The introduction of the $1.6 million transfer balance cap from 1 July will have a dramatic impact on the amount some people can have in retirement phase. It also means anyone providing advice on super may need to expand their horizons to cover estate planning in a much broader context.
The immediate reaction to the new rules is that they relate only to those who have more than $1.6 million in superannuation or are in pension phase. But that’s not the case when it comes to death benefits. In fact, for a couple who have over $800,000 in super and are in accumulation or retirement phase, the death of one partner can require the measurement of the deceased’s benefit against the transfer balance cap of the survivor. That means the combined value of super of the couple is used to determine whether the survivor needs to move their pensions into accumulation phase or withdraw amounts out of the superannuation system altogether.
How death benefits are measured against the transfer balance cap can depend on a number of factors, including when the member died and the type of benefits they had in super at the time of their death. This leaves a whole range of issues to consider from what can be left in super, what needs to be taken out and whether (usually) adult children will end up benefiting from the death of one or both members of a couple. In some cases, this may extend to the wording of the person’s will and the distribution of personal assets to beneficiaries. That’s where the estate planning comes in for an adviser.
However, let’s just limit the breadth of the death benefits discussion to superannuation entitlements that arose prior to the start of the new rules on 1 July, some transitional issues and death benefits payable from commencement of those rules.
Death benefit entitlements prior to 1 July 2017
Death benefit entitlements prior to 1 July 2017 can be identified as those payable to a surviving spouse and other death benefits payable to dependants. Some death benefit pensions payable to a surviving spouse are treated in a unique way if they became payable prior to 1 July 2017. If the surviving spouse is in receipt of a reversionary pension and the death benefit period has elapsed, then it is possible for the spouse to commute the pension and transfer it to their accumulation account in the fund. Non-reversionary pensions or amounts in accumulation phase that are used to commence a pension as a result of the death of the spouse do not qualify for these unique rules.
The death benefit period is set out in section 307-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and applied until 30 June 2017. This period is generally three months after the grant of probate or six months after the person’s death. It also includes other periods, for example, in situations where legal action has been taken to contest the payment of the benefit. Any commutation of the reversionary pension needs to occur after those times depending on the circumstances. In some situations, where the spouse has died after 31 December 2016, it will not be possible to access this unique opportunity as the death benefit period will not have elapsed until after 30 June 2017, which is after the commencement of the new rules (see Example 1).
As part of the implementation of the new rules from 1 July 2017, the ATO considered that the interpretation of the ITAA 1997 did not lend itself to the above interpretation. However, that longstanding interpretation has been in common use by the superannuation industry for many years and was supported to some extent by rulings published by the ATO. As a result of this discrepancy, the ATO has taken a practical view in Practical Compliance Guideline PCG 2017/6, which says it will accept industry practice and will take no action in situations where relevant amounts have been transferred to the surviving spouse’s accumulation account.
The changes from 1 July will permit the commencement and roll over of death benefit pensions in a more flexible way than the previous rules. However, in the case of a spouse in receipt of a reversionary pension as described previously, the reversion will not be able to be commuted to a lump sum after the death benefit period and credited to their accumulation account. The only route for a reversionary pension from 1 July is for it to continue to be paid to the surviving spouse, subject to the cap, or commute it, if permitted, and roll over to another pension or withdraw it in part or whole from the fund as a lump sum.
Transitional death benefit entitlement rules from 1 July
The $1.6 million transfer balance cap restricts the value of pensions in place as at 1 July 2017 plus the value of any new pensions from that date to no more than the cap amount at the time they commence. There are exceptions in the case of defined benefit pensions, which use a special value that may determine a higher alternative cap value, however, in the vast majority of cases the cap is $1.6 million. Until 1 July 2017, anyone who was in receipt of a death benefit pension and other pensions did not need to limit the value of any pensions to which they were entitled. However, commutations of one or more of those pensions may be necessary to reduce their value to no more than $1.6 million to avoid the potential tax penalty applying.
The decision as to which pension is required to be commuted will depend on whether the pensioner wishes to maximise the amount held in the fund or withdraw any excess. If the commutation relates to a reversionary pension or death benefit pension on or after 1 July 2017, the amount commuted must be withdrawn as a lump sum by the surviving spouse as it cannot be transferred to accumulation phase. In the case of any other pensions in retirement phase payable to the member which are not death benefit pensions, it is possible to commute the pension and transfer it to accumulation phase or draw it from the fund as a lump sum. If the commuted pension is transferred to accumulation phase, it can maximise the amount held in superannuation and provide a tax-effective strategy for the client.
