The recently released Exposure Draft of Treasury Laws Amendment Instrument 2024 – SMSFs – legacy retirement product conversions and reserves marks a significant shift in how legacy retirement products are managed within the self-managed superannuation fund (SMSF) sector.
Specifically, the regulations relax commutation restrictions on certain superannuation income streams and allow for more flexible management of reserves. These changes are designed to modernise retirement planning and provide greater flexibility for individuals holding outdated products.
Understanding Legacy Superannuation Products
Legacy superannuation products, such as lifetime, life-expectancy, and market-linked income streams, were popular before 2007. These products were created to provide retirees with a guaranteed income over a long period. However, their rigid structure often left individuals with limited options for changing their retirement strategies. Unlike modern account-based pensions, which allow retirees to draw down their savings more flexibly, legacy products have strict commutation rules. Essentially, they lock individuals into receiving a specific income for life or a set term, making it difficult to adapt to changing financial circumstances.
For years, retirees holding these legacy products were unable to voluntarily exit them without triggering significant tax and regulatory consequences. The only available option was to convert them into other legacy products, further entrenching them in outdated financial arrangements. This limited flexibility created challenges for retirees looking to optimise their retirement savings in line with evolving personal needs and market conditions.
Key Changes in the 2024 Amendments
The Treasury Laws Amendment Instrument 2024 addresses these issues by introducing a five-year grace period during which holders of legacy products can fully commute their pensions. This means that individuals can voluntarily exit these outdated income streams without the severe tax penalties that previously applied. Under this new regime, retirees can move their capital into more modern, account-based income streams, leave it in an accumulation account, or withdraw it entirely from the superannuation system.
This shift is especially beneficial for individuals who have found that their legacy products no longer suit their retirement needs. By commuting these products, retirees gain access to more flexible, contemporary options that provide better control over their retirement income.
Watch our recent ‘feeling smarter’ video on the release of these draft regulations:
The Role of Reserves in Legacy Products
A critical feature of legacy retirement products is the use of reserves. When these products were initially set up, a portion of the capital was placed in reserve to cover potential future liabilities, ensuring a guaranteed income. Over time, these reserves could grow significantly, depending on investment performance. However, these reserves often became trapped within the superannuation system due to strict contribution cap rules, limiting how much of the reserve could be allocated to members.
The 2024 amendments also address this issue by providing a more flexible pathway for distributing reserves. Under the new regulations, trustees can allocate reserves to members without breaching concessional or non-concessional contribution caps, provided certain conditions are met. This change will help unlock unallocated reserves that have been stuck within the superannuation system, enabling members to receive the benefits more equitably and efficiently.
Flexibility in Allocating Reserves
Previously, if a reserve allocation exceeded certain thresholds, it could be counted towards an individual’s contribution caps, potentially resulting in excess contributions penalties. To avoid this, trustees would distribute reserves in small, titrated amounts, which often led to large sums remaining unallocated.
The new rules provide exemptions from contribution caps for allocations that are made when a legacy product is commuted. This means that, in many cases, reserves can be distributed more freely, giving members access to these funds without adverse tax consequences. In particular, if a reserve is used to pay off liabilities related to a ceased superannuation income stream, the allocation is exempt from both concessional and non-concessional caps.
This change offers substantial benefits for SMSF members holding legacy products, enabling them to exit outdated income streams and access capital more freely. Additionally, it simplifies the management of reserves, helping trustees and members manage their funds more effectively.
Conclusion
These draft regulations bring much-needed flexibility to the management of legacy retirement products within the superannuation system. By relaxing commutation restrictions and providing more pathways for distributing reserves, these regulations help retirees better manage their retirement savings in line with modern financial realities. For SMSF trustees and members, this represents a significant opportunity to optimise their superannuation strategies, freeing them from the constraints of outdated products and enabling them to make more informed, personalised decisions about their retirement.
These changes will provide greater financial flexibility, improve the efficiency of the superannuation system, and help individuals make the most of their retirement savings in a rapidly evolving financial landscape.
Consultation on the instrument is available up until 08 October 2024.
You can read more about these draft regulations on the Treasury website: