1. Death Benefits overview
When a person dies, an individual beneficiary may be entitled to receive a death benefit from the deceased member's super fund either in the form of:
- a lump-sum cash payment made to the beneficiary 'outside super' — that is, the lump-sum is no longer held or managed in the superannuation system: these payments can generally be made only to the deceased's dependants or legal personal representative; or
- as a superannuation income stream (that is, a pension): these payments can be made by the fund only to certain of the deceased's dependants — as discussed below: while each pension payment is made to the beneficiary outside super, the capital supporting the pension continues to be held and managed in the superannuation system.
This article looks into the implications of the new laws insofar as SMSFs and account-based pensions are concerned.
2. Current laws recap — when can a death benefit be paid as a pension rather than a lump-sum?
When a member dies, the current laws require that their super benefits are cashed out 'as soon as practicable' after their death. The new laws don't change this requirement.
These benefits can only be cashed to a beneficiary as a pension if the beneficiary is a certain type of 'dependant' at the time of the member's death. We refer to these dependants as 'pension dependants', and is a person who at the time of death was:
- a spouse of the deceased;
- a child of the deceased (less than 18 years of age, or financially dependent and less than 25 years of age, or has a disability); or
- in an interdependency relationship with the deceased.
While a child can receive a death benefit as a pension, that pension must be commuted and paid to the child as a lump-sum by the time the child turns 25 (unless they have a disability).
Under the current super and income tax laws, a super death benefit:
- cannot be paid by the fund to the accumulation phase of another member — if it is paid to an eligible dependant, then it must be paid as a pension or as a lump-sum outside of super;
- cannot be paid by the fund to another fund, except for the purpose of immediate cashing out as a lump-sum.
3. The $1.6 million transfer balance cap — how is it calculated and how can it be managed?
Further discussion on the transfer balance cap and how it can be managed can be found in our ClearLaw January 2017 article titled "Superannuation reforms".
4. So when does a person have, or start to have, a transfer balance account?
A person has a transfer balance account if, as at 30 June 2017, they are receiving a retirement phase pension. In this instance, the member's transfer balance account comes into existence on 1 July 2017.
On one reading of the new laws, a person may also have a transfer balance account as at 1 July 2017 if they have received a pension before this date but the assets funding the pension have since been exhausted.
Otherwise, the member's transfer balance account arises as soon as they start a retirement phase pension.
5. Does the transfer balance cap impact on when a death benefit can be paid as a pension?
5.1 Yes, first where spouses are beneficiaries:
When a death benefit is being or to be paid to a spouse, one must consider the transfer balance cap of the beneficiary spouse: namely, whether paying a pension will cause the spouse to exceed their transfer balance cap.
If paying the pension to the beneficiary spouse would result in them exceeding their transfer balance cap, then some or all of the death benefit would need to be paid to them as a lump-sum payment outside of super.
Alternative ways to work around these issues are discussed below at paragraph 6.
5.2 Yes, secondly where children are beneficiaries:
Under the new laws, child beneficiaries do not start with a simple cap limit on amounts held in their transfer balance accounts, that is, they do not have a general transfer balance cap imposed on them. Rather, how a child's transfer balance cap is determined depends on:
- whether the deceased parent had any savings in the 'retirement phase' at their time of death; and
- whether the deceased parent had a transfer balance account at their time of death.
If the deceased parent did not have a transfer balance account
If before passing away, the deceased parent does not have a transfer balance account, then the child's transfer balance increment (that is, effectively the child's transfer balance cap ) is either:
- $1.6 million if they are the sole beneficiary; or
- if there are other dependants entitled to a portion of the total death benefit to be distributed — $1.6 million multiplied by the child's proportional entitlement to the death benefit.
In this instance, the trustee can pay death benefits to a child as a super income stream up to the child's transfer balance increment, with any excess being paid as a lump-sum outside of super.
If the deceased parent did have a transfer balance account
If the deceased parent is taken to have a transfer balance account on and from 1 July 2017 and also had part of their super savings in an accumulation account, then the situation becomes slightly more complex. In this situation, the main rules are:
- The child's transfer balance increment will be represented by the amount of the death benefit pension received from the parent's retirement phase account;
- Accordingly, any death benefit pension to a beneficiary child must be sourced solely from the deceased parent's retirement phase account;
- Conversely, an eligible pension dependant who is a child cannot be paid a death benefit pension if it, or any part of it, is sourced from the deceased parent's accumulation account;
- If any part of the child's death benefit pension is sourced from the deceased parent's accumulation account — then this automatically causes the child to exceed their transfer balance cap;
- Because a transition to retirement phase income stream (TRP) is not a 'retirement phase' pension, a death benefit pension to a beneficiary child cannot be sourced from the deceased parent's TRP pension account.
