Defined pension tax free percentage calculation - BENDZULLA by hjkuiw354


									                     BENDZULLA ACTUARIAL PTY. LTD.
                                CONSULTING ACTUARIES


Trustees have an obligation to calculate the tax-free component percentage for all types of
benefits including defined pensions. This would appear to apply irrespective of the type of
defined pension. Even a non guaranteed period, non commutable life time pension may
subsequently be converted to a market linked pension and so will need tax proportions for an
eventual death benefit.

This technical note sets out how that calculation needs to be carried out. This note as usual,
considers only benefits from a taxed source. The pension support pack on the website will deal
with account based pensions and crystallisation of accumulation accounts.

A trigger event.

For income streams that commenced before 1 July 2007, the tax-free percentage until a trigger
event is the fixed dollar annual deductible amount spread over the actual payments in the
financial year. The percentage that is tax free will vary each year. Once the trigger event has been
reached, the proportioning rule must be used when working out the tax-free and taxable
components of all subsequent payments.

The trigger events are:
1.the fund member is 60 years or over at 1 July 2007
2.the fund member turns 60
3.the fund member dies, or
4.the income stream is partially or wholly commuted

The majority of cases we will see for these closed defined pensions will have a trigger event of
being 60 years of age or more at 1 July 2007. However a similar approach to that set out below
will apply for other trigger dates.

Step 1: Value the Super Interest

Some administrators keep a notional account balance backing the defined pension rather than a
simple unallocated pool of monies backing all defined promises. This is not the value of the
super interest.

The value of the super interest just before the trigger event can be determined as the sum of:

1.the value of the annual amount of the income stream payable just before the trigger event
multiplied by the applicable valuation factor. The valuation factors are set out in Schedule 1B of
the ITAR 1997. Table 1 sets out payable for life factors and Table 2 for a fixed term; plus
2.the value of a residual capital value (RCV), if any, multiplied by the factor set out in Table 3.

A couple of practical points. In the ATO guide “Calculating the components of a super benefit”,
the “Valuation factor” definition mentions level of reversion and level of indexation like the SIS
Act factors. The tables in ITAR 1997 do not have this structure. The ATO Super Info line and
technical staff are not familiar with the issue. I will assume the ITAR 1997 factors can be used
for all levels of reversion and only require indexed or non indexed specification.

                                                                          Bendzulla Actuarial Pty Ltd
The ATO note is also not very clear on how to calculate the value of an RCV on a lifetime
pension. The logical term to use would be the relevant life expectancy based on ALT 2000-02.
The type of residual capital values we will find in a SMSF will be fixed dollar RCVs (see ATO ID

Step 2: Work out the Unused UPP

This is the original UPP less deductible amounts claimed subsequently less any tax-free
components of any benefits paid from the income stream after 1 July 2007.

If the information to calculate the above is not available, it is possible for the client to ask the
ATO for assistance. They should have the information from the RBL system plus pre 1 July
2007 deductible amounts claimed.

The ATO Guidance note differentiates pre 1 July 2007 “deductible amounts” and subsequent
“tax-free components”. However in essence they are the same value.

Step 3: Work out the Pre July 83 Component

This will be the lesser of:

        The value of super interest multiplied by Pre 83 days / Total Days; or
        The value of super interest minus UUPP

The Pre July 83 component will be the nil if the income stream commenced before 1 July 1994
or the income stream was purchased after 1 July 1994 with the roll over of pre 1 July 1994
pension monies. The reason for this is that the components included in a UPP changed at 1 July
1994, and up to that date included the Pre July 83 component.

Step 4: Calculate the Tax-Free Component

The tax-free component is the sum of the UUPP and the Pre July 83 component.

The taxable component is the value of the super interest less the tax-free component.

Step 5: Calculate the Tax-Free Proportion

The tax-free component (%) = Tax-Free Component / Value of Super Interest x 100

The taxable component (%) = 100% - tax-free component (%)

The calculations are to 3 decimal places, rounded to 2, with 0.5 rounded up.

All subsequent payments (lump sum or income stream) must be made up of the same proportion
of taxfree and taxable components. For many pensioners, being over age 60, this is irrelevant, as
all benefits have no tax impost, but will be relevant if there is a death benefit.

                                                                             Bendzulla Actuarial Pty Ltd
Help with Calculations

The website has a calculator under legacy pensions
(DefinedPensionTaxFree.xls) that will carry out the calculations required.


                                                                        Bendzulla Actuarial Pty Ltd

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