Confusion still exists on a number of fronts regarding the cashing out of pensions upon the death of an SMSF member. Michael Hallinan explores the issue in the light of two recent ATO determinations.
On the death of a super fund member, the Superannuation Industry (Supervision) (SIS) Regulations require the death benefit to be cashed out as soon as practicable after the death of the member. Additionally, the SIS Regulations require, subject to one exception, the death benefit to be paid to or among the eligible beneficiaries of the deceased member. The eligible beneficiaries include the legal personal representative, spouse and children of the deceased member. The exception arises where no eligible beneficiary can be found. In this case, the trustee may allocate the benefit to an individual selected by the trustee.
The death benefit of a member is cashed out when it is paid as a lump sum to an eligible beneficiary or used to commence a pension from the fund for an eligible beneficiary.
However, if the eligible beneficiary is a child of the deceased member, cashing out by way of a pension from the fund is only permitted if:
- the child is under 18, or
- the child is aged 18 or over and under 25 and was financially dependent on the deceased, or
- the child is aged 18 or over and the child has a specified disability (defined by reference to the Disability Services Act 1986).
The regulations clearly state the date of the death of the member is the date at which the age of the child is to be determined. If the child is younger than 18 at the date of death, then the benefit paid to the child can be paid as a pension. It is irrelevant that the date on which the pension commences is after the child has turned 18. Similarly, if the child was financially dependent on the deceased at the date of death, it is irrelevant that the financial dependency has since ceased.
Generally, a child pension must cease by the time the child turns 25 and the pension account balance, if any, paid as a lump sum to the child. The child pension could terminate before the child turns 25 due either to the pension account being exhausted, because the pension has been commuted before the child turns 25 or because the terms of the pension specify a termination date that is before the child turns 25.
If the pension is commuted, whether before or at the age of 25, the lump sum will be tax-free if the child was younger than 18 at the date of the death of the member and is taxable otherwise. If the lump sum arising from the commutation is taxed, the taxable component of the lump sum will be taxed at the marginal tax rate of the child (but capped at 20 per cent) and the tax-free portion will not be taxed.
The recently released Australian Taxation Office (ATO) Taxation Determination 2013/12 confirms that if the child pension is commuted before or at age 25, the commutation lump sum will be tax-free if the child was under 18 at the date of death of the member. Consequently, the view that the commutation lump sum was only tax-free if commutation occurred on or before age 18 is not correct. It should be noted that, if the child had attained age 18 at the date of death, the commutation lump sum would still be tax-free if at the time of the commutation the child was permanently disabled.
Disablement child pensions
In general, child pensions can only be commenced if the child is under 18 at the time of the death of the member or has turned 18, but not 25, and was financially dependent on the member at the date of death. Also, child pensions must be commuted at the age of 25 if they have not previously been commuted or terminated by exhaustion.
Disablement child pensions have different commencement and termination requirements. If the child satisfies the relevant disablement requirement, then the pension can be commenced whether or not the child has turned 18. Further, if the child satisfies the relevant disablement requirement at age 25, then the compulsory commutation requirement does not apply and the pension can continue to be paid.
There are two interesting issues in relation to disablement child pensions: one has been resolved and the other remains unresolved. Additionally, the recently released determinations raise the further issues as to whether child pensions can be cashed out, rolled back or rolled over.
The relevant disablement requirement is that the child has a disability of the kind described in section 8(1) of the Disability Services Act 1986. The ATO has confirmed in SMSF Determination 2013/1 the trustee must reconsider whether the child satisfies the disablement requirement on turning 25. If the requirement is satisfied, the pension can, but need not, continue to be paid after the child has turned 25. If the requirement is not satisfied, then the pension must be commuted and the resulting lump sum paid to the child.
There are two interesting issues in relation to disablement child pensions: one has been resolved and the other remains unresolved. Additionally, the recently released determinations raise the further issues as to whether child pensions can be cashed out, rolled back or rolled over.
The first and resolved issue is that a child pension can be commenced as a non-disablement pension. However, if the child at age 25 satisfies the relevant disablement requirement, the pension need not then be commuted but can continue past age 25. The relevant point being whether commutation at age 25 is mandatory depends entirely upon the disablement status of the child at age 25 and the disablement status of the child at the date of death of the deceased member is not relevant.
