Superannuation law is currently undergoing the most significant period of change since mid-2007. As a consequence of the Federal Government’s reform measures, including the $1.6 million transfer balance cap (‘TBC’), it is important that the succession plans of fund members are reviewed as soon as possible so that appropriate and tax effective succession arrangements can be put in place prior to 1 July 2017.
One of the key areas of succession planning that will need particular attention is the decision of whether or not to implement an automatically reversionary pension (‘ARP’). This article summarises some of the main considerations that should be weighed up in determining whether an ARP is an appropriate succession planning strategy in respect of an account-based pension.
Note that it is soon proposed to preclude transition to retirement income streams from being reversionary and special rules apply to other pensions.
Table of ARP considerations
Timing of death benefit
|Broadly, death benefits must be cashed ‘as soon as practicable’ under reg 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’).|
The relevant superannuation benefits can be paid to the deceased’s dependants and/or their legal personal representative (‘LPR’) (ie, the executor of the estate) after the SMSF trustee has exercised its discretion, subject to the governing rules.
|The pension reverts (eg, to the surviving spouse) on the deceased member’s death automatically.|
The pension interest will not form part of the deceased member’s estate.
Minimum pension payments required
|No pension payment is required in respect of an account-based pension in the financial year of death due to an administrative concession afforded by the ATO.||A minimum pension payment is required in the year of death. The payment is the deceased’s percentage factor for the first financial year and then it becomes the recipient beneficiary’s factor on the next 1 July.|
Extension of the pension exemption
|The pension exemption can continue after death until as soon as it is practicable to pay a lump sum or new pension.|
There is no definitive guidance on what ‘as soon as practicable’ means. However, if payment of a lump sum or fresh pension is delayed beyond 6–8 months there should be sound reasons and not merely tax considerations or convenience. Any fresh pension is subject to the recipient beneficiary’s TBC from 1 July 2017.
|The pension exemption continues as the pension does not cease for tax law purposes in accordance with TR 2013/5, and from 1 July 2017, subject to the recipient beneficiary’s TBC.|
Transfer balance account (‘TBA’)
|If a death benefit pension is paid, the TBA credit occurs when the fresh pension commences.||The TBA credit occurs 12 months after the deceased member’s death.|
|The TBA credit value is the market value of the pension capital at the time the fresh pension starts (ie, when the SMSF trustee commences the pension).||TBA credit value is the market value of the pension capital at the time of the deceased member’s death.|
Centrelink and Department of Human Services (‘DHS’)
|Asset test eligibility grandfathering for certain Centrelink/DHS concessions is lost for the fresh pension in relation to:||Asset test eligibility grandfathering for certain Centrelink/DHS concessions is preserved for the pension in relation to:|
|Additional documentation and administration required:||The pension continues automatically and the reversionary pensioner has immediate access to cash flow.|
This may save considerable attendances and costs.
Tax free vs. taxable component
|Broadly, provided that nothing other than investment earnings are being added to the income stream on death, the taxable vs. tax free components of the pension are maintained.||The continuation of the pension on death means that the taxable vs. tax free components are preserved.|
Life insurance in an SMSF
|If a life insurance policy is held in the SMSF and premiums were being paid from the deceased’s pension account, proceeds will broadly form part of the taxable component.||If a life insurance policy is held in the SMSF with premiums paid from the deceased’s pension account, the proceeds will broadly take on the proportions of the pension interest as at the date of the pension’s commencement.|
Note the above table is not an exhaustive list of all relevant considerations.
As the above table demonstrates, there are many factors that need to be considered in deciding whether or not to implement an ARP as there is no one-size-fits-all solution.
However, in relation to managing the potential problem of an excess TBC, the 12 month deferral in the timing of a credit to a recipient beneficiary’s TBA that is granted for ARPs may generally provide greater flexibility in relation to death benefit pensions compared to the more limited exemption that applies to non-reversionary pensions. However, every situation is different, and there may be reasons to leave the decision to pay a death benefit pension at the discretion of the SMSF trustee, particularly where control is in trusted hands.
Naturally, all SMSF succession planning strategies, including ARPs, rely on a firm foundation in relation to the governing rules of the SMSF and related SMSF documents, such as pension documents and binding death benefit nominations. Accordingly, it is important that quality SMSF documents are used to ensure that a member’s chosen succession plans are legally effective, tax efficient and capable of withstanding legal challenge. Additionally, it should be noted that SMSF succession planning should not be done in isolation from the member’s overall estate plans. The super reforms will require all members in retirement phase to review and most likely revise their current documents.
Given the complexity of the reforms we recommend that every member in receipt of a pension should seek assistance from a suitably qualified adviser in relation to their SMSF succession plans.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.
7 February 2017