One of the most significant consequences of the transfer balance cap is the effect it has on the payment of death benefits. This will affect all couples who have a combined superannuation balance of $1.6 million.
Currently, for couples, super benefits can remain in super until the death of a survivor. This is because upon the death of the first, the deceased’s benefits can be paid as a death benefit pension to the survivor. It is only on the death of the survivor (assuming there are no children eligible to receive a death benefit pension) that the super benefits must exit the super fund.
Death benefit pensions counted for the transfer balance cap
A death benefit pension (other than a child pension, discussed below) counts for the recipient’s transfer balance account (in the new terminology the death benefit pension is a credit to the recipient’s transfer balance account).
Therefore, a death benefit pension can only be paid to the extent that it would not cause a recipient to exceed their transfer balance cap. If the death benefit does cause the recipient to exceed their cap, the recipient will have an excess transfer balance. Any death benefits which are over and above the recipient’s transfer balance cap would have to be paid as lump sum death benefit (ie those excess amounts would have to be paid out of the super).
If the recipient already has their own pension account, that existing pension could be commuted to an accumulation account to allow the death benefit pension to be used for the transfer balance account.
At 1 July 2017 Lucy and Trevor each have a pension account of $1.6 million and an accumulation account of $400K. Two years later, Trevor dies. At that time Lucy and Trevor’s pension accounts are each worth $2 million and their accumulation accounts are each worth $500K.
The first option is for Lucy to keep her pension account and her accumulation account. Given she has maxed out her transfer balance cap, she cannot receive any further pensions. Therefore, if the death benefits are to be paid to Lucy, Trevor’s $2.5 million must be paid out to Lucy as a death benefit lump sum. Lucy is left with her $2.5 million in super.
The second option is for Lucy to commute her existing pension back to her accumulation account. This would result in a $2 million debit to her transfer balance account, meaning that her account would be effectively -$400K (ie $1.6 million - $2 million). Lucy could then receive a death benefit pension equal to $2 million. Trevor’s remaining benefits ($500K) would need to be paid as a lump sum to Lucy. Therefore, Lucy would have $4.5 million in super (being the death benefit pension of $2 million and an accumulation account of $2.5 million).
Special rules for reversionary pensions
There is a 12 month deferral for reversionary pensions. This means that the reversionary pension will not cause a debit to the recipient’s transfer balance account until 12 months after it becomes payable to the recipient (typically, a reversionary pension becomes payable upon the death of a member). As a result, a reversionary pensioner has 12 months to sort out the reversionary pension even if that pension would cause the recipient to exceed their transfer balance cap.
For reversionary pensions in existence at 1 July 2017, the 12 month period will commence from 1 July 2017 and end at 30 June 2018. Therefore, such reversionary pensioners have until to 30 June 2018 to commute their pensions (if required) so as to ensure they do not exceed their transfer balance cap.
Timing of the credit
The timing of the death benefit pension credit to the transfer balance account depends on whether the death benefit pension is a reversionary pension or not.
If the death benefit pension is not reversionary, then the credit will occur at the time the death benefit pension becomes payable (ie when the trustee determines to pay it).
If the death benefit pension is reversionary, then the credit will occur 12 months after the pension is payable to the recipient. Typically, that will be 12 months after the death of the member.
Amount of the credit
The amount of the death benefit pension credit also depends on whether the death benefit pension is a reversionary pension or not.
If the death benefit pension is not a reversionary pension, the amount of the credit is determined at the time the death benefit pension is paid to the recipient. This will include earnings that accrued to the pension account between the date of the member’s death and the date the death benefit pension begins to be paid.
If the death benefit pension is a reversionary pension, the death benefit pension is calculated at the time that the reversionary pension becomes payable (typically upon the death of the member).
Jill dies with a pension account worth $2 million. Her benefits are to be paid to her husband David. David has an existing pension account of $1 million while his transfer balance account is $800K. David has an indexed transfer balance cap of $1.65 million.
If Jill’s pension was a reversionary pension, then the reversionary pension would be payable to David from the date of Jill’s death. Twelve months after Jill’s death the reversionary pension has grown to $2.5 million. However, David receives a credit to his transfer balance cap equal to the value of the pension at Jill’s death (ie $2 million). Therefore, he has a transfer balance account equal to $2.8 million (ie his $800K plus the $2 million reversionary pension) and an excess transfer balance of $1.15 million.
If instead, before the 12 months David had commuted the reversionary pension and/or his pension by $1.15 million then he would not have an excess account balance. This could have been effected by commuting his pension back into accumulation and partially commuting his reversionary pension by the balance.
If Jill’s pension was not a reversionary pension, then the death benefits pension would be payable from the time the trustee determines to pay the death benefit. Here, say that occurs 6 months after the death of Jill when the pension has grown to $2.2 million. David decides to commute his existing pension then worth $1.1 million giving him a transfer balance account of -$300K ($800K less $1.1 million). He then receives a death benefit pension of $1.95 million (ie the difference between his transfer balance account of -$300K and his transfer balance cap of $1.65 million). The balance of Jill’s pension ($250K) is paid to David as a death benefit lump sum. David would then hold $3.05 million in super (his death benefit pension of $1.95 million and his accumulation account of $1.1 million).
Rollover of death benefits
The new laws include a welcome change, as the now permit the rollover of death benefit pensions. Under the current laws, when a death benefit pension is rolled over to a new fund, it loses its death benefit status under the tax laws and is taxed as member benefit. This means that recipients of a death benefit pension were “stuck” in their existing fund due to the potential adverse tax consequences of swapping funds.
This will be changed under the new laws so that a rolled over death benefit will retain its death benefit status.
What if a death benefit pension ceases to be in retirement/pension phase?
Both member pensions and death benefit pensions can cease to be in retirement phase in certain circumstances.
