Can Reserves be Added to Pensions?

By Daniel Butler & Claire Malone

The ATO has recently commented on allocations from reserves, providing greater certainty for those who wish to top up existing pensions. (Refer to NTLG Superannuation Sub-Committee minutes of 8/9/09.)

Broadly, the ATO confirms that it is possible to add to an existing pension by way of allocation from reserves. This is possible since an allocation from reserves is not a ‘contribution’ or a ‘roll-over’ for SIS purposes (once a pension has commenced, the capital supporting the pension cannot be added to by way of ‘contribution or roll-over’). However, although it is not a ‘contribution’, an allocation of reserves can count towards a member’s concessional contribution cap for tax purposes due to the operation of the tax legislation (see below).

The ‘fair and reasonable’ 5% test

Generally, allocations from a reserve will count towards the receiving member’s concessional contributions cap, unless an exception applies (reg 292-25.01(4) of the 1997 tax regulations). One exception that can apply is where:
the amount is allocated, in a fair and reasonable manner, to an account for every member (or if the reserve amount relates only to a particular class of members, to an account for every member of the class); and the amount allocated for the financial year is less than 5% of the value of the member’s interest.

Assuming an allocation is within the 5% limit, the question then arises: if one member has an accumulation account and also a pension (eg, account-based pension (‘ABP’)), does the trustee have to split the allocation between the two interests in order for it to be ‘fair and reasonable’?

The ATO confirms that, to be fair and reasonable, the trustee cannot necessarily just allocate the amount all to one interest (eg, all to the ABP and nothing to the accumulation account). It must be ‘fair and reasonable’ between the two interests. DBA’s view is that ‘fair and reasonable’ generally means on a proportionate basis, but there may be grounds to allocate on a disproportionate basis if this is fair and reasonable, eg, if there are special circumstances.

How does the allocation affect the component mix?

The ATO confirms that an allocation from reserves to an accumulation interest adds to the taxable component. This is because the ‘taxable’ component of an accumulation balance is, by definition, anything that is not tax free.
On the other hand, an allocation from a reserve to a pension account will simply add to the pension in the same tax free/taxable proportions as the pension itself. This is because the proportions of a pension are ‘locked in’ forever on the commencement day of the pension. Therefore, if the pension is 40% tax free, this means an allocation from reserves would also become 40% tax free.

Daniel Butler and Claire Malone are lawyers with DBA Lawyers Pty Ltd.