C30/2002 Income Streams Changes - Veterans' Affairs Legislation Amendment (Further Budget 2000 and Other Measures) Act 2002

Purpose

The purpose of this Departmental Instruction is to advise States about changes to the income streams rules contained in the Veterans' Entitlements Act 1986 (the VEA).

Legislation

The amendments are contained in Schedule 3 to the Veterans' Affairs Legislation Amendment (Further Budget 2000 and Other Measures) Act 2002 which was given Royal Assent on 4 April 2002.  Schedule 3 is divided into two parts:

• Part 1: Small superannuation accounts; and
• Part 2: Other income streams amendments.

Other systems enhancements

In addition to these changes, a number of systems enhancements have been made relevant to the processing of income streams.  These changes are detailed in the Stateline issued on 21 September 2001 entitled Changes to Income Stream Processing.

Effective dates

Small superannuation accounts - 1 July 1995

All other income stream amendments – 20 September 2001

Authorised by

Roger Winzenberg

Branch Head

Income Support

17 July 2002

ATO Small superannuation accounts (Schedule 3, Part 1)

These amendments to the VEA are consequential to the enactment of the Small Superannuation Accounts Act 1995 and mirror changes to the Social Security Act 1991 (SSA) at that time, hence the commencement date of 1 July 1995.

The Superannuation Laws Amendment (Small Accounts and Other Measures) Act 1995 provided for a series of amendments to the SSA which were required as a consequence of the changes made to the administration of small superannuation accounts by the Small Superannuation Accounts Act 1995.  That Act provided that such accounts would be held in the Superannuation Holding Accounts Reserve and administered by the Australian Taxation Office.

The amendments to the SSA provided that small superannuation accounts under the new scheme would receive the same income and asset test treatment as superannuation funds, deferred annuities and approved deposit funds.

The Superannuation Laws Amendment (Small Accounts and Other Measures) Act 1995 did not provide for any amendments to the equivalent provisions of the VEA, hence these changes.

Other income streams amendments (Schedule 3, Part 2)

Income streams are a regular series of payments, made for life or for a fixed term, and purchased with a capital sum or made directly from accumulated superannuation contributions.

In September 1998, the Department of Family and Community Services (FaCS) and the Department of Veterans' Affairs (DVA) introduced changes to the legislation affecting income streams

To align VEA with the SSA so that it is consistent with other legislation regarding small superannuation accounts.

5

5J(1)
5J(1B)
5J(1C)

5J(6A)

5J(7)

ATO Small Superannuation Accounts are now specifically included in the definitions of “investment”, “return” and “superannuation benefit”.  This ensures that such accounts receive the same means test treatment as other types of superannuation.

Technical amendment - term

5J(1)

The term “public sector scheme” changed to “public sector superannuation scheme”.

Technical amendment -

nature of contract

5JA(1)

The new rules clarify that it is the income stream that arises under the contract or governing rules that must satisfy the ATE criteria (not the contract).

Asset test exempt income streams change no 1 - actuarial certification to obtain and maintain assets test exempt (ATE) status.

5JA(1)
5JB(1)

5JA(1B)
5JB(1C)

5JA(1C)
5JB(1D)

The Repatriation Commission must be satisfied that for certain classes of providers (those private funds which have a higher risk of failing to make the payments indicated in accordance with the legal agreements) there is in force a current actuarial certificate.

Guidelines will be issued for determining this.

There will be a 6-month period of grace to regain certification if a fund's certificate expires.

ATE income streams change no 2 – changes to commutation rules within 6 months

5JA(2)(h)(i)

5JB(2)(h)(i)

Commutations within the first 6 months will be much more restricted.  An income stream may only be commuted within the first 6 months if it was not funded by the commutation of an earlier income stream.

ATE income streams change no 3 – commutation on grounds of hardship.