- If a death benefit is paid to the child from an accumulation account or TRP account, then the child's relevant transfer balance increment is $0. Therefore, the benefit can only be paid to the child as a lump-sum outside of super.
Alternative ways to work around these issues are discussed below at paragraph 7.
6. Are there any alternative options to work around these issues?
6.1 Yes — commute a beneficiary spouse's own pension, to create room under the spouse's transfer balance cap
Where payment of a death benefit pension would cause a beneficiary spouse to exceed their transfer balance cap, a number of alternative solutions exist in order to retain the funds in the concessionally taxed super environment.
One reason the beneficiary spouse's transfer balance cap may be exceeded, is if they have their own transfer balance account.
So, if the receipt of the death benefit pension is likely to result in them exceeding their cap, and they have capital which is funding a retirement phase pension, then the beneficiary spouse should consider commuting the excess funds out of their retirement phase account and into their accumulation account.
The death benefit pension can then be paid to the beneficiary spouse as a death benefit pension to the limit of the spouse's transfer balance cap. This means that:
- the spouse maximises the balance of their super accounts (and therefore any earnings on assets in these accounts will be taxed concessionally); and
- likewise, it minimises the amount which must be paid to the spouse as a death benefit lump-sum outside super.
6.2 Yes — make current pensions reversionary
It will be preferable for any current pensions to be structured as reversionary pensions (see discussion on what is a reversionary pension at item 8 below).
Why? Because — assuming the beneficiary was an eligible pension dependant — the beneficiary of the death benefit will have a 12 month period before the deceased's pension income stream is credited into the beneficiary's transfer balance account. The idea behind this is that the beneficiary has 12 months to organise their affairs in preparation for the addition of this amount to their transfer balance account. Accordingly:
- rather than having to immediately make the arrangements referred to in paragraph 6.1 in respect of the beneficiary's existing super balances, they will have 12 months to make those arrangements; and
- throughout that period, the augmented balance of the beneficiary's retirement phase superannuation accounts:
- remain in retirement phase, with the benefit of the earnings tax exemption; and
- do not have to be either commuted to an accumulation account (to which an earnings tax exemption does not apply), nor cashed out of the super system.
7. Are there any options to better accommodate child beneficiaries?
7.1 Yes — if deceased has both accumulation and pension phase accounts, parties should explore distributing pension to child and accumulation account to spouse as a pension
Where the deceased parent has superannuation in both their retirement phase accounts and accumulation accounts, in order to avoid a child exceeding their transfer balance increment, the deceased's fund should consider distributing the pension to a child beneficiary (because any payment to a child sourced from an accumulation account must be paid as a lump-sum outside of super).
Accordingly, any funds remaining in the deceased's accumulation account can be distributed to a remaining spouse as a pension. The condition is that this does not cause the remaining spouse to exceed their own transfer balance cap. If this is the case, the fund will be required to distribute this amount to the spouse as a lump-sum outside of super.
7.2 Also — the decision to start a pension from part of accumulation savings should not be taken lightly
If a deceased parent had a transfer balance account throughout their lifetime but the assets supporting the pension were exhausted before they passed away, the transfer balance account is still a relevant consideration. In that situation:
- assume the deceased had a balance in their accumulation account, from which death benefits may be funded;
- the deceased had a pension account balance of nil;
- the deceased still has a transfer balance account; and
- the death benefits can only be sourced from the accumulation account.
This would mean any death benefit paid as a pension to a child beneficiary will result in the child automatically exceeding their transfer balance increment and will therefore need to be paid to the child outside of super as a lump-sum.
John dies on 1 July 2018. During his lifetime he was being paid a pension from his super. However, in 2016 all of the assets funding this pension were exhausted. At the time of death, John still has $500,000 in his accumulation account.
John's daughter, Stacey, is a dependant beneficiary who is entitled to receive a death benefit as an income stream. If Stacey were to request payment of the death benefit as an income stream, under the super laws it would automatically result in her exceeding her transfer balance cap (as it has been sourced solely from the parent's accumulation account). Accordingly, Stacey is left with no option but to request that the death benefit be paid to her as a lump-sum outside of super.
From this example, it can be seen that a child beneficiary with a deceased parent that never commenced a pension is ultimately in a better position than a child with a deceased parent who commenced a pension but exhausted all the assets supporting this pension.
7.3 Also — parties should ensure a deceased's TRP definitely becomes a 'retirement phase' pension once a condition of release is met
After a person reaches their preservation age they can access income by way of a TRP. Accessing a TRP enables individuals to receive an income stream from their super assets with the idea that individuals will need to work less hours whilst receiving this income. Limits apply to commuting that pension, and to maximum annual payments, until the person satisfies a condition of release in respect of which the cashing restriction for preserved benefits or restricted non-preserved benefits is 'nil'  (nil cashing restriction).
