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DIY Funds and Reasonable Benefit Limits

DIY Funds and Reasonable Benefit Limits

by Ross Stephens, KPMG

Released November 2001

What is a reasonable benefit limit?

The reasonable benefit limit (RBL) rules set limits on the amount that a person may receive during his or her lifetime subject to concessional tax rates.

Generally, superannuation entitlements are taxed as follows:

  • if drawn as lump sum, subject to a maximum tax rate of 16.5%, and

  • if drawn as pensions, subject to a maximum tax rate of 33.5%.

Both of these maximum rates rise to 48.5%, to the extent that the entitlements are above a person’s RBLs.   

Why do we have RBLs?

The Government provides a range of income tax concessions for superannuation and similar payments.  These include deductions and rebates for contributions, lower tax rates on earnings in superannuation funds, and lower tax rates on payouts from funds (or on similar payments such as golden handshakes paid by employers).

These concessions are provided as part of the Government’s retirement incomes policy, which has as one of its key objectives to promote self-funding of retirement (rather than increased reliance on the age pension).

In this context, the Government is of the view that the tax concessions do not need to be unlimited.  This is because, once persons have built certain levels of superannuation and like entitlements, they are unlikely to qualify for the age pension in any case.

Thus, the Government has sought to cap its outlays on the superannuation tax concessions in line with what it considers is the accumulation of reasonable levels of total entitlements.

History of RBLs

Prior to 25 May 1988, the only limit was a power provided to the Commissioner of Taxation to determine what is ‘reasonable’.  The Commissioner approached this power by releasing guidelines as to both the maximum amount that could be contributed to funds, and the maximum benefits that could be paid.

These guidelines were largely calculated as a function of the salary of the person (typically with a maximum of 7 x salary for lump sums or 11.25 x salary for pensions).

From 1 July 1990, these guidelines were put into the legislation.

From 1 July 1994, the salary-based limits were replaced by flat dollar limits.  These limits were $400,000 lump sum and $800,000 pension.  These flat dollar limits are indexed each year, such that the 2001/2002 limits are $$529,373 and $1,058,742 respectively.

Certain classes of persons who would have had larger RBLs under the former systems were allowed to keep some of these RBLs, under a system of ‘Transitional RBLs’.  This mainly affected persons aged over 45 on 1 July 1994.

How does the present system of RBLs work?

At the time of certain events, including:

  • a lump sum payment is made from a superannuation fund,

  • a pension is commenced to be paid by a superannuation fund, or

  • a lump sum ‘golden handshake’ payment is made by an employer,

  • the superannuation fund or employer is required to provide a report, called an RBL notification form, to the Australian Taxation Office for RBL purposes.

Amongst other information, this report shows the amount of the payment (or capital value of the pension) that counts towards RBLs.  All payouts from superannuation fund (and the capital value of all pensions), except undeducted contributions, count towards RBLs. 

Where the recipient is not associated with the employer, only 85% of the post-June 1983 component of an employer ETP counts towards RBLs.  However, where the recipient is an associate of the employer, 100% of the pre-July 1983 component, and 85% of the post-June 1983 component of an employer ETP count towards RBLs.

The ATO compares the information on the RBL notification form with its records of previous payments reported to it, and calculates whether the new payment (or capital value of pensions), and provides notification to the person as to whether part or all of the new payment exceeds the person’s RBLs.  For lump sums, the determination of any excess is notified as a dollar amount.  For pensions, the determination of any excess is notified as a percentage, such that this percentage of each pension will be non-rebatable.

If the person disputes the ATO’s determination, he or she can seek review of the determination through the usual objection and appeals procedures that apply to income tax assessments.

For lump sums, any difference between the taxes deducted by the fund or employer at the time of payment (typically 16.5% for superannuation funds or 31.5% for employers, and this 48.5% tax, is payable after the person lodges his or her income tax return for the year of payment.  For pensions, the non-rebatable portion of the pension is effectively subject to tax at ordinary rates (48.5% if the person is on the top marginal rate).

Transitional RBLs

Clearly, as their purpose is to provide RBLs larger than the present flat-dollar RBLs, there can be substantial advantage in obtaining registration of ‘Transitional RBLs’.

The groups of persons that typically qualified for transitional RBLs included (amongst others):

  • persons aged above 50 whose salary based RBLs, as calculated at 1 July 1994, were larger than the flat dollar RBLs,

  • persons aged above 45, where a formula-based combination of superannuation entitlements actually accumulated, and salary based RBLs, as calculated at 1 July 1994, were larger than the flat dollar RBLs,  

  • persons below age 45, whose superannuation entitlements actually accumulated were less than their then salary based RBLs, but above the flat dollar RBLs, and

  • persons with certain benefits in rollover funds pre-dating 15 February 1990.

To obtain a transitional RBL, it was necessary to make application to the ATO to have the details of salary based RBLs and other data registered with the ATO.

The ATO had originally set a date of 4 April 1997 as the cutoff date after which it would not, without special reasons, accept such applications.  The list of special reasons was quite restrictive, such as major illness of the person or close relative.

