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Introducing a CGT pension bonus scheme

When an active or retained member of your fund transfers to an account-based pension, unrealised capital gains tax (CGT) provisions are released, creating the potential to offer a pension bonus to the member. Indeed, some funds have already introduced a CGT pension bonus scheme.

Here we outline some of the challenges to be addressed when considering such a scheme.

How does a CGT saving arise?

Within a complying superannuation fund the tax payable on investment earnings, whether that be on income received or realised capital gains, is different depending on whether the underlying assets are supporting account-based pensions. The earnings from assets that support complying pensions are tax free, whereas earnings on other assets are generally taxed.

When a member moves from being an active or retained member to an account-based pensioner, the unrealised capital gains attributable to their account balance move from being taxable to tax-exempt and, consequently, a portion of the tax provision held to meet the tax on those unrealised gains is released.

It is this release of the tax provision that creates the potential to grant members taking up an account-based pension a "bonus" under a CGT pension bonus scheme.

Introducing a CGT pension bonus scheme

At least four larger funds - AustralianSuper, SunSuper, QSuper and BUSSQ - are now promoting pension bonus schemes as part of member equity and retention strategies, and several other funds are also looking to introduce this type of bonus.

While on the surface this appears to be a "tax" issue, in working with our clients we have found that in fact it is much broader, also involving considerations of equity, benefit design, sustainability, administration and communications.

So what issues do trustees need to work through to design such a scheme?

Based on our work in this area, some key challenges which arise include:

- If a fund is providing account-based pensions, where and to whom is the release of the tax provision currently going?

Trustees need to understand how members transferring to a pension affects the tax payable by their fund - and how to capture and equitably allocate any tax benefit. This means understanding tax calculations, tax provisioning, how tax is allowed for in unit pricing or crediting rates and what tax and tax provision data is regularly and readily available.

- What is an appropriate bonus level? 

To identify an appropriate bonus level, we have undertaken historical analysis for our clients to estimate the release of tax provisions that have occurred in the past as a result of pension take-up.

No two funds will be the same and bonus rates may vary depending on how many members are expected to transfer to complying pensions each year, the investment strategies of the active members and how often investments are realised (so how much unrealised capital gains are being provisioned for). Indeed, the bonus rates that can be offered by a single fund may need to change over time depending on the fund's tax position.

- How do trustees design a bonus scheme that balances member equity, communication and administration capability?

The funds currently offering pension bonuses have adopted a range of different features, including flat rates, rates that vary by investment option, bonuses set in advance and those calculated when the transfer occurs.

There are also different rules about eligibility, when the bonus is paid and how it might be clawed back. Even commentary on whether the bonus is treated as a concessional contribution varies amongst the current bonus schemes. It is important that appropriate rules are put in place to manage the risk of selection by members.

From our work it is clear there is no 'one-size-fits-all' solution to designing a pension bonus scheme.

- What are the risks involved in paying a pension bonus - for example, what happens if there are capital losses?

Sustainability and robustness of a pension bonus scheme design are important if it is to run successfully and without adverse impact on non-pensioner members.  Tracking and monitoring of the scheme needs to be established, to assess financial outcomes and the impact on member and asset retention.  There may be times when a bonus can't or shouldn't be paid.

- How will your administration system identify the bonus payment is due, calculate the amount and deposit the payment in the pension account?

Depending on the design of the pension bonus scheme, its implementation and ongoing administration may not be trivial.  There may also be changes to unit pricing calculations, reporting requirements and, of course, development and updating of appropriate governance documents and communication material.

Although the process includes complex considerations, the end result can be a simple, equitable and robust pension bonus scheme that is fairer and attractive to members thinking about taking up an account-based pension in your fund.

This article was co-authored by Kate Maartensz, also a senior consultant at Willis Towers Watson.

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