Death and Pensions: An introduction
Superannuation funds are generally exempt from tax on income and capital gains derived from assets which are used to fund pension liabilities that are currently payable. Superannuation interests subject to this rule are treated as being in pension phase or subject to a pension exemption.
Recent changes to the superannuation rules have capped the amount of superannuation interests that can access the pension exemption to $1.6 million (i.e. the pension transfer balance cap).
Generally, a superannuation income stream/pension ceases as soon as a person in receipt of the pension dies. This is the case unless a dependant beneficiary of the deceased person is automatically entitled, under the governing rules of the superannuation fund or the rules of the income stream to receive a pension on the death of the person (i.e. a reversionary pension).
If a dependant beneficiary is entitled to receive a reversionary pension upon the person’s death, the superannuation income stream/pension is taken to continue and the pension exemption continues to be available to the superannuation fund.
David is a member of the EFG Superannuation Fund and has been married to Aggie for 20 years. The governing rules of the EFG Superannuation Fund provide that if David is in receipt of a superannuation income stream/pension at the time of his death, the income stream will continue to be paid to his spouse, provided that the person had been David’s spouse for at least three years prior to his death.
David commences to receive a superannuation income stream on 1 July 2018, but David dies on 1 September 2018.
Aggie is automatically entitled to receive (and does receive) superannuation income stream benefits under the governing rules of the superannuation fund. There is, therefore, a continuing liability to make payments under that superannuation income stream.
In these circumstances, there is no cessation of the superannuation income stream/pension.
Moreover, the death of a member of a superannuation fund results in what is known as a compulsory cashing event. This means that the deceased’s benefit must be ‘’cashed” or paid to a beneficiary as soon as practicable after the date of death. The law generally does not allow the deceased’s benefits to be retained in the superannuation fund.
Where a reversionary pension is paid to a dependant beneficiary the deceased’s superannuation benefits can be retained in the superannuation fund.
Recent amendments to the superannuation regulations allow a superannuation fund continued access to the pension exemption even where a pension has ceased because of the death of the recipient. The regulations provide that the super fund will be treated as being in pension phase until the death benefits are cashed provided the benefits are paid as soon as practicable following the deceased’s death.
Unfortunately, the Australian Taxation Office has not provided detailed guidance on the meaning of the words ‘as soon as practicable’. Generally, determining whether a benefit has been cashed as soon as practicable after a person dies will be an objective question of fact to be determined in light of the individual circumstances of each case.
Arthur was a member of a complying superannuation fund who was receiving a superannuation income stream/pension immediately before his death on 1 September 2018.
The pension did not automatically revert to another person on Arthur’s death and no amounts (other than investment earnings) were added on or after his death to the superannuation interest that was supporting the pension.
The trustee of the fund determined that the entire value of the deceased’s benefit would be paid to the deceased’s widow as a lump sum. On 20 December 2018, which was in the circumstances as soon as practicable after Arthur’s death, a single lump sum of $100,000 was paid to the widow using only an amount from the relevant superannuation interest.
For the purposes of the pension exemption, the $100,000 will be taken to be a pension benefit that was payable from 1 September 2018 until 20 December 2018.
Generally, a pension will be a reversionary pension if the pension reverts to the reversionary beneficiary automatically upon the original recipient’s death. That is, the pension continues with the entitlement to it passing from one person (the original recipient) to another (the dependant beneficiary).
‘Automatic’ means that the entitlement to the pension passes immediately upon the member’s death to the beneficiary. Ordinarily, a pension reverts automatically because the rules of the fund or the agreement/standards under which the pension is provided expressly provide for reversion.
It should be noted that only death benefits dependants can be nominated as reversionary beneficiaries. A death benefits dependant is:
- a spouse or former spouse — broadly, including a de facto spouse, same-sex spouse or person in a registered relationship;
- a child of the deceased under 18 years of age — broadly, including an adopted child, step?child or ex-nuptial child and child of the individual’s spouse;
- any other person with whom the deceased had an interdependency relationship; or
- any other person who was a dependant — a dependant has been held to mean any person who is financially dependent, such as a full time student who is over 18 or an infirm parent.
A significant benefit of a reversionary pension is that an eligible beneficiary can gain immediate access to the deceased’s superannuation benefits. In addition, if the pension was tax free in the hands of the original recipient because they were over the age of 60 at the time they received the pension, the pension will generally be tax free in the hands of the reversionary beneficiary for the term of their life regardless of their age.
This is illustrated in the following example.
Liz and Larry are married. Liz (aged 70) is considerably older than Larry (aged 35) as Larry is Liz’s second husband. Liz has left the majority of her substantial estate to Larry in her will.
Unfortunately, Liz expects that her ex-husband Richard and their children are likely to contest the will as they are not fond of Larry.
Expecting a long drawn out court battle before probate is granted, Liz takes a reversionary income stream from her superannuation fund during her life which will automatically revert to Larry upon her death. In the event of her death, Larry will automatically receive the next payment from Liz’s pension, despite her passing, allowing him to continue to meet general living expenses in the difficult period following Liz’s death.
In addition, the pension should be tax free when received by Larry as Liz was over the age of 60 at the time of her death.
In certain circumstances, a dependant beneficiary may commute a reversionary pension. Commutation is defined as giving up part or all of the pension payable in exchange for an immediate lump sum.
