What Does Commutation of Pension Mean

If your time to retire is around the corner, you might be able to make a commutation of your pension. This will allow you to choose a preferable way of receiving your income stream.

Read on to get the answer to “What does commutation of pension mean?”, learn how to calculate it, and judge if it is in your best interest to get a lump sum.

What Does Commutation of Pension Mean

Commutation of pension meaning entails converting all or part of your pension into a lump sum. The commutation can include cash withdrawals or rollovers of the lump sum. 

Commutation of pension in Australia is available for most employees in the public sector or commissioners, including senators and members, defence force members, South Australia public sector and others.

How Does the Commutation of Pension Work?

The Australian Taxation Office issues a commutation authority which is a notice to the super fund when the transfer balance cap has been exceeded. The ATO also sends excess transfer balance determination to the member. The commutation authority is issued when:

  • The member has not commuted the extra amount in full by the due date.
  • The member has chosen to send a commutation authority and commute the excess amount.

Note: If you don’t want to comply with the commutation of pension after the death of a member, lodging a transfer balance account report (TBAR) at the ATO is necessary. The TBAR due date is 60 days upon the date of issue.

Calculating Commutation of Pension

The two elements influencing the total lump sum are the commutation factor and the amount of your annual income you decide to let go. Let’s dissect what the commutation factor stands for and what it is used for.

What Is a Commutation Factor?

Commutation factors are used for calculating the lump sum you will receive when you commute a certain amount of your annual income. According to the commutation of pension rules, the factors vary depending on your age and the regulations of the superannuation of your choice.

The commutation factor is the gross amount you will receive for every dollar commuted.  But, what is a good commutation factor? The greater the commutation factor, the bigger the lump sum you receive. Generally, anything above 20:1 is considered a good commutation factor.

So how exactly is pension commutation calculated? Let’s take the Super SA pension scheme commutation rates as an example.

Source Super SA

Let’s say you want to retire on your 59th birthday and have decided to commute $15,000 within the first three months of your pension payments. Your total annual retirement income for the purposes of this example is $50,000.

With the commuted $15,000, you will reduce your annual income to $35,000. Your gross lump sum will be calculated by multiplying your commuted amount with the commutation rate according to your age. In our case, that would be $15,000 x $10.70, which would amount to a gross lump sum of $160,500.

Types of Pension Commutations

You can make four types of commutation to your pension: partial rollback commutation, full rollback, partial withdrawal, and full withdrawal commutation. Let’s take a look at what each of them implies:

  • Partial rollback commutation – Rolling a part of your pension balance into a super accumulation account.
  • Full rollback commutation –  Rolling your entire pension balance into a super accumulation account.
  • Partial withdrawal commutation – Withdrawing a segment of your superannuation pension balance.  
  • Full withdrawal commutation – Withdrawing your total pension capital balance.

The rollbacks or rollovers can either be added to the same superannuation fund in another income stream or put into a different super fund.

Retirement Transfer Balance Cap

The transfer balance cap (TBC) is a threshold for the transferrable superannuation from your accumulation account to an account with a non-taxable retirement phase. The transfer balance cap is a lifetime limit, and all lifetime pensions are counted towards the Federal Government Transfer Balance Cap.

Your age pension or other government payments and pensions from other superannuation funds do not influence your transfer balance cap. Instead, your transfer balance cap relies on two types of income streams

  • Retirement phase income streams
  • Retirement phase death benefit income streams

Exceeding your personal TBC will leave you with two options: commuting or paying tax on the excessed earnings. To make sure you’re on the right track, you can check your TBC online on myGov.

Furthermore, a personal TBC of $1.7 million will apply to everyone who begins their retirement phase income stream from 1 July 2021. Before these changes occurred, the transfer balance cap was $1.6 million. Nevertheless, for pensioners with an opened TBC account before 1 July 2021, the TBC will be calculated proportionally, considering the highest account balance.

You might be interested in finding out how to find a unique superannuation identifier

Taxability of the Commuted Pension

If you choose to commute your fortnightly income to a lump sum, it won’t be taxed the same as it would when getting the amount as a fortnightly income. One of the benefits of commutation of pension is that upon receiving your lump sum entitlement, it will be divided into a tax-free and a taxable component

The after-tax contributions, according to the previously determined non-taxable percentage, will make up the tax-free component of your lump sum. Additionally, different taxation rates will apply if you choose to take the lump sum in cash or roll it over.

Did you know that making voluntary contributions to your superannuation is a way you can save on taxes?

Bottom Line

Commutation of pensions is a great option for governmental employees that allows for gaining access to a lump sum of the pension instead of annual income. So, consider all of the options available and be aware of the mandatory deadlines for submitting the necessary paperwork.

FAQs:

1.What is a full commutation of a pension?

Full commutation of pension entails converting the full amount of the pension exceeding the transfer balance cap into a lump sum.

2.What is the interest rate of commutation of pension?

The commutation is calculated through a commutation factor that depends on your age. The bigger the factor, the more money you will receive in your lump sum. For a detailed explanation and an exemplary table, refer to our  “What Does Commutation of Pension Mean” guide.

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