Julie Steed, Senior Technical Services Manager
In a previous article, Estate planning and the $1.6 million transfer balance cap we outlined the impact of the $1.6 million transfer balance cap on the estate plans of super members and their beneficiaries. This is because the cap places a limit on the amount of super that can be used to commence a pension which receives tax-free investment returns.
We now turn our attention to the rules surrounding the transfer balance cap and the payment of super death benefit pensions to child and spouse beneficiaries, including what you and your clients need to be aware of and the changes that may be required.
Following the introduction of the $1.6 million transfer balance cap on 1 July 2017, advisers should review clients with large super death benefits - either from accumulated balances or from holding insurance in super.
On the death of a member, their super death benefit must be ‘cashed’ and paid to their super dependants, who are most commonly a spouse or child. The benefit may be cashed by paying a lump sum benefit, by paying one or more pensions or a combination of both.
If the death benefit is paid as a pension, the amount that can be used to start the pension is restricted to the transfer balance cap of $1.6 million. Any amount above the transfer balance cap must leave the super system. There are special rules for benefits paid to children, and in situations where there are multiple beneficiaries, each child receives a proportionate share of either the parent’s retirement phase interests on death or the general transfer balance cap.
If a beneficiary has commenced a pension themselves, their own pension and the death benefit pension they receive both count towards the transfer balance cap.
Importantly, a member’s own pension may be commuted back to accumulation phase, but a death benefit pension cannot. From 1 July 2017, a death benefit pension may be rolled over to another fund, however, it must always retain its identity as a death benefit and thus can never be rolled back to accumulation phase.
A super death benefit can only be paid to the child of a deceased member if the child is:
If a parent’s death benefit is paid as a pension to a child, the benefit must be fully commuted by the child’s 25th birthday, unless they have a significant disability.
The amount that can be used to commence a death benefit pension for a child depends upon whether the parent had their own transfer balance account. The deceased will have a transfer balance account if they ever had a pension account after 30 June 2017, even if they did not have a pension account at the date of their death.
When the pension ceases (generally when the child turns 25 or the assets backing the pension are exhausted), the child’s transfer balance account is deleted. This ensures that if an individual received a death benefit pension as a child it does not impact their ability to start a pension when they retire.
If the parent does not have a transfer balance account, the child will be subject to the general transfer balance cap, with the amount pro-rated on the proportion of the super benefit they are to receive.
For example, if they are entitled to 50 per cent of the deceased’s super death benefit, their cap will be 50 per cent of the transfer balance cap in force at the time (which would currently be $800,000).
Case study – Sharon and her children
Sharon is a single parent with two children age six and eight. She has an accumulation account with a balance of $400,000 and life insurance totalling $3 million. She has binding death benefit nominations to her two children in equal shares. Sharon has never started a pension so she does not have a transfer balance account.
If Sharon dies, her total super death benefit will be paid 50 per cent to each child ($1.7 million each). Before 1 July 2017, each child could have received $1.7 million as a death benefit pension. However, from 1 July 2017, each child is limited to a death benefit pension of $800,000 (half of the $1.6 million cap). The remaining $900,000 each must leave the super system as a lump sum payment.
It suits Sharon’s plans for each of her children to have $800,000 as a death benefit pension but she does not want them to have access to the additional $900,000 until they are 25. Sharon changes her death benefit nomination to direct the $900,000 each to her estate and establishes a testamentary trust for each child via her Will.
If the parent has a transfer balance account, the cap for the child is the value of the pension on the date of the parent’s death (pro-rated based on their interest in the parent’s pension).
It is important to understand that the test is to determine whether a transfer balance account exists, not whether there are any active retirement phase pensions at the time of the parent’s death.
If the parent had a retirement phase pension at any stage since 30 June 2017 but had no retirement phase pension at the date of their death, then the child could not have any benefit paid as a death benefit pension – the entire benefit must leave the super system. Generally, this will only be of significant impact to clients who have had children much later in life, however, there may be planning implications for clients who established a super disability pension early in life.
Case study – Darren and his children
Darren is a single parent who has two minor children. He has a pension account with a balance of $800,000 and an accumulation account with a balance of $400,000. Darren has binding nominations to his two children in equal shares.
If Darren dies his total super death benefit will be paid 50 per cent to each child ($600,000 each). Before 1 July 2017, each child could receive $600,000 as a death benefit pension. However, from 1 July 2017, each child will be limited to a death benefit pension of $400,000 (half of Darren’s pension account). The remaining $200,000 each must leave the super system as a lump sum payment.
