Market linked pensions

Market Linked Pensions: Everything You Need to Know

Are you approaching the age of retirement and looking for a pension scheme that fits your lifestyle? Or maybe you have a friend or family member close to retirement who is seeking advice on pensions. Whichever it is, there are a few pension schemes in Australia that cater to people with different circumstances and needs. 

A Market Linked Pension is a type of hybrid pension that provides benefits based on the value of the fund itself and the amount of money that remains in it. This type of pension has existed since 2004, and can assist in early retirement, although it has less flexibility than standard pensions. 

To help, we have taken the initiative and have crafted a guide to help our readers understand market-linked pensions. In this guide, we tackle the background, terms, and income calculations among others, to assist with your superannuation and retirement planning. Read on below.

What Is a Market Linked Pension?

A Market Linked Pension is a retirement income stream that is accessible to retirees in a Self-Managed Superannuation Fund. 

The regulations that govern market-linked pensions can be found within the Superannuation Industry Supervision Regulations 1994

  • Background: The first market-linked pensions were made available in September 2004. During this time any retiree was able to commence a market-linked pension in a self managed super fund. However, this setup only lasted until September 2007, as reforms were put in place.

    Market-linked pensions that commenced after September 20th 2007 were then required to be an account-based pension as defined in the SIS Regulations. This means that members are no longer allowed to commence new market-linked pensions with the accumulated interest in their SMSF.

    However, members are allowed to commence a new market-linked pension under an SMSF with a balance that was rolled over from an existing complying pension (e.g. a defined benefit pension, or another market-linked pension). 

    Another big change that came with these reforms was the requirement for new market-linked pensions to satisfy minimum pension standards for account-based pensions. These requirements are on top of the existing income payment rules for a market-linked pension.

Market Linked Pensions allow individuals to:

  1. Vary pension payments +/- 10% of the prescribed amount
  2. Choose between monthly, quarterly, bi-annual, or annual payments
  3. Specify how much and to whom benefits are to be paid upon death
  4. Choose from a range of investment options

Market Linked Pensions are also tax-effective because:

  1. Investment earnings within a market-linked pension account are tax-free
  2. Pension payments are taxable but contain a tax-free component (individuals over 69 years of age are tax-exempt)
  3. Some individuals may be entitled to a tax rebate

However, Market Linked Pensions also has some disadvantages:

  1. Individuals are limited in varying income by only -/+ 10% of the prescribed amount
  2. You cannot commute lump sums
  3. There is no guarantee that pension payments will continue throughout an individual’s lifetime. Making maximum withdrawals and poor investment choices could drastically reduce the value of the investment fund.
  4. The pension cannot be split between spouses to reduce tax

What’s the Difference Between a Market Linked Pension and an Account-Based Pension?

A Market-Linked Pension is a type of Account-Based Pension. An Account-Based pension simply refers to a retirement income stream that is bought from your superannuation fund. 

The term ‘market linked’ specifically refers to the way in which the pension’s interest is linked to the market value of assets. Market linked pensions are also known as Term Allocated Pensions (TAPs) because pensioners can choose a fixed term to make the stream payments upon commencement. 

What’s the Difference Between a Market Linked Pension and an Allocated Pension?

Since Market-Linked Pensions fall under Account-Based Pensions, there is no difference between them and Allocated Pensions. 

Allocated Pension is actually a relatively outdated term that refers to income streams provided by accumulated superannuation funds upon retirement. ‘Allocated Pensions’ were replaced by the term ‘Account-Based Pension’ after the Simplified Superannuation reforms were introduced in 2007.

So, in essence, there is no difference between Allocated and Account-Based Pensions. All rules and policies that covered allocation pensions before the introduction of the 2007 reforms were automatically transferred to the new account-based pensions.

Although the term ‘allocated pension’ is outdated, it remains widely used. So you still often hear superannuation and income stream providers still use the term allocated pensions to refer to account-based pensions. Using them interchangeably is still accepted.

How Is a Market Linked Pension Calculated?

The payment amount for a market-linked pension is determined by dividing your pension account balance by the relevant percentage factor stipulated in the SIS Regulations. The answer will be rounded to the nearest ten dollars to determine your repayment amount. 

The payment factors for Market Linked Pensions will be based on the remaining pension term in whole years.

  • Income payments are made on a financial year basis, so a rounding rule applies after the term has been calculated.

    If the pension originally commenced in June, the remaining term will be rounded up on the 1st of July. But, the term will be rounded down if the pension commences between July and December.

    If there is only one year remaining on the pension’s term, then the payment factor will be one. Consequently, this means that the member will have to draw down their market-linked pension to a value of zero dollars in the final year of the term. Keep in mind that there is no residual capital value for market-linked pensions.
  • Payments must be made within 10% of the calculated payment amount. Meaning the actual pension payment for the year can be anywhere from 90% to 110%. 