The second and unresolved issue is whether a child pension can be paid to a child who has satisfied the relevant disablement requirement at the time of death of the member but was then aged 26 or older. If the two relevant SIS Regulations of 6.21(2A) and (2B) are read together, then it seems to be implicitly required that the child must not have turned 25 at the time of death of the deceased member. Consequently, it seems the answer to the second issue is that disablement child pensions can only be commenced if the child has not turned 25 at the date of the death of the member.
Can child pensions be cashed out?
Cashing out a pension involves converting a pension into a lump sum payment to the child. If the pension is completely stopped, then the payment to the child will be taxed as a superannuation lump sum. If the pension is only partially stopped, the payment to the child will only be taxed as a superannuation lump sum if the child has prior to the payment made an election that the payment be taxed as a superannuation lump sum. If no election has been made, the payment will be taxed as a pension payment.
Child pensions can be cashed out at any time and generally must be cashed out by the time the child turns 25. Child disablement pensions also can be cashed out at any time, but need not be cashed out at age 25 if the child satisfies the requisite disablement requirement.
Can child pensions be rolled back?
Rolling back a pension involves stopping the pension and returning the superannuation interest that supported the pension to the taxable side of the fund: in short, the pension is turned off.
Strangely, the SIS pension rules do not recognise child pensions: they are simply account-based pensions that are paid to a child of a deceased member. The requirement that non-disablement child pensions be commuted at age 25 is not set out in the SIS pension rules, but imposed by the payment standards.
As the SIS pension rules do not recognise child pensions, it may be suggested that child pensions can be rolled back as there are no rules against rolling back. However, this view overlooks the policy behind the cashing out of death benefits, that is, death benefits can only be retained in the superannuation system by being paid as a pension – sometimes that could be death benefit pensions.
To allow a child pension, or equally a pension payable to the spouse of a deceased member, to be rolled back undermines the policy of death benefits being cashed out. A technical argument to support the policy objective could be based on the view that rolling back a death benefit pension does not generate a rollover superannuation benefit. If so, the rolled back amount would not be exempt from the SIS contribution acceptance rules or from the superannuation caps and would be treated as a superannuation lump sum benefit received by the child member and then applied as a superannuation contribution.
Can child pensions be rolled over?
Rolling over a pension involves the commutation of the pension, transferring the resultant commutation lump sum to the accumulation side of the fund to constitute a discrete superannuation interest and then the transfer of that superannuation interest transfer as a transfer payment to another complying super fund. Once the other complying superannuation fund has received the benefit, the fund will then commence a pension with an initial pension balance equal to the transferred payment.
In short, a pension cannot be transferred, however, one pension can be stopped, an amount rolled over to another fund and a new pension commenced in the other fund. The old pension and the new pension are different pensions. The minimum pro-rata pension payment will have to be paid before the rollover benefit can be paid to the other fund. The other fund will have to determine the minimum pro-rata pension payment for the balance of the financial year and using the 4 per cent drawdown rate, unless the pension is a disablement pension and the transfer has occurred after the child turned 25 during the course of the current financial year.
However, there is a possibility that the tax-free percentage of the pension in the new fund may be different from the percentage that applied in the old fund. This will occur if the child member had an accumulation account in the old fund and the commutation amount merged with the accumulation account. Even if the child member has no accumulation account, the period between stopping the pension and the payment to the other fund will be relevant for the proportioning rule and alter the tax-free percentage.
Death benefit pensions, including child pensions, generally cannot be rolled over. An exception applies to a death benefit pension that is paid to the spouse of the deceased member.
This different treatment of death benefit pensions arises because the lump sum arising from the commutation of a death benefit pension payable to the spouse of a deceased member constitutes a rolled over superannuation benefit, while the lump sums arising from the commutation of other death benefit pensions do not qualify as a rolled over superannuation benefit.
When the lump sum is paid to the other superannuation fund and as it is not a rollover superannuation benefit, the lump sum will be treated as a new superannuation contribution that can only be accepted by the other trustee if the child satisfies the SIS contribution acceptance rules, and the lump sum will be tested against the contribution caps.
If this analysis is correct, the policy issue arises as to what the justification is to prevent child pensions from being rolled over. The policy objective that death benefits be cashed out and only re-enter the superannuation system as new contributions can be achieved by the requirement that the pension from the new fund commences immediately.