Superannuation death benefits paid to children have different implications now in light of the change in the retirement savings laws. Daniel Butler and Philippa Briglia examine how child pensions now operate in conjunction with the new retirement income stream balance limits.
The introduction of the superannuation reforms and the transfer balance cap (TBC) in particular has had a significant impact on succession planning.
Prior to the superannuation reforms, paying a pension to a child from the superannuation death benefits of a deceased parent was a relatively straightforward strategy. The situation is now more complicated. This article is a general guide that steps through some of the major issues that need to be considered.
Is the child eligible?
Firstly consider whether the child of the deceased member is eligible to receive a death benefit income stream as a child recipient (refer to regulation 6.21(2A)(b) of the Superannuation Industry (Supervision) Regulations 1994).
- Are they under age 18?
- Are they between the ages of 18 and 25 and were they financially dependent on the deceased parent at the time of the deceased’s death?
- If the child is 18 or older, does the child have a permanent disability within the meaning of section 8(1) of the Disability Services Act 1986? (Note: no upper age restriction applies here.)
If the answer to any of the three questions above is yes, then the child of the deceased member is eligible to receive a death benefit income stream as a child recipient or child pension.
How long can the child pension run?
Unless the child recipient has a permanent disability, upon turning 18 (unless the child is financially dependent on the deceased at the time of the deceased’s death, in which case they can continue to receive the pension until the age of 25) the child recipient is required to cash out all death benefit income streams and withdraw the remaining capital from the superannuation environment. At this time their transfer balance account (TBA) and modified TBC will cease unless the account balance supporting the child pension has already been exhausted.Child recipients with a permanent disability are not, however, required to cash out the child pension upon turning 25. Broadly the child pension can continue to be paid and their modified TBC will cease when all of the account balance supporting the child pension has been exhausted. Some exceptions apply if the child recipient also has other superannuation income streams such as another pension that is not a child pension.
However, the pension may cease prior to the child turning 25 if, for instance, on the child turning 18 they elect to commute the pension and withdraw the remaining capital as a lump sum. Alternatively, as there is no maximum limit on an account-based pension, the child could withdraw the entire account balance in one pension payment instead of commutating the pension. Some parents may be concerned as to how flexible a child pension can be and may not necessarily trust the child’s judgment after they turn 18, especially if the remaining amount is substantial. Broadly, a child has the ability to withdraw the entire amount when they attain adulthood and may well decide they do not need to pursue further education or a career as they now have enough money to enjoy themselves with their new found friends who can help them spend it.
A solution could be to implement a tailored SMSF deed and pension documents with special restrictions that seek to limit the pension to the minimum annual payment amount and preclude any commutation prior to reaching a specified age, such as 25.
What is a cap increment?
A child who receives a child pension obtains a modified TBC, which generally takes into account the value of the deceased parent’s retirement-phase interests they receive. This is achieved through a series of TBC increments that accrue to the child recipient instead of obtaining the usual $1.6 million general TBC (as indexed).
How much can a child receive?
In order to answer this question, we first need to identify when the individual started receiving a child pension.For a peson who started receiving a child pension before 1 July 2017, their cap increment is equal to the general TBC of $1.6 million. That is, a child can be in receipt of a child pension of up to $1.6 million without exceeding their modified TBC. If there are a number of children, each can receive their own $1.6 million modified TBC.
For a child who started receiving a child pension after 30 June 2017, the position is more complex and requires consideration of the deceased parent’s TBA status. The cap increment that will apply depends on whether the deceased parent had a pension in retirement phase (and therefore a TBA) on their death.
Deceased parent did not have a TBA on their death
If the deceased parent did not have a TBA on their death (for example, they died at age 40 before they were in retirement phase), then a cap increment will arise for the child recipient on the starting day of the child pension. If the child is the only recipient of a child pension in respect of the deceased, then the cap increment that arises is equal to the general TBC of $1.6 million (or the $1.6 million as indexed in future years if the child pension commences to be paid at a later time). If the child is not the only person to receive a death benefit pension in respect of the deceased, then the cap increment is equal to the proportion of the general TBC that corresponds to each person’s share of the deceased’s superannuation interests.
