What does it mean to commute a pension?
A pension commutation is a lump sum withdrawal from the theoretical capital supporting the pension.
The theoretical capital is not exactly calculated as the pension balance itself.
Basically, if a lump sum withdrawal is made from a pension it is classified as a commutation, unless that lump sum withdrawal was a pension payment.
The pension commutation meaning is much less relevant these days, yet still important to understand.
Commute Pension Meaning & History
Prior to the Simpler Super reforms, superannuation pensions were different.
The current account-based pension was referred to as an allocated pension.
The owner of an allocated pension was required to draw an income between a minimum and maximum amount.
The minimum and maximum amount was calculated based on your age, account balance and life-expectancy.
If you needed more money, you would need to make a pension commutation.
The pension commutation would reduce the theoretical capital value of your pension.
A commutation would then affect the calculation of the minimum and maximum payments, as well as the income assessment for Centrelink purposes.
After the simpler super reforms, the calculation of the minimum and maximum pension payments was removed and replaced with a minimum pension income factor.
The minimum pension income factor is a percentage of your total pension balance, based on your age.
It determines how much pension income you must withdrawal for the financial year as an absolute minimum.
There is no longer a maximum pension income threshold for standard account based pensions.
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Therefore, a pension owner can now nominate how much income they want to receive each year, provided it is above the minimum amount.
In most cases, you can simply take an increased pension payment, rather than partially commute your pension, if you need additional money.
A maximum income threshold of 10% does apply to Transition to Retirement (TTR) Pensions.
Transition to retirement pensions are also known as non-commutable account based pensions.
As the name suggests, commutations cannot be made on TTR pensions.
Types of Pension Commutations and Their Meanings
There are four types of pension commutations that can be made.
These include a partial rollback commutation, full rollback commutation, partial withdrawal commutation and full withdrawal commutation.
The meaning of each of these types of pension commutations is detailed below:
| Commutation Type | Meaning |
|---|---|
| Partial Rollback Commutation | Rolling part of your pension capital balance back to a super accumulation account |
| Full Rollback Commutation | Rolling your total pension balance back to a super accumulation account |
| Partial Withdrawal Commutation | Withdrawing part of your pension capital balance out of the superannuation environment altogether |
| Full Withdrawal Commutation | Withdrawing your total pension balance from the superannuation environment altogether |
Transfer Balance Cap Pension Commutation
The introduction of the Transfer Balance Cap from the 1 July 2017 super changes brought in the need for some people to make compulsory commutations.
The Transfer Balance Cap limits the amount of superannuation savings that can be held in pension phase.
The current Transfer Balance Cap is $1.6 million.
If you had a total pension balance in excess of $1.6 million on 30 June 2017, the excess amount above $1.6 million had to be partially commuted.
The partial commutation could be a partial rollback or a partial withdrawal, as defined in the table above.
A formula, which can be found here, was used to calculate the capital value of a defined benefit pension for Transfer Balance Cap purposes.
Pre-1 January 2015 Pension Commutations
A non-grandfathered account based pension is assessed using the deeming provisions for Centrelink income test and aged care means tested purposes.
However, a pre-January 2015 grandfathered pension is assessed using the deductible amount for Centrelink and social security purposes.
The reason this is important is because partial commutations will affect the calculation of the deductible amount, which can affect Centrelink entitlements and aged care fees.
A full pension commutation, including a pension refresh, will result in a pre-1 January 2015 grandfathered pension no longer being grandfathered.
Should I Commute My Pension?
Whether you should commute your pension or not depends on what you are trying to achieve.
Commuting Pension to Lump Sum
If you need a lump sum for a one-off purpose, such as a new car, you may consider making a lump sum withdrawal pension commutation.
However, a one-off increased pension payment can have the same outcome.
If you have a post-1 January 2015 pension, there is no real difference between an increased pension payment or a commutation.
If you have a pre-1 January 2015 grandfathered pension, you need to calculate the implications of a commutation on the future deductible amount, compared to the immediate consequences of a one-off increased pension payment.
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Commute Pension Back To Accumulation Phase
If you have too much in pension phase and required to draw an income more than you need, you may decide to commute part of your pension back to accumulation phase.
The benefit of a partial rollback commutation is that it can reduce the amount of income you have to withdraw and preserve the amount held within super.
The downside of a partial rollback commutation is that earnings within a super accumulation account are taxed at up to 15%; whereas earnings within a standard pension account are taxed at 0%.
Pension Commutation Example
Let’s say you have a pension that you started on 1 July with a balance of $500,000.
By 1 December of the same year, the balance had earned income (e.g. dividends) of $8,000, had capital growth of $20,000 and paid pension payments of $12,000 and fees of $1,000.
The balance at 1 December would be $515,000.
If you made a lump sum commutation on 1 December of $30,000, the balance would reduce to $485,000.
For standard account based pensions, this is no different to if you had simply opted to make an increased pension payment of $30,000.
However, for a grandfathered pension, this commutation would affect the deductible amount calculation.
The deductible amount calculation = (Original Pension Purchase Price – Any Commutations Since Inception) / Relevant Number At Commencement.
You can now see how a commutation will reduce the Centrelink deductible amount and therefore increase the assessable income for income test purposes.
If you have a grandfathered pension, you can ask your superannuation provider for your Centrelink Schedule which provides you with all the information you need to calculate your deductible amount.
