C46/2002 Assessment of Income Streams Paid from Self Managed Super Funds (SMSFs) or Small APRA Funds (SAFs)

Purpose

The purpose of this departmental instruction is to provide procedural information on how to assess income streams paid from Self Managed Super Funds (SMSFs) or Small Australian Prudential Regulatory Authority (APRA) Funds (SAFs).

Background

An increasing number of pensioners are setting up their own “do-it-yourself” self managed superannuation fund and paying themselves income streams.

DI C30/2002 – Income Stream Changes, dealt briefly with the requirement to request Actuarial Certificates for asset-test exempt income streams paid from SMSFs and SAFs.

This instruction provides more detailed procedural information on assessing income streams paid from SMSFs and SAFs.

SMSFs and SMFs

“Do-it-yourself” or self managed superannuation funds fall into two categories:

•   SMSFs (Self Managed Superannuation Funds), regulated by the Australian Taxation Office (ATO), and

•   SAFs (Small Australian Prudential Regulatory Authority – APRA - Funds) or Small APRA Funds, regulated by APRA as they do not meet the ATO criteria.

What is a SMSF ?

A Self Managed Superannuation Fund (SMSF) is a superannuation fund with less than 5 members, where:

• all members are trustees (or directors of a corporate trustee) and no other persons are trustees (or directors of a corporate trustee); and
• no member is an employee of another member (unless the members concerned are relatives); and
• trustees do not receive remuneration for their services.

A single member fund may have one additional trustee (or director of a corporate trustee) provided the member is not an employee of the trustee (or employee of the director of the corporate trustee).

To be classified as a SMSF, the fund must meet all of these conditions as specified in the Superannuation Industry (Supervision) Act 1993.

A pensioner receiving the benefits from a SMSF will usually also be a trustee of the fund (however, reversionary beneficiaries of members need not be members of the fund).

To set up a SMSF, a person must:

•       buy an off-the-shelf trust deed from a supplier, accountant or solicitor or have a trust deed drawn up by a legal firm;
•       complete an 'Application to Register for the New Tax System Superannuation Entity' form to apply for a tax file number, Australian business number, GST registration, and elect for the trust to be regulated as a superannuation fund investment;
•       open the fund's bank account and purchase investments in the name of the trustees on behalf of the fund; and
•       keep the assets of the fund separate from any personal assets.

SMSFs are supervised by the Australian Taxation Office (ATO).

What is a

SAF ?

A SAF, is a superannuation fund with less than 5 members which:

•       does not meet the definition of a SMSF; and
•       has a corporate trustee that is approved by APRA.

SAFs are supervised by the APRA.

Documents required

Self Managed Superannuation Funds (SMSFs) and Small APRA Funds (SAFs) may offer income streams if the trust deed allows it.

If a SMSF or SAF offers an asset-test exempt income stream, the income stream must:

• meet all requirements of sections 5JA or 5JB of the VEA; and
• satisfy all relevant prudential requirements of the Superannuation Industry (Supervision) Act 1993.

If a pensioner claims they are receiving an income stream from their SMSF or SAF, they must supply the following documentation to enable DVA to be able to classify the income stream.  The checklist contained in Attachment B contains a list of the relevant characteristics which should be present for the income stream to be accepted as an asset-test exempt income stream and the documentation described below (and checklisted in Attachment A) should be examined to ensure that all these characteristics are present:

• the trust deed under which the income stream is paid; and
• any contract between the pensioner and the superannuation fund for the income stream; and
• any other document (such as minutes of a trustees meeting) that sets out the conditions under which the income stream is paid; and
• if the SMSF or SAF has purchased an annuity to directly fund the income stream, a copy of the contract for the fund providing the annuity; and
• an income stream schedule for Veterans' Affairs purposes (form D0563), which provides the current income stream details, with a declaration from the trustee as to whether the income stream meets all the requirements of section 5JA or 5JB of the VEA; and
• if the pensioner is claiming the income stream is asset-test exempt, a current Actuarial Certificate prepared in accordance with the Institute of Actuaries (Australia) Guidance Note 465 (GN 465), stating that the SMSF or SAF has a high probability of meeting the income stream payments specified in the contract, trust deed or governing rules.

The pensioner will not have to provide a current actuarial certificate if the income stream:

•       is an allocated income stream; or
•       has been purchased by the fund from an established life office to back its payment of an asset-test exempt income stream and the annuity payments are paid directly into the SMSF or SAF.

Why are additional documents required ?

SMSFs and SAFs are financial arrangements where the pensioner (who is often the trustee) controls the investment decisions.

The pensioner decides where their money is invested and what type of income stream they want to receive from their fund.

