2005

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Superannuation funds and life insurance companies that are income stream providers may need to adjust their fund rules or annuity contracts to reflect the changed requirements for new income streams. In addition, system changes may also be necessary to ensure the required minimum payments are made upon commutation.

Broadly, the amendments are aimed at strategies involving repeated stopping and recommencing of income streams. The changes were first announced in July 2002 by the assistant treasurer and were proposed to take effect for pensions or annuities with a starting date on or after July 1, 2003. However, the Government has deferred the commencement date by three months to October 1 of this year to allow time for income stream providers to fully comply.

The amendments seek to address the Government’s concern that some pension strategies attempt to avoid the withdrawal of superannuation after retirement, thereby utilising super tax concessions for purposes other than retirement income, such as wealth creation and estate planning. Under the existing SIS Regulations, there is some latitude in the timing of the first income payment. This provides an opportunity for a repeated commutation strategy, thereby avoiding the need to make an income payment by never allowing an income stream to run long enough to necessitate the first payment.

Specifically, the amendments require a minimum payment to be made from a superannuation annuity or pension prior to the commutation of that annuity or pension. The annuity of non-fixed payments (ie. allocated pensions and annuities) will be required to meet conditions for commutation set out in new SIS Reg 1.07A, and the annuity of fixed (or CPI adjusted) payments must meet the conditions for commutation set out in new SIS Reg 1.07B.

Under the new conditions, 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 Sch 1a of the SIS Regs. The minimum payment condition will not apply to a commutation resulting from the death of the recipient. Similarly, it will not apply to:

n a commutation for the sole purpose of paying a superannuation contributions surcharge;

n giving effect to an entitlement of a non-member spouse under a family law payment split; or

n meeting the rights of a member to return a financial product under the FSR cooling-off period.

The amendments also 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 (ie. the “April 1 rule” will be replaced with a “June 1 rule”). As a result, fund members seeking to commence an allocated pension or annuity between April l and June 1 should be advised of the rule change which will require them to draw down the minimum payment amount by June 30 of that financial year.

In addition, the changes clarify that the six-month commutation period for a “complying” income stream is a once only “cooling off” period that cannot be extended through a rollover to another complying income stream.

Super protected in bankruptcy

In a recent High Court case, it was held that superannuation entitlements rolled over to other super funds by a person who subsequently became bankrupt, were protected from creditors.

In Cook v Benson [2003] HCA 36, Benson’s employment was terminated in April 1990 and he became entitled to $96,192 from his employer’s superannuation fund. In September 1990, he rolled over $80,000 of this money into three superannuation funds to be applied to the purchase of insurance policies and bonds. Subsequently, he was declared bankrupt with effect from September 1991.

The Full Federal Court had ruled that the payments to the super funds by Benson, within two years prior to his bankruptcy, were not voidable “dispositions of property” against the trustee in bankruptcy under s 120 of the Bankruptcy Act 1966. Accordingly, those funds were not available to the trustee in bankruptcy to meet the debts of Benson. The High Court affirmed this decision holding that the rollover amounted to a “disposition of property” in favour of a purchaser in good faith and for “valuable consideration” under s 120. The Court found that the trustees of the super funds satisfied the requirements of s 120 as purchasers for valuable consideration.

In dissent, Kirby J considered that the super funds were not purchasers for valuable consideration. His Honour warned that the approach of the majority would effectively permit a person facing the possibility of bankruptcy to put significant funds beyond the reach of creditors.

However, persons facing bankruptcy seeking to rely on this decision to protect assets from creditors should note that the fraudulent disposition provisions in s 121 of the Bankruptcy Act 1966 may still apply to void such payments.

— Stuart Jones is a tax writer at Australian Tax Practice. Email: [email protected]