The estate pension solution

Michale Hallinan

Michael Hallinan details a strategy to ensure the remaining balance of a deceased SMSF trustee’s pension goes to the nominated members of a blended family.

Many clients now have blended families arising from subsequent marriages. Is it possible to provide an income stream for the second spouse with any balance remaining on the death of the second spouse to go to the children of the client? The solution considered in this article is the estate pension – a pension payable to the second spouse for their lifetime where the balance of the pension account is automatically allocated to the children of the client. Such a pension is not a defined benefit pension, it is merely an account-based pension with an overlay of special conditions. As the pension is account based, it is possible for the pension to be exhausted during the lifetime of the second spouse, with the result that no benefit can be paid to the children of the client. However, if the pension account is not exhausted, then the estate pension will prevent the balance being allocated to the children or estate of the second spouse.

Case study

Your client’s situation

Your client, George, has recently remarried and wishes to discuss his superannuation position with you. He wishes to commence an income stream, but also wishes to make provision for his second wife, Mary, and also for his own children.

Mary also has children from her previous marriage. While Mary had some superannuation in her own right, she had decided to cash out a substantial portion of her super as a gift to her children. The balance remaining will provide a modest pension.

George is aware that while relations between the children are currently civil, this may change upon his death. He is also aware Mary’s children may, after his death, pressure her to provide them with further financial support from her super, and also any super she receives as his widow.

George wishes to provide adequate support for Mary given her super has been materially reduced, but also wishes to provide some financial benefit to his own children.

Your preparation for the meeting

In anticipation of your meeting with George you consider some possible solutions. The first solution to be considered is to simply commence an account-based income stream wit Mary as the named reversionary beneficiary.

This solution provides an income stream for George during his life and also to Mary during her life. However, what happens to the account balance on Mary’s death? Will the balance go to Mary’s estate?

Will the balance be paid directly to her children? Will his children even be eligible to be considered as dependants of Mary? This solution is quickly assigned to the circular filing cabinet.

Your next solution to be considered is to commence an account-based pension for George and on his death have a binding death benefit resolution stipulating that a portion is to be paid as a pension to Mary and the balance is to be paid to his children.

After much thought, this solution is not practicable as the account balance of George’s pension at death will not be known, therefore it is not possible to determine if the portion selected for Mary will be reasonable.

The meeting

Unfortunately, thinking and preparation time has now finished as George has just arrived at your office for his appointment. You head to the meeting trusting in your ability to talk through the issues and to pull a rabbit out of a super reserve.

After the pleasantries, George defines the issue – he wants his pension and on his death he wants the pension to transfer to Mary, and on her death the account balance is to be allocated to his children.

The account balance is not to go to Mary’s children or to her estate. George realises as the pension is account based, it may terminate during his lifetime and may terminate during Mary’s lifetime.

However, he is adamant that if there is an account balance remaining on Mary’s death, the balance is to be paid to his children.

After the meeting

You consider George’s views – they are not unreasonable: reversionary pensions are not unknown and clearly permitted by the Superannuation Industry (Supervision) (SIS)

Regulations pension rules. Also on Mary’s death, why does the account balance transfer to her beneficiaries? Is such a transfer of wealth from George’s children to Mary’s children mandated by the pension rules contained in the SIS Regulations?

The meeting ends on the basis that you will consider the technical issues and advise George whether such an arrangement is possible.

Your interest in the constraints of the regulations’ pension rules has been aroused. Looking at regulation 1.06(9A), which relates to account-based pensions, you are struck by the fact the rules are surprisingly open ended: the rules specify what the pension cannot provide more than they specify what the pension can provide. Consider whether a pension can be reversionary.

Regulation 1.06(9A) does not say the account-based pensions can be single life only or reversionary, but seems to presuppose they can be reversionary and provide that the pension can only transfer on the death of the pensioner.

Again, surprisingly the pension rules do not specify the nature of the relationship between the primary beneficiary and the reversionary beneficiary. After much thought you suppose this gap in the pension rules is addressed by other SIS regulations, such as 6.22(2), which specifies to whom benefits of a deceased member can be paid or even by the sole purpose test of section 62 the SIS Act.

Clearly George’s account-based pension can be reversionary to Mary as the pension will only transfer on his death and Mary will be a dependant of his, so the pension can transfer to her and be paid as pension as the restrictions on benefits being paid as pensions set out in regulation 6.21(2A) do not apply.

However, there is the final issue.

Assuming there is an account balance remaining on Mary’s death, do the pension rules require the balance be paid to her estate or to her dependants? You discover the pension rules make no such specification.