As these financial decisions are not made at arm's length, the income streams paid from SMSFs and SAFs have a higher likelihood of:

•       failing to make payments in accordance with the income stream contract, trust deed or governing rules;

•       not returning the purchase price over the specified term;
•       being used for estate planning to maximise income support payments (ie. deprivation may occur if the income stream payments do not provide adequate financial consideration for the purchase price paid to acquire the income stream).

Given these risks DVA must obtain additional documentation to assess income streams paid from SMSFs and SAFs.

This additional documentation will enable staff to:

•       determine whether the income stream meets all of the requirements for asset-test exemption as specified in sections 5JA or 5JB of the VEA (in particular that a current actuarial certificate exists and that the purchase price has been wholly converted to income);

•       check for deprivation (ie. that the income stream payments are appropriate for the purchase price paid to acquire the income stream).

The beneficial rules for assets test exemption were introduced as an incentive to encourage pensioners to purchase an income stream that could be expected to last over their retirement.

It would be unreasonable to expect taxpayers to support the use of some of the purchase price for purposes other than paying the retirement income stream (ie. intentionally leaving a lump sum to the pensioner's estate).

Additional documents not required

Unlike SMSFs or SAFs, institutional funds involve financial arrangements where the investment decisions are not controlled by the pensioner.

Institutional funds (eg. life offices, public offer superannuation funds and public sector superannuation schemes) decide where funds are invested and the terms of the income streams they offer.

As these financial decisions are made at arm's length by institutions subject to prudential standards and commercial incentives, it is generally accepted that institutional funds attempt to provide the best possible returns to the investor in the market place.

APRA imposes strict reserving standards on institutional funds offering income streams, which serve to ensure that income stream payments specified in the contract, trust deed or governing rules, will be met.

Given that income streams paid from institutional funds are determined by market forces under strict regulations, they are not required to provide DVA with additional documentation to assess their income streams, other than:

• an income stream schedule for Veterans' Affairs purposes (form D0563), which provides the current income stream details, with a declaration from the trustee as to whether the income stream meets all the requirements of section 5JA or 5JB of the VEA.

Deprivation provisions

All asset-test exempt income streams paid from a SMSF or SAF must be checked for deprivation because the purchase price is an amount nominated by the pensioner from a fund controlled by the pensioner.

The nominated purchase price can be either:

•       part of the SMSF or SAF account balance (in which case that amount must be segregated by the trustee from any other remaining funds not used to purchase the income stream); or

•       all of the SMSF or SAF account balance (in which case the total beneficial interest in the fund is used to purchase the income stream).

Deprivation can occur if the purchase price of an income stream is greater than the present value of the total payments specified in the income streams contract, trust deed or governing rules.

The calculation of present value is complex and must only be made by the Australian Government Actuary (AGA) following a referral by the Manager of the DVA Investment Database Unit in Sydney.

The following example demonstrates the application of the deprivation provisions in for a very simple case:

For example: A pensioner nominates and transfers $100,000 to purchase an income stream for a fixed term of 10 years.  Payments are fixed at $6,000 per year.  All payments to be returned over the term of the contract total $60,000.

The present value of these total payments (as calculated by an actuary) is $50,000.

As the purchase price of $100,000 is greater than the present value of  $50,000, the pensioner has deprived themselves of $50,000 because they did not receive adequate financial consideration in return for the purchase price.

The deprived amount of $50,000 must be recorded as a deprived asset.  The commencement date of the income stream is also the deprivation date.  Assuming the pensioner is entitled to the allowable $10,000 gifting limit, a deprived asset of $40,000 will be added to their financial assets and deemed for a period of 5 years from the deprivation date.

The purchase price of the income stream remains recorded as $100,000 on the PIPS PC income streams screen.

Identification

Staff must identify any income streams paid from a SMSF or SAF, to ensure that the appropriate documentation is requested.

The most effective way to differentiate between income streams paid from institutional funds and those paid from SMSFs and SAFs is to ensure an income stream schedule for Veteran's Affairs purposes (form D0563) is requested.  Two tick boxes on form D0563 indicate whether the income stream is paid from a SMSF or SAF.

Another way to identify income streams paid from a SMSF or SAF is by the provider name, as it will often contain the surname of the pensioner (eg. The Robinson Family Superannuation Fund) or be linked to a private company or corporate trustee (eg. suffix is Pty Ltd).

If there is any doubt, staff must contact the pensioner or financial representative to clarify if the income stream is being paid from a SMSF or SAF.

Requesting  documents

After identifying that an income stream is being paid from a SMSF or SAF, processing staff must:

•       obtain all of the appropriate documentation using the checklist at Attachment A; and
•       classify the income stream as either asset-test exempt, asset-tested long term or asset-tested short term.

Where the pensioner claims that they receive an asset-test exempt income stream, staff must examine all of the appropriate documentation to:

•       check if the income stream meets all of the requirements specified in section 5JA or 5JB of the VEA using the checklist at Attachment B; and

•       check if the Actuarial Certificate prepared in accordance with the Institute of Actuaries (Australia) Guidance Note 465 (GN 465) is current.  See Attachment C for additional information.