5JA(2)(h)(v)
5JB(2)(h)(vi)

Partial commutation is available to provide for “hardship amounts” as defined – new subsection 5JA(7) & 5JB.

ATE income streams change 4 - What if the person who owns the income stream dies?

5JA(2)(i)
   (i) & (ii)

5JB(2)(i)

Contracts or governing rules that provide for transfer to further reversionary beneficiary in the event of the death of the first reversionary beneficiary will be permitted.

5JB(2)(h)
  (iii)&(iv)

For life expectancy or 15 year minimum term (5JB) products only – contracts or governing rules that provide for transfer of the legal or equitable interest to further reversionary beneficiaries if the first has died will be permitted.

ATE income streams change 5 - Joint lifetime annuities paid into single account.

5JA(2A) 5JB(2A)

A joint lifetime annuity (which pays a single income stream into a joint account) will retain its assets test exempt status when the level of payments to the survivor is reduced following the death of one of the partners.

ATE income streams change 6 – debt to result if income stream commuted contrary to the commutation rules

52ZMA

When an income stream is commuted contrary to the contract under which the income stream was originally provided debt recovery provisions apply.

The amount is the difference between the amount of service pension or income support supplement that has been paid and the amount that would have been paid had the income stream been classified as not assets test exempt during the relevant period.

ATE income streams change 7 - life expectancy or 15-year minimum term income streams (5JB) only – greater flexibility of term.

5JB(2)(a)(i)

If the person's life expectancy is < 15 years, the period of payment of the income stream can be up to life expectancy or now any fractional number between life expectancy and the next whole number rounded up.  For example, if life expectancy is 11.2 years, then the period may be up to 11.2, 11.3, 11.4...or 12.0.  Previously the number could only be 11.2 or 12.0.

ATE income streams change 7, continued - life expectancy or 15-year minimum term income streams (5JB) only, greater flexibility of term.

5JB(2)(ii)

If the person's life expectancy is ≥15 years, the period of payment of the income stream can be 15 years, any fractional number between 15 and the life expectancy (eg 17.5) and now, any fractional number up to the next whole number rounded up (eg 18.0).  Previously it could only be 15-17.5 or 18.

Technical amendment - definition of “binding arrangement”

Schedule 5, Item 12(4)

The Minister has the power to exempt specified financial investments for particular individuals from amendments to the means test treatment of income streams.  The changes are a technical amendment.

Background

The Australian Prudential Regulatory Authority imposes stringent reserving standards on institutional providers of income streams to ensure that income stream payments can be met under the income stream contract, trust deed or governing rules for the product.  Similar longstanding reserving requirements apply to corporate superannuation funds under the Superannuation Industry (Supervision) Act and its predecessors.

Individuals can also set up their own income streams (superannuation funds) colloquially known as “do-it-yourself” funds. These fall into 2 categories:

• SMSFs (Self-Managed Superannuation Funds) regulated by the Australian Taxation Office (ATO) since 1999; and

• SAFs (Small Australian Prudential Regulatory Authority – APRA - Funds) or Small APRA funds – these do not meet the ATO criteria and continue to be regulated by the Australian Prudential Regulatory Authority (APRA).

The use of individual superannuation funds continues to grow and two issues have emerged:

• Individual superannuation funds have a higher risk of failure than their institutional equivalents – either they cannot continue to make payments in accordance with the legal agreements or cease making payments altogether.

• Individual superannuation funds can also be used in some circumstances as an estate-planning device and as a device to maximise pension payments.  In some cases, individual funds have been set up where the actual income stream is disproportionately small compared with the assets backing it.  In these circumstances, deprivation may have occurred.

The new requirement for actuarial certification will apply to SMSFs and SAFs as these types of income streams will be specified for the purposes of subsections 5JA(1) and 5JB(1).

