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How to preserve estate money in super

The introduction of the biggest tranche of change in the super rules in a decade will impact the estate plans for many. The changes will affect the amount of a deceased spouse’s super that a surviving spouse can retain in super and the ability to transfer a death benefit pension to another super fund.

In the first of two articles, we will focus on the effect of the transfer balance cap (TBC) on the ability to pay a death benefit as a pension to a surviving spouse.

What happens to a member’s benefit on death?

From a superannuation perspective, the death of a fund member is known as a ‘compulsory cashing event’. The deceased member’s benefit must be ‘cashed’ to a dependent, as defined under the superannuation law, as soon as practical, either as a lump sum or as a pension or a combination (although there are some restrictions on paying a death benefit as a pension).

Who can receive a death benefit pension?

Usually, only a surviving spouse is entitled to receive a death benefit pension. However, a child of the deceased can also be paid a death benefit pension, provided they are under age 18 or aged 18 to 24 and ‘financially dependent’ on the deceased parent. Once a child turns 25, any residual capital balance of the death benefit pension must be paid to them, unless they are ‘disabled’, as defined under the Disability Services Act 1986, then the pension can continue. According to the ATO, there are not many death benefit pensions being paid to children.

What are the changes on 1 July 2017 to death benefit pensions?

Firstly, where a person receives a pension due to the death of their spouse, the value of the pension will count towards their TBC. On 1 July 2017, everyone in retirement phase starts with a TBC of $1.6 million. In effect, the TBC restricts the amount of a deceased member’s benefits that can be retained inside superannuation and paid to the surviving spouse as a pension or income stream. Currently, there is no limit.

What if the death benefit pension breaches the TBC?

If a person exceeds their TBC, the ATO will issue a notice advising of the excess, which will also include an amount of ‘notional earnings’, calculated based on the 90-day bank bill rate plus 7% (for example, it would have been 9.2% for 2015/16). The amount above the surviving spouse’s TBC plus the ‘notional earnings’ must be removed from the death benefit pension account by way of a lump-sum benefit payment, that is, removed from superannuation.

Alternatively, if the surviving spouse has their own pension, they can partially commute it and they have the option of transferring the amount to their accumulation account or withdrawing it from superannuation as a lump sum. Income generated by the partially commuted amount, as part of the accumulation account, will be subject to 15% fund income tax.  However, it will not have been forced out of the superannuation fund. Further, the ‘notional earnings’ amount will be assessable to the surviving spouse and taxed. For a first-time breach of the TBC, the applicable rate is 15%, for a second and subsequent breach, the rate is 30%.

Is there a different treatment for reversionary and non-reversionary pensions?

A reversionary pension is one where a person receives an automatically reverted pension due to the death of a spouse who had already been in receipt of the pension at the time of their passing. There are two points to note about the assessment towards the surviving spouse’s TBC:

  • The value of the deceased member’s pension at the time of their death will be the amount that is applied to the surviving spouse’s TBC, and
  • It will not be applied against the surviving spouse’s TBC until 12 months after the death of the member.

This provides time for the surviving spouse to ascertain whether they have exceeded their TBC due to the death benefit pension and take appropriate action.

Reversionary pension on death and TBC example

Don and Hillary are members of their SMSF. Both are retired and have each commenced account based pensions. Each pension was established as reversionary to each other in the event of their death. The value of their pensions at 30 June 2017 are:

Don      $1,250,000

Hillary   $1,400,000

Soon after 30 June 2017, Don dies and his pension automatically reverts to Hillary. At the time of Don’s passing his pension had the same value of $1,250,000. This will be the amount that will be a credit to Hillary’s transfer balance account 12 months after Don’s death and will count towards her TBC.

Hillary has already used $1.4 million of her $1.6 million TBC when she commenced her own pension and at the time did not think she would have a TBC issue. However, if Hillary takes no action, in 12 months there will be a credit of $1,250,000 in her TBC account, taking her to $2,650,000, exceeding her TBC by $1,050,000. The ATO will issue Hillary with a notice requiring her to remove the excessive amount from her pensions, together with an amount of ‘notional earnings’, that the ATO has calculated. For Hillary, as a first offence for exceeding her TBC, she will pay tax of 15% of the ‘notional earnings’ amount.

Within 12 months of Don’s death, Hillary has the following options to avoid exceeding her TBC:

Option 1 — partially commute Don’s pension

Take a lump-sum death benefit payment of $1,050,000 from Don’s pension (partial commutation). As Hillary was Don’s spouse, she will pay no tax on the lump-sum death benefit payment. She will retain the remaining balance of Don’s pension in the SMSF and receive pension payments, along with her continuing pension.

A year after Don’s death, a credit of $1,250,000 will arise in Hillary’s transfer balance account, together with a debit of $1,050,000 (the partial commutation of Don’s reversionary pension), resulting in a net increase to Hillary’s transfer balance account of $200,000. No excess will arise.

However, this means that Hillary has been forced to remove $1,050,000 from the superannuation environment, where income is taxed at no more than 15%. Being outside superannuation, income will be subject to the applicable tax rate, depending on which tax structure Hillary uses.

Option 2 – partially commute her own pension

Instead of commuting Don’s pension, which requires the commuted amount to be withdrawn from superannuation, Hillary could partially commute her own pension to the extent of $1,050,000. As this is her own pension, she would not be required to remove it from superannuation, but retain it in an accumulation account in her name. This partial commutation of her own pension would also result in a debit to her transfer balance account, reducing her transfer balance account balance from $1.4 million to $350,000.

Hillary retains all of Don’s pension, which reverted to her on his death. A year after his death, a credit of $1,250,000 arises in Hillary’s transfer balance account, increasing her balance to $1.6 million but not in excess.

Again, income earned from Hillary’s accumulation account will be subject to fund 15% tax, while income earned on her pension account and Don’s reversionary pension will be tax-exempt. However, under this option, Hillary has retained all of her and Don’s retirement capital inside of superannuation with a maximum tax rate of 15% on the accumulation account.

Revision of estate plans for superannuation

Although the introduction of the TBC did not initially affect Don and Hillary as they were both under the $1.6 million cap, upon the death of Don, Hillary had to deal with a potential excess-TBC issue. This leads to a review of estate planning for couples where their combined superannuation is more than the TBC, as the original plan may no longer be able to be followed due to the restriction of the TBC. So, dust off the wills, pension documents and death benefit nominations, and see if any changes are required to ensure that your estate plan can still be implemented under the new rules.

In our next article, we discuss the changes to the ability to transfer a death benefit pension to another superannuation fund.

 

Mark Ellem is Executive Manager, SMSF Technical Services at SuperConcepts, a leading provider of innovative SMSF services, training and administration. This article is for general information only and does not consider the circumstances of any individual.

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