Checking deprivation

Having classified the income stream, the staff member processing the case must contact Eddie Bolanac (Manager, Investment Database Unit, Sydney) on 02 9213 7875 to discuss the details of the case to see if investigation of the deprivation issue is warranted.

If appropriate, copies of the relevant documentation will need to be sent to the DVA Investment Database Unit in Sydney for vetting to examine if a referral to the Australian Government Actuary (AGA) is required to determine if deprivation has occurred.

Checking for deprivation

Provided all the appropriate documentation is obtained, staff can classify the income stream and complete the initial data collection of the income stream details for the pension assessment.

However, as the present value of the income stream is unknown at the classification stage, staff will not be able to determine whether or not the pensioner has made a deprivation.

To check for deprivation, the staff member processing the case must:

•       contact Eddie Bolanac (Manager, Investment Database Unit, Sydney) on 02 9213 7875 to discuss the details of the case;

and, if appropriate:

•       refer copies of all of the relevant documentation to the DVA Investment Database Unit in Sydney for examination.

As there are significant costs involved in obtaining actuarial valuations (approximately $500 to $600 per case), the Investment Database Unit will act as a vetting and referral centre for these cases.

If it is likely that the deprivation provisions may apply, the Investment Database Unit will refer the case to the Australian Government Actuary (AGA) to obtain actuarial valuations to determine whether:

•       deprivation has occurred (ie. if the purchase price is greater than the present value of the total payments to be made over the term of the income stream); and

•       the purchase price has been wholly converted into income stream payments.

The outcome of any AGA valuation will be referred back to the relevant State Office to record details of the deprived amount in the pension assessment, if applicable.

It is important that staff obtain all of the appropriate documentation in these cases, as the information will be used by:

•       processing staff to classify the income stream;
•       the Investment Database Unit to determine if a referral for actuarial valuation is warranted; and
•       the Australian Government Actuary to perform actuarial valuations for the present value and return of purchase price.

Financial difficulty

Where an income stream paid from a SMSF or SAF is in financial difficulty, it may either:

•       cease making payments;
•       reduce the level of payments; or
•       continue payments, but may have trouble obtaining future actuarial certification because some assets are not performing.

These cases are complex and will require detailed examination of the circumstances of the financial difficulty.

Pending the outcome of the examination, the income stream may either:

•       lose its asset-test exempt status and be re-classified as an assets tested long term or short term income stream; or

•       no longer satisfy the definition of an income stream and be re-classified as a superannuation fund investment.

Detailed procedures are available for examining these cases and will be issued under a separate departmental instruction.

Contact

If you have any enquires about how to assess income streams paid from SMSFs or SAFs please contact Eddie Bolanac (Manager, Investment Database Unit, Sydney) on 02 9213 7875 to discuss the details of your case.

Additional Documents - Checklist

If a pensioner is receiving an income stream from a Self Managed Super Fund (SMSF) or Small APRA Fund (SAF), the following documents must be requested to classify the income stream and determine whether the income stream meets all of the requirements of section 5JA or 5JB of the VEA:

• the trust deed under which the income stream is paid.

Yes      No

• any contract between the pensioner and the superannuation fund for the income stream.

Yes      No

• any other document (such as minutes of a trustees meeting) that sets out the conditions under which the income stream is paid.

Yes      No

• an income stream schedule for Veterans' Affairs purposes (form D0563), which provides the current income stream details, with a declaration from the trustee as to whether the income stream meets all the requirements of section 5JA or 5JB of the VEA.

Yes      No

• a current Actuarial Certificate prepared in accordance with the Institute of Actuaries (Australia) Guidance Note 465 (GN 465), stating that the SMSF or SAF has a high probability of meeting the income stream payments specified in the contract, trust deed or governing rules.

Yes      No

• Exception:  the pensioner or trustee will not have to provide

          a current actuarial certificate, if the income

          stream:

• is an allocated income stream; or

• has been purchased by the fund from an established life office to back its payment of an asset-test exempt income stream and the annuity payments are paid directly into the SMSF or SAF.

• If the SMSF or SAF has purchased an annuity to directly fund the income stream, then a copy of the contract for the fund providing the annuity must be provided.

Yes      No

Asset-Test Exempt Income Stream - Checklist

Asset-test exempt income streams must meet all of the requirements for asset-test exemption specified in VEA sections 5JA (for lifetime income streams) or 5JB (for life expectancy or 15 year minimum income streams):

Is the income stream:

• paid for life ?   OR

Yes      No

• a term equal to the person's life expectancy or life expectancy rounded up to the next whole number, provided the person has attained pension age ?              OR

Yes      No

• a term of 15 years or more, provided the person has attained pension age, and the person's life expectancy is 15 years or more, and the period is not more than the person's life expectancy ?

