Market-linked income streams (MLIS) first appeared in the early part of this century and have never been particularly popular because they were designed to solve a very limited range of problems. Some people tried to rename them Term Allocated Pensions or TAPs, but it’s unusual to see these names used now.
Despite their lack of popularity, MLISs plays an important role in the pension system.
The role of MLISs in the pension system
If your SMSF pays a lifetime pension that has gone pear-shaped financially and an actuary can’t certify that the pension’s likely future health is robust, then you have to convert your lifetime pension to an MLIS. If you don’t do this then Centrelink will impose various penalties. If you convert the lifetime pension to an MLIS, then Centrelink will allow you to retain these concessions.
If you’re in this circumstance I strongly recommend you seek expert advice because the process of converting a lifetime pension to an MLIS can be quite tricky.
An MLIS is a type of account-based pension and therefore has typical features of this product genre. That is, the account balance will increase with capital gains and income earnings and decrease because of income payments and expenses. They suffer from the perennial problem for all these pension types; namely, you have to think very carefully about how income is generated in them.
This type of income stream was specifically designed to offer the Reasonable Benefit Limit and Centrelink concessions that had only been given to guaranteed lifetime pensions and annuities with specific design features. The Government wanted to give these to a wider product range.
The RBL and Centrelink concessions were removed in July 2007 and at the same time it was made impossible to commence a new MLIS, except in very limited circumstances.
There are four major features to an MLIS:
- The pension is non-commutable;
- The term of the pension remaining at any point in time;
- The income that must be paid during a financial year; and
- The investments used by super fund trustees to provide the required income.
As noted, the product is non-commutable, which means once it has started it can’t be stopped except to transfer the current account balance to another MLIS, non-commutable lifetime pension or annuity. More importantly, you can’t take a small lump sum out of the product.
The term of the pension has to be determined before the product commenced. Under the initial design of the product a complex system was put in place to determine what terms were allowed. The allowable terms took into account a pensioner’s life expectancy at commencement or the life expectancy of any nominated reversionary and their life expectancies if they were both up to five years younger. It was an unnecessarily complex system designed to provide flexibility and help people, but confusion was all it achieved.
Fortunately, in time this system was dropped for something a little bit easier to understand. Now, the term of an MLIS can be anywhere between the life expectancy of the pensioner and the period of years to their one-hundredth birthday. If there is a nominated reversionary, then the term of the pension can be anywhere in a similar time spectrum.
For example, a 65-year-old male currently has a life expectancy of 18.54 years, with 35 years until he turns 100 years of age. This means the terms allowed for an MLIS are between 19 and 35 years.
Once the term has been selected, the level of income that has to be paid can be determined by reference to the remaining years in the products life. For example, let’s look at a 65-year-old male who commences an MLIS with a 30-year term.
This will mean that in the first year his income must be between 4.9% and 6.0% of the MLIS’s initial account balance where the assets are valued at net market value.
These minimum and maximum income levels are reset each 1 July based on the pension’s remaining years. As the remaining term gets smaller, the level of income that must be paid gets larger. For example, with 20 years to run, the minimum pension must be 6.3% and 7.7% of the pension’s account balance at this point in time.
The purpose of the increasing income is to ensure that at the end of the product’s term all the remaining account balance will be paid out as income.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.