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Pension reversionary or reversionary-not – there is no try

storm troopers

There are advantages and disadvantages associated with making an SMSF pension reversionary. Jemma Sanderson details the pros and cons of the strategy.

Even if you don’t get the Star Wars reference, you would have had to have been living under a rock if you were unaware of the transfer balance cap (TBC) provisions and the complexities that now arise when making a pension reversionary (or not). Recent cases also continue to shed light on the treatment of superannuation death benefits and how they are to be dealt with.

There are substantial practical implications to consider when members set up pensions and deciding whether to make the pension reversionary or not, including:

  • the reporting requirements – now and when a member dies,
  • the valuation requirements at death,
  • the minimum pension payment requirements, and
  • changing a pension from being reversionary or not in situ – can it be done?

Let’s go back a long, long time ago, to a galaxy far, far away.

There are substantial practical implications to consider when members set up pensions and deciding whether to make the pension reversionary or not

Jemma Sanderson

The Phantom Menace – transfer balance cap regime

Since the introduction of the TBC, we need to be mindful of the following:

  • The $1.6 million TBC, which is the amount a member can commit to a retirement pension to receive a tax exemption on the earnings assets.
  • The TBC is a point-in-time assessment – members don’t have to peg their pensions to the limit each year (upwards or downwards) as subsequent transactions that will generally impact on their transfer balance account (TBA) are:
    • pension commutations,
    • reversionary pensions, and
    • new pension commencements upon the death of a spouse.
  • Where a member dies, they have used their TBC and they have a spouse, generally, any assets in the deceased’s accumulation account need to exit superannuation.
  • It is the surviving spouse’s TBC that is important, not the deceased’s, as that will determine how much of the deceased’s benefit can remain in pension phase for the spouse.
  • Where a pension is automatically reversionary to the spouse, the spouse has 12 months where both the deceased’s and the spouse’s pension can receive the pension exemption before the spouse has to consider their own TBC position and restructure (where they need to), as the deceased’s pension value at the date of death will be a transfer balance credit (TBCredit) for the spouse.
  • Where a pension is not automatically reversionary, the pension benefit will continue to be eligible for the pension exemption, provided it is dealt with as soon as practicably possible. At that time, as the new pension will be a TBCredit for the spouse, their own pension may require restructuring.
  • As a general rule, when a member passes away and the surviving spouse is in the position that their own benefit plus a pension from the deceased would result in an excess to the TBC, with the aim of keeping as much as possible in superannuation, they would generally look to commute their own income stream back to accumulation, and continue to receive the deceased’s pension, or commence a new pension from the deceased’s benefit.
  • There are reporting obligations to the ATO, where any transaction that impacts on the member’s TBA needs to be reported either with the annual return or quarterly.

The Empire Strikes Back – a reversionary example

Han (64 and in retirement pension phase at 30 June 2017 with $1.6 million) and Leia (62 and retired at the end of 2018/19 and only commencing a retirement-pension at 30 June 2019) have the benefits in superannuation at 30 June 2019.

If Han were to pass away on 1 September 2019, his total pension benefits would be worth about $1,943,290. Assuming his pensions automatically revert to Leia, then the following would occur:

  • Both Han’s pensions and Leia’s pension would continue to be exempt on the earnings within the fund throughout 2019/20.
  • The value of Han’s pension accounts on 1 September 2019 need to be reported to the ATO by 28 October 2019 (they would be quarterly reports under transfer balance account reporting), even though the credit won’t arise until 1 September 2020.
  • This requires either interim financial statements to be prepared or very accurate calculations of the two accounts at that time.
  • The value of Han’s accumulation account needs to be paid out of superannuation as soon as practicably possible.
  • Leia would have to take the minimum pension with respect to her own benefits ($64,000), plus with respect to Han’s benefits ($77,730) during 2019/20.
  • In the lead-up to September 2020, Leia needs to consider the options available to restructure. Let’s assume her pension account at 30 June 2020 is $1,685,000:
    • the value of Han’s two pensions at his date of death (let’s say $1,943,290) will become TBCredits on 1 September 2020 to Leia’s TBA,
    • she already has $1.6 million assessed towards her TBC, so she would then have an excess,
    • she is able to commute her own pension back to accumulation, but will still be in excess by $258,290, and
    • she will then have to commute $258,290 from Han’s pension accounts and receive it as a lump sum from superannuation in order to remain within her TBC.

Therefore, it is Leia’s TBC that is relevant, not Han’s. Accordingly, the value of Leia’s benefit at the date that is 12 months after Han’s death is also important.

If, for example, over the period Leia’s benefits increased to $1,850,000 then she would only have to commute $93,290 from Han’s pension accounts as a lump sum. Even if Han’s benefits have increased similarly, it is the value at his date of death that is recorded as a TBCredit, so his pension benefits could be worth $2,150,000, but only $93,290 needs to be paid out as a lump-sum benefit.