Where a reversionary death benefit pension has commenced prior to 1 July 2017, there is no need to commute the pension for up to one year after the death of the member. The reason being that the new rules will provide that from 1 July 2017 if the survivor is entitled to a reversionary pension, the value of that pension at the time of the member’s death is used for the $1.6 million transfer balance cap. In addition, the reversionary pension can remain in place for up to one year along with other pensions while the survivor has sufficient time to decide what to do with their superannuation benefits. This can allow an amount larger than the cap to be held in retirement phase for up to one year after the death of the original pensioner where the survivor is entitled to a reversionary pension. At that time, the measurement against the cap will take place with any adjustments made to the relevant pensions to get them within the $1.6 million cap.
The same does not apply in the case of death benefit pensions that are not reversionary. In this situation, the pensions would have been determined as a result of a binding death benefit nomination or from the operation of the trust deed. This could have occurred if the deceased was solely in accumulation phase at the time of their death or drawing a non-reversionary pension from the fund. The measurement of these types of death benefit pensions in place as at 1 July 2017 will be the value at that time. Appropriate adjustments will need to be made at that time to make sure the member is within their $1.6 million transfer balance cap.
Law Companion Guideline LCG 2017/3, which was published by the ATO in May this year, provides a discussion of how the new rules will work for reversionary and non-reversionary death benefit pensions and the timing of when they are to be measured against the member’s transfer balance cap. Examples 2 and 3 show how a reversionary and non-reversionary pension that has commenced prior to 1 July 2017 would be measured against the survivor’s transfer balance cap.
One of the concessions that applies to reversionary pensions under the transitional rules, and also under the rules that commenced from 1 July 2017, is in regard to the amount measured for transfer balance cap purposes.
Death benefits payable from 1 July 2017
Where a reversionary pension commences to be received from 1 July 2017, the value of the pension as at the date of the original pensioner’s death will be used to determine its value. The surviving beneficiary has up to 12 months to decide what they will do with their superannuation benefits, which could be to continue with the reversionary pension or withdraw all or some of it from superannuation as a lump sum. The survivor may decide to roll over the reversionary pension to other funds of which they are a member to consolidate their superannuation benefits into one fund. From a strategic point of view, the survivor has the opportunity to have their super entitlements, including the reversionary pension, retained in tax-exempt retirement phase until the 12-month period is over.
If the survivor decides to commence a death benefit pension that is not from a reversion of a pension, then the measurement for transfer balance cap purposes will be its value at the time the pension commences. It would be expected the commencement of the death benefit pension would occur sometime after the death of the member as this may take some time for the beneficiary to focus on superannuation.
As you can see, knowledge of how reversionary and death benefit pensions are affected by the $1.6 million transfer balance cap is important from an advice point of view. That knowledge should extend into ensuring the broader estate planning needs of the client are met so the right person receives the right amount at the right time, which is what it is all about.
Example 1: commutation of pre-1 July 2017 reversionary pensions payable to a spouse
To illustrate how this would take place, let’s consider the situation of Diana and Nic. Nic commenced an account-based pension on 1 October 2015 that provides a reversion to Diana on his death. Nic died on 1 November 2016 and Diana automatically becomes entitled to the reversionary pension. On 15 May 2017, Diana considers her financial situation and decides she has sufficient income to live on without receiving the reversionary pension. She decides to commute the pension as it is after the death benefit period and she transfers the balance to her accumulation account in the fund.
Example 2: pre-1 July 2017 reversionary death benefit pension
Steven has been in receipt of an account-based pension since he retired in May 2016. His spouse, Louise, is nominated as his reversionary beneficiary. Unfortunately, Steven dies on 10 April 2017 and Louise becomes entitled to a reversionary pension. As at the date of Steven’s death, the value of the pension was $1.2 million and as at 30 June 2017 the pension has been valued at $1.3 million, which will be used for transfer balance cap purposes. Louise is in receipt of an account-based pension valued at $700,000. Therefore, the total value of her superannuation benefits in retirement phase is $2 million. Louise can leave the combined value of the account-based pension and reversionary pension in retirement phase until 10 April 2018 when she will need to decide what to do for transfer balance cap purposes. The options available to Louise are that she could:
- commute $400,000 of the reversionary pension and withdraw it from the fund as a lump sum,
- commute $400,000 of her account-based pension to accumulation phase, or
- commute $400,000 of her account-based pension and withdraw it from the fund as a lump sum.
If one of those adjustments has been made by 10 April 2018, it would be reasonable to expect she would be within her $1.6 million transfer balance cap.
Example 3: pre-1 July non-reversionary death benefit pension
Let’s continue with the facts in the previous example with the exception that the pension Steven was drawing from super did not include a reversion to Louise. In those circumstances the benefit payable to Louise as at 30 June 2017 would have included the balance in the account-based pension of $700,000 and the value of the death benefit pension she commenced after Steven’s death as at 30 June 2017. The value as at 30 June 2017 is $1.3 million. As the combined value of the pensions as at 30 June 2017 is greater than $1.6 million, an adjustment will be required at that time to reduce the combined benefit to no more than that amount. This could be done by using one of the options indicated in the previous example.