Changes to forms

The forms have been updated (see Attachment B) to request type of fund eg commercial or do‑it‑yourself such as a SMSF or SAF.  If the provider does not send back the form, but instead sends the delegate their schedule, you will need to recontact the provider to request this information

Systems changes

The Stateline entitled “Changes to Income Stream Processing” advised that an enhancement to the VIEW Review facility has been introduced to include a Review Type Super Fund Certification.

Delegates must set a future date for review of any case involving a SMSF or SAF as an actuarial certificate must be provided annually.

Reviews set will be reported as currently in the Fortnightly Report for the fortnight they become due.

How to use the new VIEW Review facility

The review facility is available in VIEW in the “Review” folder under the “Client Activity Tab”.

A review is added using the following steps:

1. Select the Reviews folder
2. Click on the VIEW update button.
3. Click on the add button (+) beneath the Reviews folder.
4. Enter the Review Date.  This must be in the format dd/mm/yyyy.
5. Select Review Type of Super Fund Certification from the drop-box.
6. Enter meaningful comments in the free text Comment field.
7. Click on the Save button to save details.

Completing a review:

1. Select the Reviews folder
2. Click on the VIEW update button.
3. Select YES from the drop box in the Completed field.
4. Click on the Save button – the review will be removed from the Client Activity Tab and will be recorded as complete on any requested reports.

What does the actuarial certificate say?

The certificate is to provide that in the actuary's opinion there is a “high probability” that the provider of the income stream will be able to pay the income stream as required under the contract or governing rules.  The certificate is evidence that the fund can pay the income stream for the client's lifetime or life expectancy (as appropriate).

Guidelines

Guidelines will be issued which must be complied with when determining whether an actuarial certificate is in force and as to what constitutes a high probability of payment – subsections 5JA(1B), 5JB(1C).  These guidelines will be based on guidelines developed for the industry.

Which funds will be affected?

Specified classes of providers such as SMSFs and SAFs will be affected by the new legislation and existing fund holders will be required to provide a certificate on an annual basis on and from 4 April 2002.  Since few DVA clients own such funds, most DVA clients holding superannuation investments will not be affected by the new rules.

What about new funds subject to this requirement?

If an actuarial certificate cannot be provided upon request, when the income stream is first assessed after the new rules commence it cannot be classed as an ATE.  The 6 months period of grace only applies to funds where an actuarial certificate has expired.

How long are certificates valid?

Actuarial certificates will only be valid for 12 months from their date of issue.  The pensioner (or the fund's trustee) should provide a new actuarial certificate on an annual basis.

6 months' grace if certificate expires

If the certificate expires, the pensioner will have a further 6 month period of grace from the date the certificate ceases to be in force – new subsections 5JA(1C), 5JB(1D).  During the 6-month period the product is still assessed as assets test exempt.  If the appropriate certificate is not provided by the end of that 6-month period the product will lose its ATE status.  If this happens a pensioner's pension payment may need to be adjusted, but only from the end of the 6-month period.

Background

Commutation occurs when part or all of an income stream is cashed into a lump sum.

The circumstances in which an assets tested exempt (ATE) income stream could be commuted under the old rules was limited although there was potential for abuse of the rules.

As a consequence, there are a number of changes to the rules relating to commutation and the old and new rules are discussed below.

Commutation within 6 months – old rules

Under subparagraphs 5JA(2)(h)(i) and 5JB(2)(h)(i), an income stream could be commuted within 6 months after its commencement date - see Figure 1 below.  This was intended to provide recourse for a person who may have purchased an inadequate or inappropriate product.

Because of the concern that subparagraphs 5JA(2)(h)(i) [or 5JB(2)(h)(i)] could be misused to afford an ongoing assets test exemption to individuals who wish to retain control of their capital, subsections 5JA(4) [and 5JB(3)] were inserted.  These subsections provided what was described as a “three strikes” policy in the VEA.

