Good news! Pension earnings remain tax-free after death

Congratulations to the Federal Government for applying common sense when dealing with death benefits paid to beneficiaries from a superannuation pension account. The Government, in its 2012/2013 Mid-year Economic and Financial Outlook, has confirmed that investment earnings derived by superannuation funds on assets supporting pensions remain exempt from tax, even when there is no reversionary pension recipient.

The pension earnings tax exemption will continue following the death of a pension recipient until the deceased member’s benefits have been paid out of the fund, provided the benefits of the deceased member are paid out as soon as practicable.

Regular readers of SuperGuide, especially those readers who run a self-managed super fund, would be familiar with the recent coverage on this website regarding a draft ATO ruling on the tax status of pension account earnings when the remaining fund member dies.

The view published in the ATO draft ruling (TR 2011/D3) essentially said, that when a pension member dies, and he or she has not arranged for a reversionary beneficiary, the pension account reverts to accumulation phase. What this means for the family of the deceased is that when the fund assets are sold, any capital gains are subject to tax before the proceeds can be paid out as death benefits to beneficiaries. Alarmingly, the ATO wanted to make this interpretation of the rules retrospective to 1 July 2007.

Warning: The Government has only said that the tax exemption on pension earnings where the pension recipient has died and there is no reversionary beneficiary, will apply from 1 July 2012 and into the future. The Government has not dealt with the ATO’s earlier statements that the pension earnings would be taxed from 1 July 2007. We still have 5 years of uncertainty for family members of deceased fund members.

In an earlier SuperGuide article, I expressed the following opinion on the ATO’s position:

I personally think the current view taken by the ATO is ridiculous, and inconsistent with the principles behind offering superannuation pensions. Death benefits are by definition within the sole purpose test, and form an integral component of the superannuation system. I strongly disagree that ‘when a member dies they no longer have an entitlement to receive superannuation income stream benefits’. Payments to superannuation dependants (including non-dependants for tax purposes) are simply an extension of the pension benefit. Hopefully, some legal eagle within the super industry will successfully argue that the pension account continues (and accordingly the tax-exempt status of the pension account) until a death benefit is paid from the account…

I trust the ATO will now respond publicly to clarify its position on the tax status of pension account earnings from 1 July 2007 to 30 June 2012, after the fund member dies and there is no reversionary beneficiary.

For further explanation of how death benefits are treated including background to this issue, check out the following SuperGuide articles:

• SMSF pensions: Watch out for a shock (ing) tax bill on fund assets
• Estate planning: Beware the dastardly death tax
• Estate planning: Dear Dad, Tax for everything
• How can a SMSF live forever?