Conversely, if Leia’s benefits reduced down to $1,450,000 over the period, and Han’s likewise to $1,700,000, then a higher amount would need to be paid out of Han’s pension benefits ($493,290, being $1,943,290 less $1,450,000) to fall within Leia’s TBC.

As part of the above process, the following is also of relevance:

  • Reporting required by 28 October 2019 – difficult to ascertain the balance in Han’s accounts at his date of death without interim financials. Although the ATO is taking a practical approach regarding the time frames for TBA reporting at present, once this system has been in place for a number of years, that more relaxed approach is likely to become harsher with respect to late lodgements.
  • Minimum pension payments are required to be made to get the pension exemption on Han’s pension accounts.
  • Two additional sets of financials may be needed over the period, adding a substantial cost:
    • Han’s date of death, and
    • 12 months after Han’s date of death (to value Leia’s pension account).
  • If there is time, strategically it is worthwhile paying out Han’s minimum pension before he dies, reducing his benefit value at his date of death, and meaning Leia doesn’t have to pay out the minimum after his death to receive the exemption.

A New Hope – alternative to reversionary

Under the new regime, it may be preferable to have pensions that are not reversionary, particularly from a practical perspective.

Taking the above example, if Han’s pensions were not reversionary, and Leia was the sole beneficiary, then the following would occur:

  • Both Han’s pensions and Leia’s pension would continue to be exempt on the earnings within the fund throughout 2019/20. Han’s pensions can receive the exemption provided they are dealt with ASAP. What does that mean?
    • Leia needs to either take out a lump sum with respect to Han’s pension accounts ASAP or commence a new pension for herself ASAP,
    • the rule of thumb is between six and 12 months,
    • would 1 July 2020 suffice? Likely yes, as it is a very practical time to look to resolve Han’s pensions, as 30 June 2020 is the one time during a financial year that the benefits are known.
  • The value of Han’s accumulation account needs to be paid out of superannuation also ASAP.
  • Over 2019/20, Leia only needs to take out her minimum pension payment.
  • In the lead-up to 1 July 2020, Leia needs to consider the options available to restructure her account. Again, let’s assume her pension account at 30 June 2020 is $1,685,000 and the value of Han’s two pension accounts is $2,050,000:
    • Leia can commute her $1,685,000 pension,
    • she is then able to commence new pensions with Han’s benefits up to the $1,685,000 amount:
      • pension #1 (let’s say $690,000) with a tax-free component of 80 per cent,
      • pension #2 (the balance up to $1.685 million) with a tax-free component of 65 per cent,
    • these would be TBCredits at 1 July 2020,
    • reporting required by 28 October 2020, and
    • although the above amounts won’t be 100 per cent known at 30 June 2020, the relevant paperwork can be drafted to reflect the intention, with the balance withdrawn once the 2019/20 accounts have been completed.

The above can be a more practical approach and saves some additional requirements (interim financials, minimum payment requirements, reporting just after date of death).

In light of the above, it may therefore be appropriate to consider whether clients’ pensions should be non-reversionary.

The only downside of a non-reversionary pension from a TBC perspective is that it is the value of the benefits at the date they are dealt with that determines the TBCredit, as opposed to the situation where the pension is reversionary where it is the value at the date of death. Where assets have appreciated in value substantially, then that is the downside. However, the loss of some pension exemption on the assets could be offset by the cost of the two sets of interim financials.

Under the new regime, it may be preferable to have pensions that are not reversionary, particularly from a practical perspective.

Jemma Sanderson

Revenge of the Sith – items to watch

Despite the above, there are always areas where the above isn’t appropriate, depending on the circumstances of the individuals, such as:

  • Where there isn’t a binding death benefit nomination (BDBN) in place that provides the benefits are to be paid to Leia, and another beneficiary contests her decision,
  • Where the certainty with respect to pensions being reversionary is preferred (blended families),
  • Where the BDBN doesn’t allow for the survivor to decide how they are to receive the benefits,
  • Where there are multiple pensions and some are reversionary and some aren’t,
  • Where pensions are already reversionary – changing them to being non-reversionary requires the pension to be ceased and recommenced, which has its own issues:
    • aggregation of tax components if accumulation is also in place,
    • Commonwealth Senior Health Care Card implications,
    • have all of the estate planning implications been considered (including what a BDBN says), as changing this status may impact on that substantially, and
    • what does the deed say.

The Force Awakens – what next?

The decision about making a pension reversionary or not now requires more consideration at the initial stage when a member retires, or even when they start their transition-to-retirement pension with the intention it will be in retirement phase in the future. There are tax, estate planning, valuation, reporting and practical issues to consider. It is not just a box-ticking exercise anymore and ultimately the decision as to who gets the money should remain paramount.

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