Subsections 5JA(4) or 5JB(3) were intended to apply to people who had commuted to new income streams 3 times.  After the third commutation, the Commission had the discretion to determine that no subsequent income stream owned by the person would qualify for an assets test exemption - see Figure 2 below.  Subsections 5JA(4) or 5JB(3) were not intended to apply in circumstances where a number of partial commutations were made where the person could commute part of the capital for some other purpose and still retain the benefits of an assets test exempt income stream.  This was because the original income stream remains intact with the same commencement date and relevant number.

Since 1998, the practice of making repeated commutations from a given income stream suggested that the rules were open to abuse.  Repeated commutations were contrary to the original policy of affording assets test exempt status to income streams which could only be drawn down steadily over a long period with no access to capital.

Commutation within 6 months – old rules

Figure 1 – Commutations from original income stream – old rules

Under the old rules, there was no limitation to the number of partial commutations that could be made from the original income stream:

Figure 2 – Operation of the three strike rule

Under the old rules, people could commute an ATE income stream 2 times within the first six months but upon the 3 — rd commutation, the delegate could invoke subsection 5JA(4) or 5JB(3) with the consequence that any future income streams owned by that person were not accorded ATE status.  By using the rules in this way, a person could have unrestricted commutations from their ATE income streams up to 18 months from the original income stream.

New six month rules

Within the first six months, commutation of an ATE income stream is still allowed but only in the case of an income stream that is a non-commutation funded income stream

How the new rules operate?

The new rules prevent a person from making commutations within the first 6 months of an income stream that has been purchased from the proceeds of another commuted ATE income stream.

The new rules operate as follows:

Figure 3 – One commutation allowable on second income stream

If the amount or amounts commuted from Income Stream A in Figure 3 above are used to purchase a new Income Stream B, C etc, no further amounts can be commuted from these new income streams.

Figure 4 – Further example of operation of rules, Multiple commutations allowable on original income stream

In Figure 4 above, no further commutations can be made from Income Stream B within 6 months, as it is a commutation funded income stream.  Further partial commutations from the original Income Stream A are allowable. If the amounts withdrawn from the original income stream are not invested in another income stream product (as with the first commutation here) and is used for other purposes, the usual means test rules apply to the proceeds.

Interaction of new 6-month rules with subparagraph 5JA(2)(h)(iii) or 5JB(2)(h)(iii)

We now have a situation where the new 5JA(2)(h)(i) or 5JB(2)(h)(i) only allows non-commutation funded ATE income streams to be commuted within 6-months.

Subparagraph 5JA(2)(h)(iii) has not been changed as a result of these changes.  Subparagraph 5JA(2)(h)(iii) allows unlimited full commutations at any time (including outside 6-months) provided that the “payment resulting from the commutation is transferred directly to the purchase of another income stream arising under a contract, or governing rules that meet the requirements of this subsection or subsection 5JB(2). (Subparagraph 5JB(2)(h)(iii) is similar).

Commutation – hardship old rules

The old rules made no provision for persons withdrawing money from ATE income streams on the grounds of hardship.

Hardship new rules

The new rules allow commutation on the basis of hardship (new subparagraph 5JA(2)(h)(v) and 5JA(2)(h)(v) refers).  See attachment A for definition.

Systems implications

There are very few DVA clients that have ever commuted an ATE product.  To minimise unnecessary messages for the majority of cases, a simple warning has been introduced to refer examiners to the new rules.  This warning is limited to any ATE products that are being either deleted or edited, either from the Summary or the Edit screen.

Explanation of systems changes

The message below will appear when editing, ie, making any change, to an ATE product on the Income Streams Edit screen.

The message below will appear when deleting or editing an ATE product on the main (Summary) Income Streams screen.

Note that because both these messages are warnings that are intended to highlight that the new rules may apply, you will need to decide whether or not the rules do apply whenever the messages appear.

Reversionary beneficiary – old rules

Old paragraph 5JA(2)(i) and 5JB(2)(i) refers.

