The super reforms have significant consequences for estate planning in the immediate future. Peter Hogan details the areas requiring revision and new considerations.
When providing estate planning advice to clients for the first time, or reviewing the existing estate plans as part of a regular review, advisers cannot ignore the impact of the 1 July 2017 changes.
Not enough has been written about the impact on ordinary retirees or pre-retirees in terms of what is going to happen to their superannuation savings on their death and the ongoing suitability of superannuation generally as a preferred retirement savings vehicle.
It can often be difficult to get clients to focus on the consequences of their death and put in place appropriate plans to ensure their wealth is passed on to their preferred beneficiaries. For those clients where nothing currently is in place, advisers must understand the impact of the 1 July 2017 changes before discussing it with clients.
For those clients who have done the hard yards and have already put their plans into place, unfortunately it may have to be done again. Advisers will need to carefully review these existing arrangements and assess how they stand up in the new environment; many will need to be adjusted or even redone to get the right outcomes for those clients. Convincing them to redo something that may have taken years to implement in the first place is a big ask for advisers – but one that should not be left in the too-hard basket.
So, what are some of the changes we should be reminded of and their relevance to the planning process for clients?
Removal of the death benefit definition from 1 July 2017
Removal of the definition of a death benefit in the Income Tax Assessment Act 1997 and the subsequent implications for the treatment of payments made on death are unusually far reaching for such a minor change.Most of the consequences that arise from this change are due to the ATO views expressed in Law Companion Guide (LCG) 2017/3. In particular, this guide sets out the tax office’s views on satisfying regulation 6.21 of the Superannuation Industry (Supervision) (SIS) Regulations regarding the cashing of a death benefit. The views expressed in this guide on this issue have not been universally accepted as correct in the superannuation industry.
Consequences for death benefit payments
The ATO has stated the removal of the time restrictions of six months after death or three months after probate from the definition of a death benefit means all benefits paid because of the death of a member will indefinitely be treated for both tax and superannuation purposes as a death benefit in the hands of the recipient superannuation dependant.It follows that to satisfy the requirements of regulation 6.21 of the SIS Regulations a death payment must be cashed as soon as practicable after death – either a lump sum or pension or a combination of both must be paid without undue delay.
Where the current ATO view differs to earlier interpretations of this regulation is that now a death benefit pension must continually satisfy this requirement by continuing to be paid until the benefit is exhausted. Any decision to commute part or all of such a pension before this time can only result in that amount being paid as a death benefit lump sum. The recipient cannot elect to roll that commuted amount back to accumulation phase and leave it there indefinitely.
In other words, the idea that a death benefit pension started because of the death of a member becomes the benefit of the recipient for them to deal with as they choose no longer applies. The inherent assumption is now that the death benefit pension is a separate superannuation interest to other entitlements that the recipient may have in superannuation.
There are both positive and negative consequences of this change
On the positive side, this means regardless of when a recipient of a death benefit pension decides to change superannuation providers, they can commute their pension back to accumulation phase, quickly roll over the resulting lump sum to another superannuation arrangement and promptly start a new pension. This new pension will continue to be treated as a death benefit pension both for tax and superannuation purposes. The mobility between providers and the continued benefits of being treated as a death benefit are valuable. As this interest is to be treated as a separate superannuation interest of the recipient, and for recipients who are members of an SMSF, the taxable components of the resulting accumulation account on commutation of the death benefit pension will not automatically mix with those of other accumulation accounts they may also have in their SMSF.
In other words, even as an accumulation interest in an SMSF, the death benefit retains its separate character as a death benefit apart from any other superannuation interests the recipient may have. This is a fundamental change from the concept that an SMSF member can only ever have a single accumulation interest in an SMSF. The quarantining of taxable components means any planning done around the make-up of the taxable components of the pension originally is preserved whether the death benefit pension is paid from the superannuation arrangement of the deceased or is moved by the recipient to another provider.
On the negative side, the ATO makes it clear where a decision to commute is made to simply stop the death benefit pension, then the resulting accumulation interest must leave the superannuation system as a death benefit lump sum payment and cannot be left in the accumulation phase indefinitely.
What about pre-1 July 2017 commutations?
If advisers have clients who have previously commuted death benefit pensions outside the later of six months after death or three months after the granting of probate and have moved the amount to accumulation phase, treating it as part of the recipient’s broader superannuation entitlements, they are able to leave these amounts in place. Practical Compliance Guideline 2017/6 clarifies that provided this was done and in place before 1 July 2017, these amounts can remain in accumulation phase without adverse consequences.