From 1 July 2017, a TRP will not be a retirement phase pension. So, further to the example above, if at the time of his death John was receiving a TRP supported by pension assets of $500,000, Stacey still could not be paid the death benefit as a pension.
So if a person commences a TRP, it is essential that when the nil cashing restriction is met, the TRP becomes a 'retirement phase' pension. Ideally this should occur automatically and the legislation may have this effect. However to put the matter beyond doubt, the pension terms should themselves be drafted so as to have this effect. This:
- ensures the earnings tax exemption applies to the assets funding the pension; and
- on the member's death, the assets funding the pension can be paid to an eligible dependant child as a pension.
8. What is a reversionary and non-reversionary (discretionary) pension
A death benefit income stream can either be a reversionary or non-reversionary pension. A reversionary pension automatically reverts to a named beneficiary upon the death of an individual.
A non-reversionary pension affords the trustee of the deceased's fund the discretion to decide which beneficiary will receive the pension, depending on the nature and form of instructions (if any) provided by the deceased member to the trustee.
9. Deadline to cash out a super death benefit v timing of transfer credit to beneficiary's transfer balance account
When a member dies, the current laws require that their super benefits be cashed 'as soon as practicable' after their death. This requirement is not changed by the new laws.
Whether a death benefit income stream is considered reversionary or non-reversionary:
- does not affect the trustee's obligation to pay the death benefit (whether as a lump-sum or pension(s) or combination) as soon as practicable after the member's death;
- does affect the timing of when the pension to the beneficiary is eventually credited to the beneficiary's transfer balance account.
In the case of a reversionary pension, the new laws give the trustee and beneficiary a 12 month period to get their affairs in order before the beneficiary's transfer balance account is credited with an amount representing the value of the capital supporting the pension. This will give the beneficiary sufficient time to make any necessary commutations to ensure they do not exceed their transfer balance cap (or transfer balance increment in the case of a child) when the income stream is eventually credited to their transfer balance account.
In the case of a non-reversionary pension, the new laws provide that the beneficiary's transfer balance account will be credited on the same day on which the beneficiary becomes entitled to receive the pension, that is, on the day the trustee decides how and when to distribute the death benefit. Therefore the beneficiary of a non-reversionary pension does not benefit from a delayed credit of the death benefit into their transfer balance account.
10. Ability to roll-over superannuation death benefits
The new laws give the beneficiary of a death benefit the ability to choose the fund from which their super income stream will be paid.
Where a death benefit beneficiary is entitled to receive a death benefit as a pension, then the new laws enable the beneficiary to roll-over the death benefit into a fund of the beneficiary's choice. The death benefit must then be paid as a pension.
The ability to roll-over does not apply where the death benefit can only be paid to a beneficiary as a lump-sum outside of superannuation.
11. Next steps
Given these reforms, it is evident that individuals and the recipients of death benefits will need to consider a number of issues when taking a death benefit as a pension income stream, including but not limited to transfer balance cap considerations.
More information from Maddocks
For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Superannuation team.
More Cleardocs information on related topics
You can read earlier ClearLaw articles on a range of topics.
Order Cleardocs SMSF packages
- Set up an SMSF
- SMSF set up + register corporate trustee
- Update an SMSF deed
- Set up an SMSF pension
- Create an SMSF Investment Strategy
- Arrange SMSF borrowing documents:
- SMSF Death Benefit Nomination — binding or non binding
- SMSF Death Benefit Agreement — binding and permanent
- SMSF Wind Up
- SMSF Minutes & Resolutions Package
 Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 and the Superannuation (Excess Transfer Balance Tax) Imposition Act 2016.
 Regulation 6.22(2) of theSuperannuation Industry (Supervision) Regulations 1994 (SIS Regulations).
 Regulation 6.21(1) of the SIS Regulations.
 Regulation 6.21(2A) of the SIS Regulations.
 Regulation 6.21(2B) of the SIS Regulations.
 Regulation 6.21(3) of the SIS Regulations.
 Item 4 of Schedule 1, subsection 294-15 of the Income Tax Assessment Act 1997.
 Item 4 of Schedule 1, subsection 294-185(1) of the Income Tax Assessment Act 1997.
 Item 4 of Schedule 1, subsection 294-200(3) of the Income Tax Assessment Act 1997.
 Item 4 of Schedule 1, paragraph (b) of column 3 in item 2 of the table in subsection 294-25(1) of the Income Tax Assessment Act 1997.
 Item 4 of Schedule 1, subsection 294-200(4) of the Income Tax Assessment Act 1997.
 See definition of "Preservation age" in regulation 6.01 of the SIS Regulations.
 Schedule 1 to the SIS Regulations.
 Regulation 6.21(1) of the SIS Regulations.
 Schedule 1, item 4, subsection 294-25 of the Income Tax Assessment Act 1997.