These rules limited the transfer of an ATE on the death of the person to a reversionary beneficiary in the case of an ATE to which section 5JA applied or to a reversionary beneficiary or to the person's estate if an ATE to which section 5JB applied.

Glossary - beneficiaries

The person or primary beneficiary

The initial client who takes out the income stream

The reversionary beneficiary

Someone to whom the income stream is transferred on the death of the primary beneficiary

Another reversionary beneficiary

Someone to whom the income stream is transferred on the death of the reversionary beneficiary

Reversionary beneficiary – old rules - problems

The above rule only permitted transfer to one reversionary beneficiary and did not explicitly provide for the transfer to another reversionary beneficiary if the first reversionary dies.

Additional reversionary beneficiary – new rules

The new rules allow the transfer on the death of a reversionary beneficiary to another reversionary beneficiary – new paragraph 5JA(2)(i)(i)&(ii):

Income Stream:  I----X       Þ 1 — st RB        Þ   2 — nd RB  Þ ...etc

                                  Ý                   Ý                      Ý

                          Person dies     1 — st RB dies       2 — nd RB dies etc

If the ATE is a Life Expectancy or 15 Year Minimum Term income stream to which section 5JB applies, commutation is allowed:

• to transfer the income stream on the death of the primary beneficiary to a reversionary beneficiary – new subparagraph 5JB(2)(i)(i);

• to transfer to the estate of the primary beneficiary if no reversionary beneficiary; or

• to transfer on the death of a reversionary beneficiary to another reversionary beneficiary or if there is no other reversionary beneficiary to the estate of the reversionary beneficiary.

Income Stream:  I----X       Þ 1 — st RB        Þ   2 — nd RB  Þ ...etc (or estate if

                                  Ý                   Ý                      Ý                     no other RB)

                          Person dies     1 — st RB dies       2 — nd RB dies etc

Superannuation surcharge

No changes to the rules have resulted - partial commutations to cover any superannuation contributions surcharge that the person is liable to pay when purchasing the income stream is allowed – paragraphs 5JA(2)(h)(iv), 5JB(2)(h)(v).

Joint lifetime annuity

Under the old rules an income stream, which was a joint lifetime annuity paying a single income stream into a joint account, which reduced its payments on the death of one of the annuitants, lost its ATE status.

New subsections 5JA(2A) and 5JB(2A) specifically enable such a product to retain its ATE status despite the fall in payments made by the income stream.

Overpayments

The legislation will take account of the financial advantage a pensioner has had through having their income stream accorded ATE status.

The new section 52ZMA provides for the calculation of the debt that arises from the overpayment of a service pension or income support supplement while a person is in receipt of an income stream.  The overpayment arises from a commutation of an assets test exempt income stream that is a contravention of the income stream contract.

The debt is the difference between the amount of pension that has been paid and the amount that would have been paid had the income stream been included as an assessable asset during the relevant period.  The relevant period begins on:

• the day 5 years before the day the income stream was commuted; or
• the commencement day of the income stream;
• or 20 September 2001 (being the earliest date section 52ZMA can be applied);

whichever occurs later.

Subsection 52ZMA(5) provides that in working out the asset value of the income stream, as if it had not been assets test exempt, it should be assumed that the income stream was assets tested from the commencement day.  The asset value of the income stream is to be depleted in accordance with the formula in subsection 52A(4).

Binding arrangements

This gives the Minister the power to exempt specified financial investments for particular individuals from amendments to the means test treatment of income streams.  These provisions only apply where the person entered into the binding arrangement prior to 20 September 1998.

These are products where the arrangement with the provider does not allow the person to commute the income stream or the arrangement may only be terminated on terms that are likely to cause severe detriment to the person.  See new sub-item 12(4) of Schedule 5.

Nature of the contract

Prior to these amendments, subsections 5JA(2) or 5JB(2) required that the contract or the governing rules “specify” the different characteristics of an assets test exempt income stream.