Anakin dies on 30 September 2017 at age 40 with an accumulation interest of $2 million. His son Luke, 16, is to be the only recipient of Anakin’s superannuation death benefits. Luke’s cap increment is equal to the general TBC, so a $1.6 million modified TBC applies.
Anakin dies on 30 September 2017 at age 40 with an accumulation interest of $2 million. His son Luke, 16, and daughter, Leia, 14, are each to receive 50 per cent of Anakin’s superannuation death benefits. Luke and Leia’s cap increment is equal to 50 per cent of the general TBC, so an $800,000 modified TBC applies for each child.
Deceased parent did have a TBA on their death
If the deceased parent already had a pension in retirement phase and a TBA on their death (for example, they died at the age of 65 when they were receiving a retirement-phase income stream, such as an account-based pension), then the child’s cap increment will depend on the source of their death benefit pension. This is because only child pensions that are funded from retirement-phase interests of a deceased parent are entitled to a cap increment.Generally an amount is considered to be sourced from the deceased parent’s retirement-phase interest if the amount relates to interests supporting pensions payable to the parent just before their death. This amount includes earnings accrued on pension balances after the parent’s death, up until the child pension commences to be paid.
Where the child pension is fully funded by the deceased parent’s retirement-phase interests, the child’s cap increment is equal to the share of the deceased parent’s interest they are receiving as a child pension.
Ned dies on 30 September 2017 with a retirement-phase interest of $1.2 million just before he died. His daughters Sansa, 17, and Arya, 14, are equal beneficiaries of their father’s super interest. In March 2018, the trustee of Ned’s super fund decides to pay each child a non-reversionary child pension of $600,000. Both Sansa and Arya are entitled to a TBC increment equal to their share of their deceased father’s retirement-phase interest ($600,000 being half of $1.2 million), plus their share of any earnings accrued on Ned’s retirement-phase interest since Ned’s death (see below for further detail on investment earnings after death).
However, if the deceased parent had a TBA, and the child recipient’s death benefit income stream comes from the deceased parent’s accumulation interest, the cap increment is nil. Broadly, this means a child recipient will have an excess transfer balance if they receive a death benefit income stream funded, either fully or partially, from the deceased parent’s accumulation interest.
Treatment of investment earnings after death
Where the deceased parent had a TBA on death, the operation of section 294-200 of the Income Tax Assessment Act 1997 (ITAA) means the child can get the benefit of any earnings accrued to the deceased parent’s retirement-phase interest between the date of death and the date when the death benefit income stream commences to be paid.
Charlotte, 15, is the only beneficiary of her father’s super interest. Her father, Marty, had $1.2 million in retirement phase when he died on 30 July 2017. Between the time of Marty’s death and the time Charlotte started receiving a death benefit income stream, earnings of $4000 accrued to Marty’s retirement-phase interest. Charlotte is therefore entitled to a $1,204,000 cap increment.
However, if Marty had $100,000 in accumulation on death, a cap increment would not apply for this amount. Cap increments only apply in relation to the deceased’s retirement-phase interests.
What about life insurance proceeds?
Where the deceased parent has a TBA on death and a fund trustee receives life insurance proceeds in relation to the member’s death, these proceeds cannot be applied to pay a child pension to a minor child (refer to section 294-200(7) of the ITAA), as they are not treated as giving rise to a cap increment in respect of the child recipient.
Good planning is key
While child pensions provide some planning opportunities, other estate planning strategies, such as a testamentary trust, may be preferred. Child pensions should only be considered as part of a proper estate and succession plan, including considering whether a restricted SMSF deed and appropriately worded pension documents are required. Naturally, expert SMSF and legal advice should be sought.