What Is a Market Linked Pension Term?

A market-linked pension term refers to the duration of the pension payments. The minimum and maximum pension terms are primarily determined by the member’s life expectancy. 

The minimum and maximum terms are shown below (These terms are only applicable to market-linked pensions that commenced on or after the 1st of January 2006). 

The life expectancies in these examples are based on the Australia Life Tables 2005-2007 by the Australian Government Actuary (AGA) and are subject to change when new data is published.

  • Minimum Term: Is based on the member’s life expectancy rounded up to the next whole number.

    For example, a 68-year-old male’s life expectancy is 16.24 years. When rounded up, this becomes 17 years — the minimum term for the member.
  • Maximum Term: The maximum term can be calculated in two ways. First, the time between the pension’s commencement date and the day when the member reaches the age of 100. Or, the member’s life expectancy based on an age five years younger than their current age. The maximum term will be based on whichever answer is greater out of these two methods.

    For example, a 68-year-old male will take 32 years to reach the age of 100. On the other hand, his life expectancy – based on the age five years younger than his own which is 63 – has a life expectancy of 20.14 years. This becomes 21 years after rounding up. Since 32 years is greater in value, this becomes the maximum term for the member’s market-linked pension. 

Can I Choose My Market Linked Pension Term?

Yes. Individuals are allowed to nominate a term that is equal to their life expectancy or until age 100. Longer terms generally result in lower-income payments, allowing a member’s pension to last as long as possible while also keeping the assets tax-free.

Can You Commute a Market Linked Pension?

Yes, members are allowed to commute their existing market-linked pensions to commence another market-linked pension. A pension commutation is a one-time lump sum withdrawal from the theoretical capital that supports the pension.

When you commence a new market-linked pension, the terms will be recalculated at the date of the new pension’s commencement. The minimum and maximum terms remain subject to the same provisions.

Using the reversionary beneficiary’s life expectancy, or nominated persons,  when deciding the term of the market linked pension is possible. If a member is using their nominated person’s life expectancy when determining the term of the new market-linked pension, a few things should be kept in mind:

  1. The rules of a market-linked pension state that the pension must continue until both the primary and secondary beneficiaries have passed away. The pension is prohibited from being paid as a death benefit lump sum upon the first death.
  1. 12 months after the reception of the reversionary income stream, the reversionary beneficiary will have a credit applied to their transfer balance account equal to the market value of the income stream. 

What Happens to a Market Linked Pension on Death?

Upon the member’s death, their market-linked pension is commutable and the remaining assets will be paid to either a spouse, a dependant, or an estate. The same treatment applies to life expectancy pensions. 

However, if the term of the market linked pension was based on the life expectancy of a spouse, then it cannot be commuted on death until the death of the spouse who survived.

Related Questions:

What Is a Life Expectancy Pension?

A Life Expectancy Pension is a type of retirement income stream that can be purchased through a lump sum obtained from a superannuation fund, or other sources, to give the member income during their retirement. 

Life expectancy pensions can be purchased from most life insurance companies and paid using superannuation money, or other sources of savings. These pensions provide members with income payments that are fixed for a term that is based on their life expectancy. Any income is fixed at the day of commencement and may be indexed to increase in value each year — either by a fixed percentage or in line with inflation.

The eligibility for an age pension is determined by taking into account both how much income the individual is getting (Income Test) and how much their assets are worth (Assets Test). 

What Is a Pension Cooling Off Period?

This refers to the period in which a member is allowed to cancel a pension policy, and must be exercised within 14 days.

Disclaimer:

This article is provided as general information only and does not consider your specific situation, objectives or needs. WealthVisory Private Clients makes no warranties about the ongoing completeness or accuracy of this information. It does not represent financial advice upon which any person may act. Implementation and suitability requires a detailed analysis of your specific circumstances.

Matthew Rutter, Director/Head Financial Advisor of WVPC

Matthew has a wide ranging background in business, finance, taxation and accounting with over 25
years’ experience, firstly as an Accountant before becoming a Financial Planner. Matthew has been in
the Financial Planning Industry since March 1998 and has been the principal of his own financial
planning practice since 2003.

Matthew has studied a Bachelor of Commerce degree from Newcastle University majoring in Financial
Accounting and the Diploma of Financial Planning from Deakin University. Matthew is a Registered Tax
Agent and is a member of the National Tax & Accountants Association (NTAA).

Matthew has particular expertise in the areas of retirement planning, superannuation, investments and
insurance. His emphasis is on building a professional, integral and lasting relationship with clients with
the objective of assisting them to achieve their financial and lifestyle goals.

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