Under the new laws a pension will cease to be in pension phase if the super fund does not release an excess transfer balance as required by a commutation authority. The pension will be deemed to cease at the start of the financial year. An auto debit will occur for the full value of the pension at the time required under the commutation authority.
A pension will also cease to be in pension phase if the trustee fails to pay the minimum pension payment. In this situation, the pension will cease at the end of the financial year. An auto debit will occur at that time equal to the value of the pension at the end of the financial year.
In both situations, if an auto debit occurs, then the trustee would need to start a new pension which in turn would cause a credit to the member’s transfer balance account.
There are special rules for death benefit pensions paid to children. Children are effectively given a special child transfer balance cap for death benefits which does not use up their normal transfer balance cap later in life.
The child caps operate differently depending on whether their parent has a transfer balance account at the time of their death.
Parent with no transfer balance account at time of death
Where the deceased parent had no transfer balance account (ie they had never started a pension and their benefits were in accumulation phase), the children may receive pension benefits up to the value of the transfer balance cap at that time. Initially, that will be $1.6 million. Where there is one child that child will receive the full cap. Where the benefits are being paid to multiple children then those children will receive a percentage of their parent’s cap in the same proportion that they will receive the death benefits.
Greg dies with an accumulation account of $2 million. The transfer balance cap is $1.6 million. Under a BDBN Greg gave 50% of his benefits to his child Sally and the other 50% of his benefits to his other two children equally. Each child is aged less than 18.
Sally will receive a child transfer balance cap of $800K (being 50% of $1.6 million) while the other two children will each receive a cap of $400K. Therefore, a pension could be paid to each child equal to their cap (ie $800K to Sally and $400K to the other two children), while the remaining benefits would be paid as lump sums ($200K to Sally and $100K to each of the other two children).
Parent with a transfer balance account at the time of death
Where the deceased parent had a transfer balance account (ie they had started a pension during their life) the children may receive a proportionate share of their parent’s pension benefits in the form of a pension. However, they may not receive any of their parent’s accumulation benefits in the form of a pension.
Michael dies with pension benefit of $1.2 million and an accumulation benefit of $900K. His benefits are to be paid equally to his 2 minor children. Each child can receive a death benefit pension equal to 50% of Michael’s pension (ie $600K). The accumulation benefits must be paid out as lump sum death benefits.
Child pensions must generally be commuted at age 25
As is currently the case, any pensions may only be paid to children if they are aged less than 18, aged between 18 and 25 and financially dependent on the deceased at the time of death or are disabled.
In addition, unless the child is disabled, death benefit pensions payable to children must be commuted once the child turns 25.
Insurance proceeds and allocations from reserves cannot be paid as death benefit pensions to children
If the deceased parent has a transfer balance account, then insurance proceeds and allocations from reserves cannot be paid as death benefit pensions to children. This is because such amounts are treated as accumulation interests which cannot be used to pay death benefit pensions to children (if the parent has a transfer balance account).
Reversionary pensions to minor children
Reversionary pensions to minor children also receive the 12 month deferral before the amounts are counted towards their child transfer balance cap.
Children can have two caps
Children receive a child transfer balance cap from each of their parent. The child cap rules apply independently for each parent’s death benefits in the same way outlined above.
For example, if both of Amy’s parents died and both of them had $2 million in accumulation benefits, then Amy could receive a $1.6 million pension from her mother’s account, a $1.6 million pension from her father’s account and a $800K death benefit lump sum.
Should pensions be paid to children?
For members with minor children it may be advantageous to pay death benefit pensions to children for the purpose of maximising the amount of benefits in super. However, this must be considered in light of whether parents want children to access super benefits at a young age (for example, once they turn 18 they could commute the pension) and the compulsory commuting of pensions at age 25.
Craig has a pension account of $1.6 million and an accumulation account of $2 million. His wife Sarah has a pension account of $1.6 million. Craig dies leaving Sarah and two minor children.
Option 1 is to leave all of his benefits to Sarah. In this case Sarah could take the full $3.6 million as a lump sum death benefit. This would result in Sarah holding $1.6 million in super. Alternatively, Sarah could commute her $1.6 million to accumulation, take a death benefit pension from Craig equal to $1.6 million and take a lump sum death benefit of $2 million. This would result in Sarah holding $3.2 million in super
Option 2 is pay Craig’s pension account equally to his children ($800K each). $1.6 million of the accumulation account could be paid to Sarah, while the remaining $400K would be paid to Sarah as a lump sum benefit. This would result in up to $4.8 million in super. However, the child pensions would need to be commuted when the children turn 25.
Estate planning under the transfer balance cap
Given the complexities in how the new laws operate for death benefits, planning for death benefits will become a lot more complicated. In addition, given that many funds will be required to pay lump sum benefits on the death of the first of a couple, liquidity issues will need to be considered, including how death benefits could be funded.
The following are a number issues that could be considered for a member’s death benefit planning:
- Reversionary pensions generally give a preferential treatment over non-reversionary pensions (given the 12 month delay in counting for the transfer balance cap)
- Existing non-reversionary pensions could be converted into reversionary pensions
- Reversionary pensions to minor children could be considered
- For a couple with a combined balance below the transfer balance cap, not much has changed
- For a couple with a combined balance above the transfer balance cap, flexibility could be preferred to deal with the number of options
- For a couple, each of whom have reached their transfer balance cap, their death benefits could be locked in (especially if they don’t have minor children)
- For couples with minor children, flexibility could be the key to obtain the best result from a tax and structuring point of view
- Non-binding death benefit nominations could be preferred for some members given the number of permutations that the death benefits could take – especially where minor children are involved
- Flexibility to commute existing pensions should be incorporated into pension documents to allow greater flexibility in how death benefit pensions could be paid
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