A government proposal to allow SMSF members to exit legacy pensions could be improved through the removal of the five-year timeframe, allowing partial commutations and exempting all reserve allocations from any form of contribution caps, the Institute of Financial Professionals Australia (IFPA) has stated.

In its submission to Treasury regarding the draft regulations released in mid-September, IFPA welcomed the proposed changes, but added minor amendments to the regulations would ensure they were more effective and flexible in allowing people to exit a pension or make allocations from a reserve.

The institute said the proposed five-year period to commute a legacy pension was unnecessary and should be open-ended to allow people who will hold a pension for more than five years from the start date of the new regulations to be able to commute it in the future.

The submission noted those holding legacy pensions beyond five years were likely to include individuals in receipt of social security benefits or who have no need to exit a pension now, but may do so at a later time.

“Some individuals may not want to commute in the short term due to the grandfathered favourable social security concessions they receive from holding their legacy pension. However, if the five-year window applies, they will be unable to exit their legacy pension at a time in the future where it no longer meets their circumstances,” it said.

“They may be happy with their legacy pension now, but they may change their mind in the years ahead. For example, when the pension’s capital value has become relatively small such that it is uneconomical for them to run an SMSF just for that pension.”

IFPA also called for partial commutations from legacy pensions, adding full commutations may limit how SMSF members can use these funds.

“It may be that the individual wants to retain their legacy pension, but they require access to capital for a particular reason or may want to commute a certain amount to remain below the defined benefit income cap so they don’t have to pay additional taxation on income exceeding the cap,” it said.

“Only allowing full commutations will restrict individuals who want to keep their legacy pension from making partial commutations and retaining a residual pension arrangement under the pre-existing rules. Specifically, this will prevent individuals from effectively using their retirement savings for health, aged care and other large and potentially unforeseen expenses in retirement without a full commutation.”

It also suggested that rather than have large reserve allocations count towards an individual’s non-concessional contribution cap and not their concessional contribution cap, all reserve allocations in an SMSF should be exempt from any contribution cap.

“Reserve allocations can lead to excess tax – although the non-concessional contribution cap is generally larger than the concessional contribution cap, the non-concessional contribution cap is linked to the size of an individual’s total superannuation balance. This means if an individual has more than $1.9 million at 30 June 2024, they will have a non-concessional contributions cap of nil for 2024/25,” it said.

“If the non-concessional cap measure is retained, we believe all members regardless of account balance or age should be able to allocate reserves up to the value of the non-concessional contribution cap.”

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