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Taxation of super benefits

Taxation of defined benefit pensions

Section: 7.12

There are two key issues for the taxation of defined benefit pensions - the amounts, if any, of tax-free component and untaxed element in the taxable component.

Tax-free component: it is necessary to look closely at all aspects of a defined benefit pension and the client's circumstances to confirm whether there is, in fact, a tax-free component and its amount, as outlined in the following tables. Of particular note is the fact that many defined benefit pensions are not eligible for a tax-free component.

Taxable component (untaxed element): defined benefit pensions with an untaxed element of the taxable component are subject to tax at the client's marginal tax rate less a 10% tax offset when age 60 and above. Under age 60, they are subject to tax at the client's marginal tax rate with no tax offset applying. This should be a consideration in any strategies that involve commencing a defined benefit pension with an untaxed element prior to the client turning age 60.

Tax-free component of defined benefit pensions commenced on or after 1 July 2007

Type of pension Tax-free component calculation
Entirely employer-financed, i.e. no member contributions Pre July 1983 component, as at date pension commenced
Partly member-financed Pre July 1983 component plus undedicated contributions component as at date pension commenced plus non-concessional contributions made after 1 July 2007

Tax-free component of defined benefit pensions commenced before 1 July 2007, following a trigger event

Type of pension Tax-free component calculation for defined benefit pension commenced prior to 1 July 1994 Tax-free component calculation for defined benefit pension commenced between 1 July 1994 and 30 June 2007
Entirely employer-financed, i.e. no member contributions Nil Pre July 1983 component, as at date of trigger event
Partly member-financed Unused undeducted purchase price (UUPP) as at date of trigger event UUPP + Pre July 1983 component, as at date of trigger event

Notes:

  • The formula under section 27A(1) of the Income Tax Assessment Act 1936 for calculating the undeducted purchase price (UPP) of pensions commenced on or after 1 July 1994 excludes any pre July 1983 component. An allowance for this amount is then added back to determine the tax free component when such a pension is triggered. However, pensions commenced before 1 July 1994 include pre 83 component in their UUPP. Accordingly, section 307-125(6A) of the Income Tax (Transitional Provisions) Act 1997 does not allow any additional pre 83 component to be added back.
  • The UUPP will be nil if at 1 July 2007 the client had already exceeded their life expectancy.
  • Refer to section 7.16 for more trigger events.

Additional taxation may apply to income over $100,000 paid from a capped defined benefit income stream from 1 July 2017. See section 13.3 for more information on the taxation of pension/annuity payments from capped defined benefit income streams.

Last modified: Friday, January 12, 2018