Where the pension is paid to a dependant child who is less than 25 years old, the child will generally be required to commute the pension when they turn 25. An eligible dependant (e.g. a spouse) may also choose to voluntarily commute a reversionary pension.
The lump sum payable on commutation of the pension will generally be treated as a tax free superannuation death benefit provided the benefit is paid by the following times (whichever is the later):
- within six months of the date of death; or
- three months after the grant of probate or letters of administration; or
- if the payment of the benefit is delayed because of legal action about entitlement to the benefit — six months after the legal action ceases; or
- if there are reasonable delays identifying and making initial contact with potential recipients — six months after the process is completed.
If the benefit is paid outside of these time frames, the benefit will be treated as a superannuation member benefit rather than a death benefit.
A Transition to Retirement Income Stream (or TRIS) also ceases as soon as the person in receipt of the TRIS dies. A TRIS can also automatically revert to a dependant beneficiary provided the trust deed of the superannuation fund or the rules of the TRIS allow for such an event. However, the pension/income stream received by the dependant beneficiary will not be subject to the restrictions that ordinarily apply to a TRIS (i.e. the pension will be commutable and not subject to the maximum annual pension payment limit). This is because the death of the original recipient would have triggered a condition of release.
Reversionary pensions and the transfer balance cap
Prior to 1 July 2017, there was no limit on the amount in a superannuation fund that could be transferred into retirement/pension phase to take advantage of the tax exemption applying to earnings from assets supporting a pension. From 1 July 2017 onwards, a $1.6 million cap applies to the amount of capital that can be transferred to the retirement/pension phase of superannuation.
The cap limits the amount of capital that individuals can transfer to retirement phase to support pensions which in turn limits the pension exemption that can be obtained per individual. In essence, individuals are limited to a maximum of $1.6 million in pension phase, with the remainder being required to be retained in accumulation phase.
As discussed above, superannuation funds are generally exempt from tax on income and capital gains derived from assets which are in pension phase while income derived from assets in accumulation phase is generally taxed at 15%.
A crucial concept relevant to the transfer balance cap is ‘retirement phase’. That is, from 1 July 2017, the pension exemption is only available where a superannuation fund is in retirement phase. Broadly, a superannuation fund will be in retirement phase if an account-based pension (ABP) is payable by the fund.
However, the pension exemption is generally not available where the pension payable by the fund is a TRIS. That is, the superannuation fund will not be in retirement phase where the only pension payable by the fund is a TRIS where the recipient has not met a condition of release.
As noted above, the transfer balance cap is designed to limit the amount of capital that an individual can transfer to retirement phase. A personal transfer balance account and a personal transfer balance cap are created for an individual when they start to receive a superannuation income stream. That is, an individual’s ‘personal’ transfer balance cap is equal to the indexed general transfer balance cap applying for the financial year in which the individual first commences to receive an income stream/pension.
Similar to a bank account, individuals will have to maintain records of credits and debits to their transfer balance account to ensure that their transfer balance account does not exceed their transfer balance cap. An individual will breach their cap if their superannuation benefits in retirement phase exceed their transfer balance cap.
The receipt of a reversionary pension by a dependant beneficiary will have implications for the transfer balance account of the beneficiary. The entitlement to a reversionary pension will ordinarily result in a credit to the transfer balance account of the dependant beneficiary equal to the value of the interest at the time of the deceased death.
However, the general rules that apply for ordinary account based pensions are modified for reversionary pensions such that the credit to the reversionary beneficiary’s transfer balance account will be delayed until 12 months after the primary beneficiary’s death. This allows the reversionary beneficiary time to adjust their affairs before any adverse consequences arise, such as a breach of their transfer cap balance.
As noted above, the value of the primary beneficiary’s pension when they died will be credited to the reversionary beneficiary’s transfer balance account 12 months after death. This crediting may result in the reversionary beneficiary going over their transfer balance cap, if the beneficiary is in receipt of a pension(s) in their own right.
Therefore, if the combined value of the reversionary beneficiary’s own pension together with the primary beneficiary’s pension cause them to exceed their cap, they will need to work out which pension to commute. It should be noted that the reversionary beneficiary cannot commute the reversionary pension back to accumulation phase but must instead cash the pension out of the fund as soon as practicable.
John was receiving a pension supported by $1 million of assets at the time of his death at 1 August 2017. John’s wife, Heather, is the nominated reversionary beneficiary, with her own pension and personal transfer balance account with a current balance of $800,000.
How will the reversionary pension affect Heather’s transfer balance account?
The reversionary pension will be credited to Heather’s transfer balance account on 1 August 2018. Therefore, as it currently stands, this credit will result in her personal transfer account balance increasing to $1.8 million and, therefore, breaching her transfer balance cap.
What options are available for Heather?
Heather could undertake either of the following:
- She could fully commute either pension; or
- She can undertake a partial commutation for the potential excess amount of $200,000.
What are the consequences if Heather partially commutes her existing pension on 1 December 2017 and receives a superannuation lump sum of $200,000?
This will result in a debit to her pension transfer cap balance of $200,000 at that time. The $1 million credit in respect of the reversionary pension will arise on 1 February 2018. This will result in her personal transfer account balance increasing to $1.6 million, but will not result in her breaching her transfer balance cap.
Disclaimer: The contents of this article are for the purposes of providing general information only. Persons should seek appropriate advice from a licensed financial planner before undertaking any investments or strategies with respect to their superannuation interests.