Yes      No

Is the Actuarial Certificate:

• a current Actuarial Certificate prepared in accordance with the Institute of Actuaries (Australia) (IAA) Guidance Note (GN) 465, stating that the SMSF or SAF has a high probability of meeting the income stream payments specified in the contract, trust deed or governing rules ?

Yes      No

Does the income stream contract, trust deed or governing rules specify  all of the requirements listed below:

• the level of pension payments in the first year (allowing for indexation increases and commutations);

Yes      No

• that pension payments are made at least annually and cannot be less than the previous year's payments;

Yes      No

• that indexation is capped at 5% fixed or CPI + 1%;

Yes      No

• the purchase price is wholly converted into income;

Yes      No

• there is no residual capital value;

Yes      No

• that commutations are limited to within the first 6 months of commencement of a non-commutation funded income stream, or to directly purchase another asset-test exempt income stream, or to pay a reversionary beneficiary or estate, or to pay a superannuation contribution surcharge, or to pay a hardship amount under VEA 5JA(7);

Yes      No

• the income stream cannot be transferred to another person apart from the reversionary beneficiary or estate upon death;

Yes      No

• the income stream cannot be borrowed against;

Yes      No

• that reversionary benefits cannot be greater than the benefit that was payable immediately before the reversion;

Yes      No

• that commuted benefits cannot be greater than the benefit that was payable immediately before the commutation;

Yes      No

If the income stream fails to meet any one on these requirements it is not section 5JA or 5JB compliant and is not an asset-test exempt income stream, and must then classified as either asset-tested long term or asset-tested short term.

Asset-Tested Long Term Income Stream - Checklist

If an income streams fails to meet any one of the requirements for asset-test exemption specified in VEA section 5JA (for lifetime income streams) or section 5JB (for life expectancy or 15 year minimum income streams), it will be classified as an:

Asset-tested Long Term income stream, if it has a term:

• greater than 5 years;

Yes      No

                 OR

• 5 years or less which is equal to or greater than the person's life expectancy.

Yes      No

Asset-Tested Short Term Income Stream - Checklist

If an income streams fails to meet the requirements for an asset-test exempt income stream and an asset-tested long term income stream, then it will be classified as an:

Asset-tested Short Term income stream, if it has a term of:

• 5 years which is less than or not equal to the person's life expectancy.

Yes      No

Superannuation Industry (Supervision) Modification Declaration 23

On 12 January 1999, the Australian Prudential Regulation Authority (APRA) issued a modification to the Superannuation Industry (Supervision) Act 1993.  The modification is known as Modification Declaration 23, which introduced tighter prudential requirements for superannuation funds paying pensions.

All superannuation funds paying pensions (other than allocated pensions or those backed wholly by life company annuities) are now required to produce an annual actuarial certificate.

How did this modification affect DVAs assessment of income streams?

On 20 September 2001, sections 5JA and 5JB of the VEA were amended to require all

asset-test exempt income streams paid from SMSFs and SAFs to provide an annual actuarial certificate to verify that the fund has sufficient reserves to meet the income stream payments.

If a current actuarial certificate is not provided, DVA will not grant assets test exemption to the income stream.

What sort of actuarial certificate is required?

In January 2001, the Institute of Actuaries Australia (IAA) released an actuarial Guidance Note (GN) 465 to provide guidance to actuaries drawing up actuarial certificates under the provisions of the Superannuation Industry Supervision Modification Declaration 23.

From 2 April 2001, all actuarial certificates must be prepared in accordance with GN 465.

Under GN 465, SMSFs and SAFs which provide asset-test exempt income streams must have asset backing sufficient to ensure that there is a 'high probability' that the fund will be able make the income stream payments specified in the contract, trust deed or governing rules.

What action must DVA processing staff take in relation to actuarial certification ?

For asset-test exempt income streams paid from a SMSF or SAF, DVA staff must:

•       obtain a current Actuarial Certificate prepared in accordance with the Institute of Actuaries (Australia) (IAA) Guidance Note (GN) 465 as a pre-requisite to granting assets test exemption status under sections 5JA or 5JB of the VEA; and

•       request a new Actuarial Certificate every year on expiry of the old Actuarial Certificate.

A review must be set on VIEW using review type 'Super Fund Certification' to ensure a new Actuarial Certificate is requested every year.

Once an Actuarial certificate has expired, a 6 month period of grace can be applied from the expiry date to allow the pensioner to obtain a new Actuarial Certificate prepared under GN 465.

If upon expiry of a 6 month period of grace, the pensioner has not supplied a new Actuarial Certificate prepared under GN 465, the income stream will lose its asset-test exemption and be re-classified as an asset-tested long term income stream.