Your views – it is possible

You conclude that an account-based pension can be established for George that is reversionary to Mary and then reversionary to George’s children.

The problem of regulation 6.21(2A) is not a problem at all – this provision simply provides that the benefits cannot be paid as pensions.

It does not invalidate the benefit, merely requires that the benefit must be paid as a lump sum (assuming George’s children are independent adults).

The technical elements

You think it is possible, but what is the technical justification for your views and what should be written down in the files to support your position?

Possibly the justification would be that account-based pensions can be reversionary and the regulations’ pension rules do explicitly recognise a pension could be doubly reversionary, that is, payable to A, then to B and then to C so long as B and C are dependants of A.

This recognition occurs in regulation 1.06(9A)(c) where the provision refers to “transfer on the death of the beneficiary (whether primary or reversionary)”.

In the present case, the primary beneficiary is George and the reversionary beneficiary is Mary. The provision is saying the pension can transfer on the death of a reversionary beneficiary.

The only restriction is that the transfer to B must be by reason of the death of A and the transfer to C must be by reason of the death of B. Can a pension be reversionary to two or more individuals?

As previously noted, the only restrictions on reversionary pensions are that the pension must transfer on death, the recipient must be a SIS dependant of the member and, if the recipient is not the spouse or underage child of the member, the pension must in fact be commuted to a lump sum to comply with regulation 6.21(2A).

Consequently, George’s account-based pension could be to George, then to Mary and then equally to the children of George.

Having made your notes, you then reflect on other aspects of the pension rules. Can a pension terminate before exhaustion of the account balance? Could George’s pension be structured so it is payable to George, reversionary to Mary, but terminates say on a specific date or after 10 years of payment to Mary?

Looking at the pension rules, the answer would have to be yes, so long as the pension simply terminates rather than transfers to another individual.

Could the termination occur by reason of an event such as remarriage? Well, the pension rules do not specify otherwise. The only constraint is the pro-rata minimum pension would have to be made before the termination event.

If a pension terminates with a positive balance, what happens to the balance? The balance is simply the unapplied death benefit of the deceased member and would still be required to be cashed out.

If so, the unapplied balance could be cashed out as a new pension for a dependant of the deceased member. In this situation, the SIS regulation pension rule that pensions only transfer on death is not infringed because there is no pension transfer: one pension has stopped and a new and different pension commenced.

You now realise more things can be done with pensions than are permitted by the software systems of product manufacturers and you now need to consider the practical issues to ensure the pension strategy is not undermined by Mary or her children after the death of George.

What are the practical issues?

The pension to Mary will be an account-based pension even if the pension to George was a transition-to-retirement pension.

The death of George is an unrestricted release condition that changes the preservation status of the pension from restricted to unrestricted.

You realise the pension could be undermined and any benefit to George’s children denied by the simple process of Mary increasing her drawdown rate from the minimum: by Mary cashing out the pension or rolling over the pension to another fund.

These attacks on the pension can be prevented by the imposition of rules on the pension that do not permit the pension to be cashed out or rolled over.

Alternatively these events could be permitted with the consent of George’s children in their capacity as reversionary beneficiaries of the pension payable to Mary.

And what about the Centrelink implications of the strategy? Post 1 January 2015 the pension will be treated as a financial investment and will be subject to the deeming (income) means test.

The problem of having reversionary beneficiaries with significantly longer life expectancies than George will no longer be a relevant issue.

Could Mary, who on George’s death will presumably control the fund, be able to amend the trust deed to override these rules? You realise this is a significant issue. Sharing the control of the fund with George’s children is one solution – they could be members of the fund.

Possibly a better solution would be to provide that any actions relating to the pension, whether trustee actions or exercise of the amendment power, first require the consent of the reversionary beneficiaries.

In this way, George’s children could protect their own interests in the fund. As the consent power has been given to the children in order to protect their own interests, the power would not be a fiduciary power and could be and would be expected to be exercised self-interestedly by the children.

Finally you consider the position if Mary simply disregarded the pension rules and did not seek the consent of George’s children in her attempt to cash out the pension. You realise the law does not prevent this from happening, but specifies the consequences that can arise if certain actions are taken.

If Mary does exercise her power as trustee, or causes the corporate trustee, to act contrary to the trust deed of the fund and contrary to the accrued rights of beneficiaries, then the beneficiaries can protect their rights by legal action and Mary may be personally exposed to the financial consequences of her actions.

Your conclusion

You can recommend a strategy to George that will achieve his goal. Admittedly the strategy will require special provisions to the pension to be drafted and most likely require an amendment to be made to the deed. However, the estate planning goal can be achieved.

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