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When you finish working, there are lots of decisions to make about your super savings to create an income that will fund your retirement years. This includes deciding whether to take a lump sum, start a regular income stream or a mix of both.
If you start a super income stream (such as an account-based pension), some super funds give you the option to nominate a beneficiary who will automatically receive your super pension when you die.
These reversionary pensions can be an easy way to provide financially for your spouse after your death, but it’s important to understand the rules before making a decision.
What is a reversionary pension?
Generally, if you are receiving a superannuation income stream or pension, it ceases as soon as you die, and the remaining balance is distributed to the beneficiary you nominated in your death benefit nomination.
Some super funds, however, give their fund members an additional option. They allow you to nominate a reversionary beneficiary who automatically becomes entitled to receive your super pension on your death. A reversionary nomination makes it clear to the trustee of your super fund who you want to continue receiving your super pension if you die.
With a reversionary pension, your existing super pension continues to be paid, but it reverts to your beneficiary. Provided your intended beneficiary is an eligible death benefit dependant at the time of your death, they will start receiving your pension immediately.
Who are my death benefit beneficiaries?
For a reversionary pension nomination to be valid, only someone classed as your death benefit dependant under superannuation law can be nominated.
This means at the date of your death your reversionary beneficiary must be:
- Your spouse (including same sex)
- Your child under age 18
- Your child who is permanently disabled
- Your child aged under 25 who is financially dependent on you immediately before your death
- Someone with whom you are in an interdependency relationship.
Under super law, you are considered to be in an interdependency relationship if you and the other person live together, have a close personal relationship, and one or both of you provide for the financial and domestic support and personal care of the other. For more on dependants under super law, see the ATO website here.
Pros and cons of a reversionary pension
- Payment certainty – Nominating a reversionary pensioner gives you a level of certainty that the person you want to receive your super benefit will get it when you die, as it’s not up to the super fund’s trustee to decide on the beneficiary.
- Rapid payments – With a reversionary pension, your beneficiary receives immediate access to the cash flow from your pension, which can be helpful at a difficult time.
- No pressure to decide – This type of nomination means your beneficiary is not required to decide about complex financial matters immediately after your death.
- Tax advantages – Generally, a super pension is tax free or concessionally taxed (depending on your age and the age of your beneficiary), so there can be tax benefits for your reversionary beneficiary.
- Assets remain in the super system – With a reversionary pension, the assets supporting the pension payments remain within the beneficial tax environment of the super system. If the death benefit is paid as a lump sum, your beneficiary may be unable to recontribute the money back into the super system.
- Tax components preserved – When a reversionary pension reverts to the reversionary beneficiary, the taxable and tax-free components calculated when the pension first commenced are preserved.
- Easy legal transfer – Reversionary pensions usually transfer seamlessly to the beneficiary and are rarely challenged.
- Nomination must be at commencement – Generally, you can only make a reversionary nomination when you start a super pension. Once a super pension has commenced, you may need to stop (commute) and restart it if you want to nominate a reversionary beneficiary.
- Potential impact on social security benefits – Receiving a reversionary pension may have an impact on your beneficiary’s social security benefits. A death benefit income stream may be assessed under the Age Pension means testing rules. For more information about income streams, visit the Services Australia website.
- Counts towards the Transfer Balance Cap (TBC) – Value of a reversionary pension will be counted towards your beneficiary’s TBC (see section below).
- No lump sum – Reversionary pensions do not provide a lump sum if the reversionary beneficiary needs to pay off debts. A reversionary pension can, however, be commuted into a lump sum if required.
- Changed circumstances – Reversionary pensions create problems if you divorce or separate from your intended reversionary beneficiary. In this situation you need to commute the pension and commence a new pension with a different nominated beneficiary.
- Invalid nomination – If your nominated reversionary beneficiary is not a death benefit dependant at the time of your death (or if they have died), your nomination will be invalid, and the fund trustee will use its discretion when paying out the balance of your super pension account.
- Limited beneficiaries – Reversionary pensions can only have a single beneficiary, so if you have multiple beneficiaries, you may need to have multiple pensions or use a BDBN.
Reversionary pensions and the Transfer Balance Cap
There is a $1.7 million cap on the amount you can transfer and hold tax-free in the retirement or pension phase. (From 1 July 2017 to 30 June 2021 the TBC was $1.6 million.)
This cap also applies to reversionary pensions, so if a dependant beneficiary becomes entitled to this type of pension, they need to ensure it does not take their retirement phase super assets over the $1.7 million cap.
To allow reversionary beneficiaries time to get their super assets in order and avoid breaching their TBC, the value of a reversionary pension is not added to the beneficiary’s transfer balance account until 12 months after the fund member’s death.
This means if you’re the beneficiary of a reversionary pension, you need to be careful that it will not take you over your $1.7 million cap. For some people, this may mean they need to commute the reversionary pension and take it as a lump sum instead.
Reversionary pension vs binding death benefit nomination
One of the key benefits of a reversionary pension is the automatic nature of the change in recipient, with the fund trustee not required to make a decision about the benefit other than confirming your nomination.
Reversionary pensions are rarely challenged by other potential beneficiaries and most legal experts see them as taking precedence over a BDBN.
BDBNs on the other hand, are sometimes challenged in court. If they are not executed properly (such as being witnessed correctly), they can be overturned in favour of other beneficiaries.
In some situations, the flexibility provided by a BDBN can allow the fund trustee to distribute your death benefit in a more beneficial way for your beneficiary, but there is not the same level of certainty as a reversionary pension nomination.
SMSFs and reversionary pensions
When you apply to commence an income stream or pension with a retail or industry super fund, you should check the details on the application form to see if you are permitted to nominate a reversionary beneficiary. Not all retail and industry funds permit this type of nomination. (Some annuities and newer longevity products permit reversionary pensions for a surviving spouse for an additional cost.)
It’s also important to do your research if you are a member of an SMSF. You need to check the trust deed and governing rules of your fund to determine what options are permitted when it comes to the payment of death benefits and whether you can nominate a reversionary beneficiary.
Another detail to check is whether a reversionary pension nomination will be given priority over a BDBN by the fund trustee, as not all SMSF trust deeds and governing rules make this explicit. A good trust deed should ensure your reversionary death benefit nomination is valid, effective and cannot be ignored or overruled by the fund trustee after your death.