Retirement

Indexation of the transfer balance cap and contribution caps

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The All groups CPI figure for the December 2020 quarter has triggered upward indexation of the general transfer balance cap (TBC) and any unused part of an individual's TBC from 1 July 2021. This sounds like good news, but the bad news is that the indexation system to be used for any individual's cap space is quite complex potentially leading to errors and unintentional breaches of the TBC rules.

Also, the movement in average weekly ordinary time earnings (AWOTE) has triggered an upward indexation of the general concessional contributions cap from 1 July 2021. The general non-concessional contributions cap, which is set at four times the contributions cap, will also increase.

Transfer balance cap

When the concept of the transfer balance cap (TBC) was introduced in July 2017 as the upper limit for pension balances in the retirement phase, the general transfer cap was set at $1.6 million.

In the year a person commences a retirement phase pension for the first time, their individual TBC is set as equal to the general TBC for that financial year. Until now, everyone has started with a TBC of $1.6 million. The general TBC and any unused part of an individual's TBC, also termed cap space, are potentially subject to indexation for movements in the CPI, but until now the movement in the CPI has not been enough to trigger any increase. It has therefore been easy to calculate the amount of any cap space by subtracting the balance of an individual's transfer balance account (TBA) from the general TBC of $1.6 million.

When a person has not fully used their individual TBC, their TBC will be increased by a dollar amount calculated as:

Increase in personal TBC = unused cap percentage x indexation increase

where: unused cap percentage is the percentage of the individual's TBC not used and rounded down to the nearest whole number.

indexation increase is the dollar amount by which the general TBC is increased by indexation ($100,000 in the 2022 financial year).

 

It is important to note that the 'not used' part of an individual's TBC is calculated using the highest balance in their TBA at any time before 1 July 2021, not just the TBA balance as at 30 June 2021.

For example, if Amir's TBA briefly hit $1.5m in the past but is now $1m, his unused cap percentage would be based on $1.6m - $1.5m = $0.1m as a percentage of $1.6m (or 6%), not on $1.6m - $1m = $0.6m as a percentage of $1.6m (or 37%).

So, using Amir's situation, on 1 July 2021 his TBC will be increased by 6% x $100,000 = $6,000 and become $1.6m + $6,000 = $1.606m.

As the unused cap percentage is rounded down to the nearest whole number, there are potentially 100 different unused cap percentages (1% to 100%) to be applied to an individual's TBC. Further, it is necessary to know an individual's complete TBA history to determine their highest TBA at any time before 1 July 2021. The result is that the dollar amount by which each individual's TBC will increase due to indexation must be calculated for each and every person. In effect we go from a situation where the TBC was $1.6m for everyone, to one where the TBC is potentially different for every person with any unused cap space on 30 June 2021.

As well as the complexity of the method used to calculate the increase resulting from indexation, there are the practical problems in determining the highest balance in a person's TBA in the past has been. Unfortunately, the ATO's records of TBAs are dependent on timely lodgement by superannuation funds of annual returns, transfer balance reports and the correction of errors.

It is possible that when the indexation provisions were drafted, there was limited appreciation of how difficult they would be to implement in practice. In its submission to the 2021 Federal Budget, the SMSF Association recommended simplification of the system by either doing away with indexation of cap space altogether or retaining indexation of the cap space but reducing the potential number of percentage steps from 100 to five (5) or some other appropriate number. Unfortunately, no simplification of the process was announced in the Budget.

Example 1:

Brian began a retirement phase pension before 1 July 2021 and at that time used his entire TBC of $1.6m. There have been on other transactions in his TBA since then.

As his cap space on 1 July 2021 is zero, the indexation of the general TBC is no benefit to him.

Example 2:

Shusmi began a retirement phase pension before 1 July 2021, using $1m of her TBC. There have been no other transactions in her TBA since then.

On 1 July 2021, her cap space will be $1.6m - $1m = $0.6m. Her unused cap percentage will then be $0.6 / $1.6 = 37.5% or 37% rounded down to the nearest whole number.

The increase in Shusmi's personal TBC on 1 July 2021 will be $100,000 x 37% = $37,000 so Shusmi's personal TBC will then be $1.6m + $37,000 = $1.637m

Shusmi has used $1m in establishing her retirement phase pension, so with the indexation increase on 1 July 2021 the unused balance of her TBC will become $1.637m - $1m = $0.637m.

Example 3:

Tod commenced a retirement phase pension in 2018 using $1m of his TBC. 

However, for the first time since July 2017, the general TBC will rise by $100,000 to $1.7m on 1 July 2021 due to increases in the CPI.  For an individual commencing a retirement phase pension for the first time in the 2021/22 financial year, $1.7m will become their individual TBC. This may be good news if the individual can delay starting their first retirement phase pension until after 30 June 2021.

Indexation also potentially applies to the cap space of an individual who already has a retirement phase pension in place on 1 July 2021, but has not fully used their individual TBC, but the details of how it is applied can lead to confusion.