Helping clients with their estate planning needs is a vital aspect of the financial planning process with superannuation being an important component of the plan.
The 2017 super reforms were wide ranging with quite a number of changes affecting superannuation death benefits. This article examines some of these changes and the various considerations when developing a superannuation estate planning strategy.
1. Inability to move pension death benefits to the accumulation phase
Prior to the recent reforms it was a common industry practice to allow a death benefit pension to be moved back to the accumulation phase after the later of 6 months from death or 3 months from the grant of probate, commonly referred to as the prescribed period.
In 2017 the Australian Taxation Office (ATO) issued guidance contrary to this practice, however the ATO stated it would not apply compliance resources to occurrences prior to 1 July 2017.
In their guidance the ATO reasoned that the compulsory cashing requirement for death benefits continued indefinitely. That is, death benefits need to be paid as a lump sum, pension or a combination of the two and this requirement does not stop at the end of the prescribed period. Moving the pension back to the accumulation phase would not meet this cashing requirement.
As super funds are required to cash death benefits the amount commuted from the death benefit pension cannot be retained in the accumulation phase.
2. Ability to roll over death benefits
Beneficiaries who are eligible to receive a death benefit as a pension are now able to rollover that benefit to another superannuation fund. This change applies to all death benefits and therefore covers existing death benefit pensions. The ability to rollover death benefits offers greater flexibility and does not lock the beneficiary into a super fund they didn’t choose.
The paying fund will notify the receiving fund the benefit is a death benefit. As such the benefit cannot be retained in the accumulation phase and must be paid as a pension or lump sum. It also means the benefit will be considered a death benefit and taxed accordingly.
An unintended consequence of this change has meant that a death benefit that contains insurance will give rise to an untaxed element upon rollover. The untaxed element is subsequently subject to tax when rolled over. The Government has acknowledged the issue and announced on 30 October 2018 that it will amend the legislation to prevent the taxation of such benefits.
3. Keeping death benefits and non-death benefits separate
The new ability to rollover death benefits could be seen as a useful way to consolidate both death and non-death benefits in the one pension. However, the Government has stated that death benefits must be kept separate from non-death benefits due to the compulsory cashing requirement applying to death benefits. Death benefits are also taxed differently in certain circumstances, which may be a further reason for separation.
4. Transfer balance cap
Death benefit pensions count towards an individual’s transfer balance cap (TBC). There is however a difference in the amount that counts towards the TBC and the time it counts towards the TBC as shown in the table below. Beneficiaries who are not children of the deceased are subject to the general TBC whereas children are subject to a modified TBC (discussed later).
| Reversionary pension | Non-reversionary pension | |
|---|---|---|
| Timing of credit: | Later of:
| Later of:
|
| Value2 of credit: | Value2 at later of:
| Value2 at later of:
|
1 Reversion is considered to occur at the time of death
2 Value for capped defined benefit income streams is based on the special value calculation
Receiving a death benefit as a pension may cause some surviving spouses to exceed their TBC, particularly where they have already used all or part of their TBC.
In such a case, consideration could be given to moving their non-death benefit pension back to the accumulation phase to create TBC capacity. This capacity is created as the commutation of the pension results in a debit in the transfer balance account.
Example 1
| Pension | $1,700,000 |
|---|---|
| Accumulation | $100,000 |
| Total | $1,800,000 |
Geoff’s non-lapsing nomination nominates his wife Kim to receive all of his benefits.
Kim (68) currently holds an account based pension worth $1,500,000 with $1,400,000 counting towards her TBC at 1 July 2017. Kim’s remaining TBC capacity is $200,000.
Scenario 1
| Pension | $200,000 |
|---|---|
| Lump sum | $1,600,000 |
| Total | $1,800,000 |
Kim’s transfer balance account will appear as follows - she has used all of her TBC and $1.6 million has been paid out of the superannuation environment.
| TBC event | Credit | Debit | Transfer balance account | Transfer balance cap remaining |
|---|---|---|---|---|
| 1 July 2017 pension value | $1,400,000 | $1,400,000 | $200,000 | |
| Death benefit pension | $200,000 | $1,600,000 | $0 |
Scenario 2
Kim may wish to maximise the benefits in the superannuation environment. To do so she takes the following action:
- Commutes her existing pension worth $1,500,000,
- Has the death benefits paid in the following way:
| Pension | $1,700,000 |
| Lump sum | $100,000 |
| Total | $1,800,000 |
Kim’s transfer balance account will look as follows - she has used all of her TBC but only $100,000 has been paid out of the superannuation environment.