Legal advice was received that that this may be defective and that it may be sufficient for the contract or governing rules to merely list the attributes to be an ATE in order to comply.

New rules

The new rules clarify that it is the income stream that arises under the contract or governing rules that satisfies the criteria.

Old rules

Subparagraph 5JB(2)(a)(i) applies if a person's life expectancy is less than 15 years and subparagraph 5JB(2)(a)(ii) applies if a person's life expectancy is greater than or equal to 15 years.

< 15 years

If a person's life expectancy was not a whole number (for example 11.2 years), the term of a life expectancy income stream product purchased by a person was limited to either:

• the life expectancy (11.2 years); or
• rounded up to the next whole number (12 years).

≥ 15 years

If a person's life expectancy was not a whole number (for example 17.46 years), the term of a life expectancy income stream product purchased by a person was limited to:

• 15 years; or
• any fractional number between 15 and the life expectancy (17.46); or
• the rounded up next whole number (18.00).

It did not include numbers between the fractional life expectancy number and the rounded up next whole number.

New rules

Last year the Department of Family and Community Services (FaCS) changed the Social Security Act 1991 to allow fractional numbers between life expectancy and the next number rounded up. The Stateline, issued on 21 September 2001, explains this more flexible approach and the relevant systems changes were made then as a policy change.  This means, in order to obtain assets test exempt status:

< 15 years

The person can now purchase an income stream with a term of:

• Life expectancy (11.2); or
• any fractional number between life expectancy and
  the next rounded up whole number (11.3, 11.4, 11.5...11.9, 12.0).

≥ 15 years

The person can now purchase an income stream with a term of:

• 15 years; or

• any fractional number between 15 and life expectancy rounded up to the next whole number (15.20,...17.48, ...18.00).

Note that the term cannot be less than the person's life expectancy.

See Figures 1 & 2 which show the difference between the old and new rules.

Figure of the difference between the old and new rules

Figure 1 – Income Stream term type when life expectancy is < 15 years

Figure 2 – Income Stream term type when life expectancy is ≥ 15 years

Bring 'Em Backs

Person paid age pension or wife pension by DVA under the Social Security Act 1991 (SSA) are to be assessed applying the Guidelines developed by the Department of Family and Community Services.  These can be found in the Guide to Social Security Law

http://www.fa — h — csia.gov.au/guides_acts/ssg/ssg-rn.html

which is also linked to CLIK) for an explanation of these rules.

Given that the rules are similar, there is no difference in the application of the new rules

Forms updated

The forms have been merged and updated to reflect the new legislation – see Form D563 Details of Income Stream Product available on DVA intranet (DVA Facts & Forms) and DVA internet site (DVA Facts).

The former D0561 form, which requested authority from the veteran for DVA to obtain financial data from the income stream provider, is no longer needed and has been removed.  Section 128 of the VEA allows DVA to obtain information from a third party for pension assessment purposes.  However it is important that the veteran be informed that a review of their entitlement is being conducted and that information will be obtained from income stream providers.

The remaining forms have been merged and a fax cover sheet added.  The fax cover sheet contains fields into which specific information can be typed, such as the provider fax number.

Eddie Bolanac of the Investment Database Unit regularly updates the provider contact list.  See Attachment B.

If you are sending the forms out to the veteran for a new claim, print only the forms and not the fax cover sheet.  The veteran is then to send the forms on to their provider.  Only use the fax cover sheet if you are contacting an income stream provider.  If, in reply, a provider sends you their own schedule, check to see that all information has been provided, for example whether the income stream is a self-funded super fund or not.

National Office contacts

Please do not hesitate to contact those below for any data collection or other relevant issues.

Eddie Bolonac, (02) 9213 7875 – procedures for handling changes;

Ian Williams, on (02) 6289 6382 - legislation or policy; and
Peter Feinler, (08) 8290 0441 – systems changes.