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Most retired couples plan to leave the bulk of their estate to their surviving spouse, which sounds straightforward. But where super is concerned, nothing is ever simple.
If you’re both retired and drawing a pension from your super, inheriting your partner’s super could have complex tax implications if you’re not careful.
Mapping out some possible scenarios and strategies now could save a lot of worry at what will already be a difficult time of life.
So, what are your options?
Pension or lump sum
The starting point is whether you stand to receive the balance of your partner’s super as a lump sum or as a reversionary pension.
SMSFs and some public offer super funds allow members to nominate a reversionary beneficiary. This means you can automatically continue to receive their pension when they die.
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For more information, read the SuperGuide article Reversionary pensions: what they are and how they work.
The main benefit is that their death benefits will not leave the tax-free super environment. Whereas, if it’s paid out to you as a lump sum you may not be eligible to contribute it back into super due to contribution limits.
If you invest the lump sum outside super in your own name, you will potentially be liable for tax on any income and capital gains you receive.
Importantly, if you do receive death benefits as a pension you can still take all or part of it as a lump sum if you need the cash.
What about the Transfer Balance Cap?
The next potential hurdle is the Transfer Balance Cap (TBC). From 1 July 2017 you can’t have more than $1.6 million in retirement phase super pensions (although they can grow through investments earnings without restrictions).
This poses a challenge for reversionary pensions if receiving your partner’s account-based pension after their death would push your combined pension account balance above $1.6 million.
Let’s look at one example:
Angela has $1 million in an account-based pension when her partner Greg dies on 1 July 2019 leaving her a reversionary pension worth $800,000. If Angela starts a Death Benefit Pension with the entire proceeds of Greg’s super her Transfer Balance Account balance will be $1.8 million, $200,000 above the $1.6 million Transfer Balance Cap.
Angela will need to remove the excess from her retirement phase account. She will also have to pay 15% tax on the notional tax on the excess amount.
The good news is that the Government allows a 12-month period from the date of your partner’s death before their reversionary death benefits are counted towards your account balance. This recognises the fact that it can take time to get your finances in order after the death of your partner.
What are your options?
To avoid paying unnecessary tax, it’s important to work out if your partner’s super is likely to push you over the $1.6 million Transfer Balance Cap and by how much.
If you do this before you start a Death Benefit Pension with your partner’s super, you will increase your options.
Here are three potential strategies:
Transfer some or all your pension account balance back into a super accumulation account, creating enough cap space to start the Death Benefit Pension in your pension account.
The amount rolled back into your accumulation account will be taxed at up to 15%. But the advantages of this strategy are that it allows you to maximise the amount you have in your tax-free super pension and avoids the need to sell assets supporting your partner’s super death benefits when you withdraw them from super as a lump sum.
The one proviso is, that your existing super pension must be ‘commutable’. A commutable pension is one that can be withdrawn or rolled out of your pension account. Most account-based pensions can be rolled back in this way, but if you have a defined benefit pension it may not be allowed, so you will need to check with your fund.
Using the example of Angela above, if her existing $1 million pension is commutable, she can roll back $200,000 into a super accumulation account, leaving her with an account balance of $800,000. She then has space for the full amount of Greg’s $800,000 death benefits.
If Angela’s existing pension is non-commutable, this option isn’t available.
Start a Death Benefit Pension with part of your partner’s death benefits and pay out any excess above the combined $1.6 million cap as a lump sum.
If your existing pension is non-commutable, this may be your best option. As super death benefits can’t be retained in super unless they form part of a Death Benefit Pension, any excess will have to be paid to you as a lump sum outside super.
For example, if Angela’s $1 million pension is non-commutable, she can start a Death Benefit Pension with $600,000 of Greg’s $800,000 death benefits, but the excess $200,000 will have to be withdrawn from super as a lump sum immediately.
If Angela and Greg have an SMSF, assets supporting Greg’s death benefits may need to be sold, and that may have potential tax consequences.
Withdraw all your partner’s death benefits out of super as a lump sum.
If you’ve reached the Transfer Balance Cap and your super pension is non-commutable, this is your only option.
This is not necessary for Angela, even if her existing $1 million pension is non-commutable. But if, for whatever reason, you would prefer to receive your partner’s death benefits as a lump sum rather than use it as a pension, then you need to be aware of the tax consequences.
Plan to secure your partner’s future
Whatever your financial circumstances, losing your partner will inevitably trigger some complex financial decisions that need to be made at a very emotional time. By acting hastily, you risk losing a chunk of your retirement income in unnecessary tax, so it’s always better to have thought through what you would do in such a scenario.
If you do lose your partner, contact your super fund or your SMSF service provider as soon as possible to work through your options.
It’s also a good idea to seek independent financial advice from a retirement expert due to the tax and timing complexities around reversionary pension strategies.
Ideally, you and your partner should seek advice while you’re both still fit and healthy, to work through your estate planning options. Then keep updating your plans as your personal and financial circumstances change.
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