Defined benefit schemes
In a defined benefit fund, this is not dependant solely on contributions and earrings. The benefits may depend on other factors, such as members year of service or financial average salary (on retirement or termination of employment). In general, no concessional contributions prior to 1 July 2017 counted towards to a members of an unfunded defined benefit scheme, e.g. a scheme for government employees, because in such a scheme a member's benefits are not financed until just before they become payable to the member.
Different rules apply for calculating contributions depending on whether they are made to:
- a funded defined benefit fund
- an unfunded defined benefit fund
- a hybrid super fund.
Defined benefit interest
A defined benefit interest exists were all or part of the superannuation benefits payable to a member are defined by reference to the person's (or another person's) salary, a specified amount or specified conversion factors.
A superannuation interest is not a defined benefit interest if the only benefits payable in reference to a salary are death or disability benefits.
Concessional contributions from 1 July 2017
From 1 July 2017, the concessional contributions of a member who has one or more defined benefit interests is the sum of:
- contributions and amounts that relate to their accumulation interests if these amounts would be included in their concessional contributions
- notional taxed contributions for the financial year in respect of each defined benefit interest, and
- the amount by which their defined benefit contributions for the financial year exceeds those notional taxed contributions.
Prior to 1 July 2017, the concessional contributions amount for a defined benefit interest was basically a member's notional taxed contributions.
Notional taxed contributions
Notional taxed contributions are the notional amount of contributions (excluding after-tax member contributions) that relate to a members defined benefit interest. Notional taxed contributions are counted towards a member's concessional contribution cap and are added to the other concessional contributions made to a member's accumulation account in a financial year to determine whether the member's concessional contributions cap has been exceeded.
The extent of the benefit, however, varies between different sub-groups of defined benefit division members, because of the way the government designed the notional taxed contributions formula.
|Notional taxed contributions formula:
1.2 x (new entrant x superannuation salary at start of financial year x days in category/365 - Any after-tax contributions )
New entrant = These rates are determined by the date the member joined the fund and groupings of the selected member contribution rates
Super salary at start of financial year = Annual salary as at 1 July of the financial year
Days in national tax contribution category = How many days in the financial year was an accruing defined member of the benefit category
Any after-tax contributions = The amount of after-tax member contributions paid by or on behalf of the member in respect of their defined benefit component in the financial year.
Special rules (grandfathering) of notional taxed contributions
For some members it could be difficult to adjust their notional taxed contributions if a member belongs to a defined benefit scheme.
The member could be liable for excess contributions tax even though they are unable to reduce their notional taxed contributions. Therefore, special rules (grandfathering) may apply if a member joined a defined benefit fund on 5 September 2006 (the day the original contribution caps were first announced) or 12 May 2009 (the reduction in the concessional contributions caps).
If a members notional taxed contribution in a financial year exceed their concessional contributions cap and they qualify for the grandfathering provisions, their fund will treat their notional taxed contributions as being equal to their concessional contributions cap.
The fund is responsible in determining if a member is eligible for the grandfathering provision.
These grandfathering provisions don't apply to other employer contributions made to their defined benefit fund or other funds.
Eligibility for grandfathering
To be eligible for grandfathering:
- for the 2007-08 and 2008-09 financial years - been a member of an eligible defined benefit on 5 September 2006 (the day the original contributions caps were first announced)
- for the 2009-10 financial year onwards - been a member of an eligible defined benefit fund on 12 My 2009 (the reduction in the concessional contribution caps)
- not had a substantial change to the rules that apply to their benefit since that date
- not had a non-arm's length change to their super salary of more than 50% in a year or 75% in three years since that date
- notional taxed contributions in a financial year in excess of the concessional contributions cap
- met other conditions specified in the regulations.
The grandfathering arrangement may not apply of their fund makes changes to its benefit rules. However, certain minor changes may still allow the grandfathering arrangement to continue.
If a transfer from a defined benefit fund to another defined fund, and continue to meet the requirements, they may still be entitled to the grandfathering arrangements in the new fund (for instance, where the funds provide equivalent rights to members).
The grandfathering provisions don't apply to a super interest in a constitutionally protected fund.
Unfunded defined benefit fund
In an unfunded defined benefit fund the benefits are not financed until just before they become payable to the member. The benefits are generally paid by their employer.
Unfunded defined benefit funds mostly cover government employees- for instance, the Commonwealth Superannuation Scheme (CSS), Public Superannuation Scheme n(PSS) and the Defence Force Retirement and Death Benefits Scheme (DFRB). Many unfunded super funds also have funded components (these are known as partially unfunded).
Concessional contributions count towards a members concessional contributions cap. These contributions on their own cannot result in exceeding their concessional contributions cap for a financial year ($25,000 in 2020-21).
Counting unfunded defined benefit fund contributions towards a member's concessional contributions cap means that their ability to make further concessional contributions to other funds is limited. There may be tax consequences for other concessional contributions.
Non-concessional contributions made to an unfunded defined benefit fund are counted towards a member's non-concessional contributions cap.
Some unfunded defined benefit funds require a member to contribute a percentage of their salary to their super. These contributions are made from after-tax income, so they are non-concessional contributions.
Liz is a PSS member. She makes after-tax contributions of $7,000 in the 2020-21 financial year. She makes further after-tax contributions of $298,000 to another super fund.
As Liz is under 65 years old, she can 'bring forward two years of contributions, giving her a non-concessional cap for the 2020-21 year of $300,000.
Her non-concessional contributions total $305,000 as it includes both the:
Therefore, Liz exceeded her non-concessional contributions cap by $5,000 and has to pay excess non-concessional contributions tax on this amount. Liz's available cap for the next two years is $0.
Hybrid super fund
Super funds having a combination of accumulation benefits and defined benefits are known as Hybrid funds.
Hybrid funds can provide:
- a defined benefit - which may be defined by a formula based on factors such as salary, length of contributory service and age at exit.
- an accumulation benefit - based on their own contributions plus earnings on those contributions.
Some super funds have both unfunded and funded portions (for example, CSS and PSS). If the super fund has an unfunded and funded portion, only the unfunded portion has a zero concessional contribution amount. Any funded portion may have concessional contributions that count towards a member's concessional contributions cap. For instance, the productivity contributions paid by employers to the CSS and PSS are concessional contributions.
Roger is 42 years old. He works for the Australian Government and is a member of the CSS. In the 2020-21 financial year, Roger's employer contributes $2,000 in productivity super contributions to the CSS. Jon also salary sacrifice $20,000 to another super fund. Roger's concessional contributions for the financial year will be $22,000 consisting of:
There are no concessional contributions as part of his unfunded benefit in the CSS. As Roger did not exceed his concessional contributions cap, he does not pay any excess concessional contributions tax.
This technical resource is intended for the use of financial advisers only. It is current as at the date of publication but may be subject to change. This publication has been prepared without taking into account a potential investor's objectives, financial situation, needs or objectives. Before making a recommendation based on this material, you should consider its appropriateness based on the client's objectives, financial situation and needs. Rainmaker Group is not a registered tax agent under the Tax Agent Services Act 2009. Your client should refer to a registered tax agent before relying on information published herein that may impact their tax obligations, liabilities or entitlements.
Last modified: Tuesday, September 15, 2020