| TBC event | Credit | Debit | Transfer balance account | TRansfer balance cap remaining |
|---|---|---|---|---|
| 1 July 2017 pension value | $1,400,000 | $1,400,000 | $200,000 | |
| Commute existing pension | $1,500,000 | -$100,000 | $1,700,000 | |
| Death benefit pension | $1,700,000 | $1,600,000 | $0 |
Kim will have the following investments under each scenario:
| Scenario 1 | Scenario 2 | |
|---|---|---|
| Pension(s) | $1,700,000 | $1,700,000 |
| Accumulation | $0 | $1,500,000 |
| Non-super | $1,600,000 | $100,000 |
| Total | $3,300,000 | $3,300,000 |
Which scenario is preferable will depend on Kim’s circumstances and it may be that a variation of these scenarios provides an even better outcome.
Scenario 2 results in a greater amount remaining in the superannuation environment however a large portion will be held in an accumulation account where taxable income will be taxed at 15%. As Kim is at least 65 she will have a personal effective tax-free threshold of $32,914 after factoring in the low income tax offset, low and middle income tax offset as well as the seniors and pensioners tax offset. As a result of this effective tax-free threshold she may be better off holding a portion of her accumulation benefits in her own name.
As values can change over time, modelling the various scenarios will help determine the most appropriate path.
In addition to the tax implications, other factors to consider include:
- Centrelink or DVA entitlements – pensions commenced before 1 January 2015 may receive grandfathered income test treatment. In the case of death benefit pensions where the death occurs on or after 1 January 2015 the grandfathered treatment will carry over from the deceased where the pension automatically reverts to the beneficiary and the beneficiary is receiving a Commonwealth Government income support payment at the time of reversion.
- Commonwealth Seniors Health Card (CSHC) – the death benefit income stream may not be deemed and income may not count towards the card’s income test. This can occur where the pension received grandfathered income test treatment in the hands of the deceased, the pension automatically reverts upon death and the receiving spouse was the holder of the CSHC at the time of reversion. Where a non-death benefit amount is moved to the accumulation phase, no amount relating to that amount counts towards the CSHC income test. On the other hand, taxable income from investments in the client’s name will count towards the CSHC income test.
- Estate planning for the surviving beneficiary - where the surviving spouse plans on leaving their super benefits to non-tax law dependants (eg independent adult children), the taxable component will be subject to tax at 15% plus Medicare levy (no Medicare levy applies if paid to the child via the estate). This tax won’t apply where the superannuation benefit is withdrawn while the client is still alive. In addition, by taking the death benefit as a lump sum before 1 July 2019, they potentially receive an anti-detriment benefit of 17.6% of the taxable component (refer section 5). However, consider other tax aspects such as the passing of unrealised capital gains on non-super assets to the estate/beneficiaries of the estate.
- Asset protection – some client’s may be exposed to higher risks than others and retaining benefits in the superannuation environment might provide a level of protection against those risks. For example, benefits held in superannuation are generally protected from the trustee in bankruptcy.
When a child receives a death benefit pension, a modified TBC (known as a cap increment) applies to the child. The cap increment is separate to the general TBC (ie $1.6 million) and limits the amount the child can receive in the form of a pension from their parent. The size of the cap increment is determined by the parent’s circumstances, as shown in the following table.
| Pension commencement | Parent had transfer balance account | Source of child pension | Cap increment |
|---|---|---|---|
| Pre 1 July 2017 | N/A | N/A | General transfer balance cap (ie $1.6m) |
| On or after 1 July 2017 | No | Accumulation phase | General transfer balance cap x % share of deceased's superannuation interests |
| Yes | Retirement phase only | Value of pension(s) received | |
| Yes | Accumulation phase only | Nil-death benefit pension generally excessive | |
| Yes | Both retirement and accumulation phases | Value of pension(s) received from retirement phase only. Pension paid from accumulation generally excessive. |
Example 2
Phil has an accumulation account valued at $800,000, has never had a transfer balance account and leaves 75% (ie $600,000) of his death benefit to his spouse and 25% (ie $200,000) his young child. From the table above we can see that the child’s cap increment would be $400,000 (ie $1,600,000 * 25%) and this will be the maximum amount the child can receive in the form of a pension. The death benefit being paid to Phil’s child (ie $200,000) is less than the cap increment (ie $400,000) and can therefore be taken in the form of a pension without exceeding the child’s TBC.