Note that a transitional RBL is set at 30 June 1994.  It is indexed at the same rate as that applying to the new flat dollar RBLs.

Late applications for transitional RBLs

Case 3 / 2001 in the Administrative Appeals Tribunal (‘AAT’) involved the consideration as to whether a person should be entitled to an extension of time, beyond 4 April 1997, in which to lodge an application for a transitional RBL.

In this case, the AAT decided that the person was entitled to an extension, notwithstanding that he had merely forgotten to apply.

Following this decision, the ATO has re-opened the application procedures for all persons.  Applications must show that the person meets requirements to be eligible for a transitional RBL, and have documentary evidence to support their applications, for example:

  • copies of group certificates or similar information to support calculations of salaries,

  • copy of superannuation fund statement or similar information to support the ‘eligible service date used’ (note that the earlier this date, typically the larger the resultant transitional RBL),

  • for persons under age 50 on 1 July 1994, statement showing value of vested entitlements in funds (or employer contract entitlement) on that date.

Non-arms length salary

For many persons who are associates working in closely held businesses, the salary based RBLs would ordinarily lead to potential under-entitlement to RBLs, due to these persons being under-remunerated for the nature of their services.  Such under-remuneration is usual in closely held businesses, where persons may draw lower salary, in effect re-investing in their businesses.

Such persons were entitled under the former salary-based RBLs, and under transitional RBLs, to use an ‘arms length salary’.  For new applicants, documentation must be attached with the transitional RBL application that shows:

  • that the person is an associate working in a closely held business, and

  • details to enable the Commissioner of Taxation to determine the value of the arm’s length salary (these details usually entail the examination by a remuneration consultant of the duties that the person performed, and the remuneration that would be typically be paid for such duties in an arm’s length situation).

Lump sum vs pension RBLs

All amounts taken in cash are tested against a person’s lump sum RBL.  The capital value of all allocated pensions are also tested against a person’s lump sum RBL.  This is the rules for an allocated pension allow commutation into a lump sum at any time, and thus would represent a means of circumventing the intention of the policy underlying the larger pension RBL if they were tested against this RBL.

The pension RBL is only available if at least one-half of the value of all pensions is taken in the form of a ‘complying pension’.  A complying pension is one that satisfies additional restrictions and conditions under the superannuation legislation.  The primary restrictions are against commutation or reversion.  Prior to 20 September 1998, the pension had also to be payable throughout the person’s remaining lifetime.

With effect from 20 September 1998, a pension that is paid for a minimum of the lesser of 15 years or the life expectancy of the person at its commencement, may also qualify for the pension RBL.  Prior to this date, it was difficult if not impossible for a complying pension to be paid by a self-managed or DIY fund, due to the actuarial ‘spreading’ across sufficient members required to enable the pension to last for each pensioner’s lifetime.

Tax determinations TD 2000/28 and 2000/29

The ‘capital value’ of a pension is the amount that is counted for RBL purposes.

For an allocated pension, the ‘capital value’ is the purchase price of the pension (in other words, the underlying lump sum).  For a complying pension, however, the ‘capital value’ is usually calculated by reference to tables in the superannuation legislation.  This can lead to the result that substantially more than 50% of total entitlements needs to be spent in acquiring a complying pension to satisfy the RBL requirements that 50% of all entitlements have been taken in the form of complying pensions.

By way of example, if total entitlements are $1 million.  If the tables in the legislation show the pension valuation factor of 10, this means that a pension of $50,000 must be paid in the first year, in order that, for RBL purposes, $500,000 of total entitlements are taken in a complying pension form.  Yet, given present lower earning rates, a person may have to spend $700,000 of the total $1 million (or more) to acquire a pension of $50,000 per annum.  

This problem has been addressed by TD 2000/28 and TD 2000/29.  These tax determinations enable the actual purchase price of a complying pension to be the capital value of the pension.

The combination of the new fixed period pensions (since 20 September 1998) and the new valuation rules for pensions for RBL purposes (since 1 July 2000) have both had the effect of mitigating some of the worst features of ‘complying pensions’ prior to these dates.

Strategies for excess benefits

Where a person exceeds his or her RBLs, the following strategies may be useful:

  • Utilising the pension RBL.  If at least 50% of total entitlements are taken in the form of a ‘complying pension’, the (typically much larger) pension RBL may be used.  Whilst this is advantageous, it needs to be kept in mind that a complying pension is much less flexible than lump sums or allocated pensions.

  • Acquiring an allocated pension with the excess portion of the person’s benefits.  Whilst this amount will not be rebatable, drawing down the minimum pension each year results in a substantial deferral of the taxes applicable to excess benefits taken as lump sums.  In addition, the loss of the rebate is potentially less onerous than the 48.5% tax rate applicable to lump sums.  This is because pensions are taxed at ordinary rates (less any rebate).  After retirement, the ordinary rates for many persons will be below the top marginal rate of 48.5% (even without the benefit of the rebate).