By Mark Ellem
The new super reforms will impact the estate plans for many. Included are changes to how much a surviving spouse can retain in super of their deceased spouse’s entitlement, and the ability to transfer a death benefit pension to another superannuation 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.
Under superannuation law, the death of a fund member is what is known as a ‘compulsory cashing event’. This means that the deceased member’s benefit must be ‘cashed’ to a ‘dependent’, as defined under the law.
Further, a deceased member’s superannuation can be cashed either as a lump sum or as a pension, or a combination of the two. However, there are restrictions on paying a death benefit as a pension.
Generally, 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 were ‘financially dependant’ on the deceased parent, at the time of the parent’s death. Once a child turns 25, any balance of the death benefit pension must be paid to them, unless they are ‘disabled’, as defined under the Disability Services Act 1986. According to the ATO, there are not many child death benefit pensions. One reason for this may be the requirement for the child to be paid the residual capital of the death benefit pension, when they turn 25 (unless a disabled child).
Firstly, where a person receives a pension due to the death of their spouse, the value of the pension will count towards their TBC. In effect, from 1 July 2017, the TBC restricts the amount of a deceased member’s benefits that can be retained inside of superannuation and paid to the surviving spouse as a pension or income stream. Prior to the 1 July 2017 changes there was no limit.
If a person exceeds their TBC, the ATO will issue a notice advising of such, which will also include an amount of ‘notional earnings’, calculated based on the 90 day Bank Bill rate, plus 7 percentage points. The amount above the surviving spouse’s TBC, plus the ‘notional earnings’, must be removed from the death benefit pension 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, which is a transfer of an amount from their pension account to an accumulation account. Income generated by the partially commuted amount, as part of the accumulation account, will be subject to 15% fund income tax. However, it will have been retained within the superannuation system.
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%.
Yes. A member of a superannuation fund can establish a pension with an automatic reversion of that pension to their spouse, upon their death. Effectively, the pension will continue to the surviving spouse, when the original member dies. For these pensions, known as a ‘reversionary pension’, there are two points to note about the assessment towards the surviving spouse’s TBC:
This provides time for the surviving spouse to ascertain whether they have exceeded their TBC, due to the automatic reversion of their deceased spouse’s pension and take appropriate action.
Don and Hillary are members of their SMSF. Both are retired and have each previously commenced account-based pensions. Each pension was established with an automatic reversion to spouse, in the event of their death. The value of their pensions at 30 June 2017 were as follows:
As each of them were under the TBC of $1.6m, they were not required to commute any part of their respective pensions, prior to 1 July 2017.
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 passing and will count towards her TBC.
Hillary has already used $1.4m of her $1.6m TBC, her pension balance at 30 June 2017. Hillary would not have envisaged having a TBC issue any time soon. However, as a result of Don’s death and his pension reverting to her, if Hillary takes no action, in 12 months there will be a credit of $1,250,000 in Hillary’s transfer balance account. This will take her transfer balance account balance to $2,650,000, exceeding the $1.6m TBC by $1,050,00. Consequently, 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.
However, Hillary has the following options to avoid exceeding her TBC, provided one of the options is acted upon before the end of 12 months after Don’s death:
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. Retain the remaining balance of Don’s pension in the SMSF and continue to receive pension payments, along with her original pension.
Twelve months 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, meaning she has used $1.6m of her $1.6m TBC. Importantly, no excess.
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 of superannuation, income will be subject to the applicable tax rate, depending on which tax structure Hillary uses. Of course, Hillary has the use of the tax-free threshold where she invests in her own name, assuming no other assessable income.
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 can 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 $1.4m to $350,000.
Hillary retains all of Don’s pension, which reverted to her on his death. Twelve months after his death, a credit of $1,250,000 arises in Hillary’s transfer balance account, increasing her balance to $1.6m, equal to her TBC, but importantly, no excessive amount.
Again, income earned from Hillary’s accumulation account will be subject to fund 15% tax, whilst 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.
Whilst the introduction of the TBC did not initially affect Don and Hillary, as they were both under the $1.6m cap, upon the death of Don, Hillary had to deal with a potential excessive TBC issue. This leads to a review of estate planning for couples where their combined superannuation is more than 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.