Importantly a child can only receive a death benefit pension in the following circumstances:
- Child is under 18; or
- Child is 18 – 24 and financially dependent on the deceased; or
- Child is any age and has a qualifying disability.
5. Phase out of the anti-detriment benefit
An anti-detriment benefit is an increase to a lump sum death benefit paid to certain beneficiaries. The payment is funded by the super fund, which subsequently claims a tax deduction on a grossed up basis for some or all of the benefit paid.
Although the anti-detriment benefit is being phased out, it remains available where:
- The member passed away prior to 1 July 2017, and
- The lump sum death benefit is paid before 1 July 2019
The anti-detriment amount can be as high as 17.65% of the taxable component (element taxed) of the lump sum death benefit paid. As such it is worth reviewing a client’s circumstances to determine whether they might be entitled to the anti-detriment amount on any lump sum death benefits paid before 1 July 2019.
A possible situation where an anti-detriment benefit might be available is where the deceased passed away before 1 July 2017 and the surviving spouse received the death benefit as a pension. A lump sum paid before 1 July 2019 from the pension account will be a death benefit and may attract an anti-detriment benefit.
Withdrawing funds from a pension account moves those funds from a tax free earnings environment to a potentially taxable environment. As noted earlier a single person who is 65 years or older has an effective tax-free threshold of $32,914 when including the benefit of various income tax offsets. This means a substantial amount of assets can be held personally before the income will be subject to tax. However, the decision to remove funds from superannuation should be made in light of the client’s overall position; taxation is only one aspect of this position.
Example 3
Jane (70) is currently receiving a death benefit pension as a result of her husband’s death in 2016. The super fund has confirmed it will pay an anti-detriment benefit on lump sums paid before 1 July 2019.
The pension is currently valued at $600,000 with a taxable portion of $400,000. The service period started after 30 June 1988, so the value of the anti-detriment benefit will be approximately 17.65% of the taxable component.
If Jane commutes the pension and takes it as a lump sum, she will receive an anti-detriment benefit of approximately $71,000, meaning she will now have $671,000 to invest outside of the superannuation environment.
Investment earnings on Jane’s death benefit pension are tax free however earnings when invested outside the superannuation environment will be subject to tax at personal marginal tax rates.
Modelling Jane’s position over time will determine whether she is better off withdrawing the pension. Where the income is subject to tax, it will take some time for the additional tax liability to exceed the benefit of the anti-detriment amount.
If it was determined that Jane would be better off retaining the pension, consideration could be given to withdrawing a portion of the pension as a lump sum.
Jane has mentioned she would like to leave her death benefit to her independent adult daughter. If Jane were to pass away her daughter would be subject to tax of $68,000 leaving a death benefit of $532,000. This is approximately $139,000 less than if Jane were to take a lump sum death benefit, attracting anti-detriment, and subsequently pass away.
As it’s not known when Jane will pass away it is difficult to determine which option will be optimum for Jane’s daughter. Modelling the various scenarios will assist in the decision-making process.
A further benefit may arise where an individual is drawing more than the minimum pension amount. Taking a lump sum for the amount above the minimum might attract an anti-detriment benefit. In addition to the anti-detriment benefit, it will have favourable treatment from a transfer balance cap perspective as lump sums are a debit against the transfer balance account whereas pension payments don’t affect the transfer balance account.
Another situation where an anti-detriment benefit might arise is the situation where the person passed away before 1 July 2017 and the super fund is yet to pay the benefit. The process of paying a death benefit can take time and such a delay is not uncommon. Where the death benefit is paid as a lump sum it may attract an anti-detriment benefit.
Not all super funds pay anti-detriment benefits and those that do may not pay in all circumstances (eg a super fund may not pay on lump sum death benefits containing death benefits rolled over from another fund) so it will be important to check with the fund on a case by case basis.
Conclusion
Recent changes have made the superannuation component of estate planning piece more complex. A thorough understanding of these changes and the laws that have remained the same will help advisers to provide high quality superannuation estate planning advice to their clients.
For further information, refer to the superannuation death benefits 2018/19 chart.