Other consequences for the average SMSF member
The stated purpose of the transfer balance cap (TBC) rules from 1 July 2017 was to limit the tax benefits of large pension accounts exceeding the new $1.6 million cap.What may be understood by advisers, but is not well understood by clients, is the consequences of the death of their partner where, as a couple, their combined interests in superannuation exceed $1.6 million in total. There is a common belief that a pension started by a spouse who then passes away can continue to be paid to the surviving spouse, regardless of their own personal superannuation arrangements. Most advisers are aware you do not inherit your deceased spouse’s TBC and that future pensions paid because of the death of your partner are assessed against your TBC. How well this has been communicated to clients is questionable and the consequences on estate planning are significant.
So for a couple who individually have, say, $1 million and $700,000 respectively in their superannuation, the TBC regime has no impact on them. Both are comfortably within the new caps. However, this only lasts until one of them dies and a death benefit pension is to be paid because of their death.
A death benefit lump sum is excluded from the TBC regime and so is not intended to be limited in amount and is otherwise not affected by the following issues.
How the TBC will apply where a pension is to be paid on death will also be dependent on whether the death benefit pension starts as a reversionary pension, a pension paid because of following a binding death benefit nomination, or because of trustee discretion under the terms of the trust deed.
A reversionary pension is generally accepted as one where the entitlement to receive the pension on the death of the original pensioner is set up at the time the original pension started. It is, in fact, part of the terms and conditions of the original pension. The ATO position on changing a reversionary nomination is outlined in LCG 2017/3, and would generally require the cessation of the original pension and starting a new pension with a new nomination of reversionary beneficiary. The guide refers to the possibility of varying this assumption depending on the rules of the trust deed without further detailed elaboration.The benefits of a reversionary pension as assessed under the TBC regime relate to the timing of the credit against the recipient’s own transfer balance account (TBA) and the value of the amount credited.
Firstly, the TBA of the reversionary pensioner is credited 12 months after the date of death of the original pensioner. However, the value of the amount credited is the value of the pension account at the date of death of the original pensioner, not the value of the pension account at the time of crediting.
This means income and capital growth accruing between the date of death and the crediting of the reversionary pensioner’s TBA is ignored for TBC purposes. Of course, so are reductions in the value of the pension account as well. The treatment for TBC purposes of any insurance proceeds received in relation to the death of the original pensioner in these circumstances remains unclear.
This also means the reversionary pensioner can receive the pension payments for 12 months before having to address the TBC issues and any consequential partial or total cessation of the reversionary pension due to TBC excess issues at that later time. If the reversionary pensioner is also receiving their own funded pension, they can continue to receive both during that 12-month period.
This can clearly be beneficial through a transitional period of the surviving spouse adjusting from two people living on a combined income stream to only one.
Assuming an increase in the value of the pension account over the 12-month period, the credit against the reversionary pensioner’s TBA will be less than the value of the pension account itself due to the income and growth of the past 12 months being ignored. In turn, this generally would mean a greater amount of total pension assets can be retained within superannuation by the reversionary pensioner compared with alternative arrangements discussed in the following paragraphs.
Pension initiated via non-reversionary means
Death benefit pensions begun other than as reversionary pensions have a very different TBC outcome.Firstly, as a pension started in this way is a new pension, it will be a credit against the recipient’s TBA at the start of the pension. There is no deferral of the timing of the credit.
Secondly, as it is usually unlikely for this type of pension to start immediately on death, there will be potential income and capital growth earned between the date of death and start of the new death benefit pension. It is also likely insurance proceeds would be paid before starting.
Unlike the reversionary option above, the income and growth of underlying assets used to start the death benefit pension that accrued from date of death to commencement date and any insurance proceeds received will form part of the credit against the recipient’s TBA.
In turn, this could well mean the recipient pensioner may need to commute excess pension accounts created due to these amounts counting towards their TBC to bring the total pension accounts under the cap limit. This would particularly be the case where the recipient pensioner has started a pension in their own right that is being paid in addition to the pension starting as a death benefit pension.
Choosing which pension to commute
The pensioner has a choice as to which pension to commute in circumstances where there is an excess due to two or more pensions all running at the same time. Where they choose to commute the excess from their death benefit pension, the excess can only be paid out as a lump sum death benefit and so will mean, compared to the reversionary option, total superannuation amounts retained in superannuation are less under this option.
Where they choose to commute the excess from their own personally funded pension, the excess can be rolled back to accumulation phase and left there indefinitely. So choosing which pension to commute in these circumstances can be an important question to get right, depending on what a client wants to achieve.