Provided that the super fund rules allow, a death benefit can be paid to a spouse as a pension from either an accumulation account or a pension account. If the death benefit is paid from a pension account, it can be reversionary or non-reversionary and the transfer balance cap treatment of the death benefit pension differs for each.
A reversionary pension is the automatic transfer of an existing pension to a reversionary beneficiary (generally a spouse) upon the death of the primary pensioner. There is no ability for the trustee to exercise any discretion regarding the commencement of the pension to the reversionary beneficiary.
Reversionary death benefit pensions are included as transfer balance credits for the reversionary pensioner. The transfer balance credit does not take effect until 12 months from the date of reversion (the date of death of the member) and the value that is credited to the reversionary beneficiaries transfer balance account is the value of the account as at the date of the member’s death. Subsequent commutations from the death benefit income stream will create transfer balance debits at the time of the commutation.
This gives the reversionary beneficiary time to consider the best way to manage their total super within the transfer balance cap and may involve commuting some of their own pension back to accumulation phase and/or making a lump sum payment.
A non-reversionary death benefit pension is a new pension paid to a nominated beneficiary after the death of a member. It can be paid from an accumulation account or a non-reversionary pension. The nominated beneficiary requests to receive the death benefit as a pension.
Non-reversionary death benefit pensions are included as a transfer balance credit when the death benefit pension commences, based on the balance used to commence the new death benefit pension.
The 12-month grace period has drawn much attention as to whether pensions should be commenced as reversionary or not and whether existing non-reversionary pensions should be made reversionary. There are several issues to consider around this piece of advice, including:
It is generally accepted that if the fund rules allow, an account-based pension may change from reversionary to non-reversionary and vice versa. In retail funds, an account-based pension is usually issued as a contract, meaning the fund rules don’t allow a change. If it is desired to make an existing non-reversionary retail pension reversionary then the existing pension must be commuted and a new pension commenced.
However, many self-managed super fund (SMSF) trust deeds and pension rules do allow a change from non-reversionary to reversionary and vice versa without the need to restart the pension.
From 1 January 2015, account-based pensions are treated as a financial asset and are subject to Centrelink deeming rules. However, account-based pension that were established before 1 January 2015 may be subject to grandfathering which means the amount included as income is the purchase price of the pension (less commutations) divided by the longer of the pensioner’s life expectancy, or the reversionary pensioner’s life expectancy.
If changing a pension from non-reversionary to reversionary results in a new pension being created, then any Centrelink grandfathering is lost.
If the pension is reversionary then the full amount of the deceased’s pension account can earn tax-exempt investment returns for 12 months. If the pension is non-reversionary then the tax-exempt investment returns only continue until the pension commences, so long as the pension is commenced as soon as practicable.
If the trust deed allows flexibility regarding the payment type, a pension still cannot commence until it is requested by the beneficiary. Accordingly, although a beneficiary won’t have the full 12-month grace period, they will have time to ensure that they do not have an excess transfer balance. It is quite possible that there will be members who end up with excess transfer balance issues because the pension automatically reverts at the date of death and they forget to organise their transfer balance issues by the end of the 12-month period. Conversely, if beneficiaries have to deal with any transfer balance issues when they are organising the death benefit payment they are likely to obtain advice and take the correct action all at the same time.
Case study – Sharon and Darren
Sharon and Darren each have $1 million in a retirement phase pension. Darren dies on 1 December 2017 and 100 per cent of his benefit will be paid to Sharon. Sharon can only have $1.6 million in retirement phase.
If Darren’s pension is reversionary then the full $1 million pension can continue to earn tax-exempt income until 1 December 2018. By this time, Sharon must either commute $400,000 of her pension back to accumulation phase or withdraw $400,000 from either her pension or the death benefit pension.
If Darren’s pension is non-reversionary then the full $1 million pension can only continue to earn tax-exempt income until the benefit starts being paid to Sharon and the benefit must be paid as soon as practicable. By this time, Sharon must either commute $400,000 of her pension back to accumulation phase or withdraw $400,000 from either her pension or the death benefit pension.
Although the reversionary pension will earn tax-exempt income on $400,000 for additional months, there is a risk that Sharon will forget to make the $400,000 commutation by 1 December 2018 and thus incur excess transfer balance tax.
It is essential that people with large super death benefits review their estate plans to ensure that they understand any benefits above the transfer balance cap will be forced out of the super system.
If this is likely to occur it is important to ensure that the amounts are directed to structures that can be controlled, such as testamentary trusts established via a Will.
Professional estate planning advice can provide clients with peace-of-mind that their super death benefits will be distributed to beneficiaries as per their wishes in the most tax-effective way.
For more information, please contact call a member of our Estate Planning Team on 1800 882 218.