Super Death Benefits & Children
By Colin Lewis,
Head of Technical Services,
Fitzpatricks Private Wealth
Don’t forget the kids
Most people are surprised to learn that superannuation is not an estate asset and is therefore not dealt with via your will, unless you specifically leave it to your legal personal representative – typically the executor of your estate.
Until now, you may not have thought about leaving your super specifically to your kids. Your spouse may have been front of mind and you’ve structured your estate plan for them to receive the lot.
Who can receive a death benefit pension?
Superannuation death benefits must be paid as a lump sum and/or income stream.
Only certain dependants are eligible to receive a death benefit pension. They include your spouse, a child, a person with whom you are in an interdependency relationship and someone financially dependent on you.
Where the dependant is a child, they must be under 18 years of age, or age 18 but less than 25 and financially dependent on you, or age 18 or more with a disability.
In this age of blended families, it is important to note that unless adopted, a stepchild/step-parent relationship ends when the marriage ceases, i.e. on death of the biological parent, or divorce of the biological parent and step-parent.
If a child receives a death benefit pension, it must be withdrawn as a tax-free lump sum no later than the their 25th birthday, unless they suffer from a disability.
Death benefits and the transfer balance cap
Up until July last year, if your spouse wished to keep your entire death benefit in the superannuation system they could have by taking it as an income stream. For the majority this will still be the case, however for many, the problem is that your spouse may now be limited on how much they can retain in super.
The $1.6 million transfer balance cap (TBC) introduced 1 July 2017 limits death benefit pensions. For beneficiaries eligible to receive a death benefit pension, this ‘cap’ now forces the withdrawal of benefits in excess of their TBC. This may not necessarily be all that bad as the lump sum paid to your spouse is tax-free. However, unless they use it to say pay down the mortgage, go on a trip, or put it to some other use, they’ll have to invest it outside super where earnings and capital gains are taxed at their marginal rate which may not be as attractive as if the money had stayed in super.
So, if you’d prefer for the excess of their TBC to stay in super, it may be possible to structure your estate plan, with appropriate death benefits nominations, that once your spouse’s TBC is exhausted, the excess goes to your eligible children where they receive a concessionally taxed income stream which remains in a tax-free environment.
Child pensions and the TBC
Where children receive a death benefit pension, a modified TBC (referred to as a ‘cap increment’) applies. This recognises that the death benefit pension is only temporary – generally paid only until age 25 – and that their TBC will come into effect for their own superannuation savings when they ultimately retire. Thus, their transfer balance account (TBA) – the account set up by the Australian Taxation Office to track progress against their TBC – will not be affected by any benefits they received as a child.
The ‘cap increment’ for child pensions depends on whether the parent had a TBA. To have a TBA the parent must have commenced a ‘retirement phase’ income stream since 1 July 2017 or had one in place at date. A retirement phase income stream is a super pension/annuity, e.g. account-based pension (ABP), but does not include a transition to retirement pension.
Where the parent had a TBA, the child’s cap increment is their share of the parent’s pension balance only – it applies to child pensions sourced solely from retirement phase interests of the parent.
For example, Christine has an ABP of $1.2 million and an accumulation of $400,000. She has a binding death benefit nomination (BDBN) to her two children Bec (17) and Sarah (15) split 50:50. Christine has a TBA, so if she dies each child has a ‘cap increment’ of $600,000 (50 per cent of $1.2 million), being their share of Christine’s ABP. They cannot take any of her accumulation interest as a pension. Thus, each child can receive a pension of $600,000 and lump sum of $200,000.
For child pensions started before 1 July 2017 where the parent had a TBA, the cap increment is $1.6 million.
However, where the parent didn’t have a TBA – that is, they haven’t had a retirement phase income stream in the new regime – the child’s cap increment is their share of the parent’s TBC.
Take Ian who has an accumulation balance of $1.8 million and a BDBN in favour of his two children Monique (26) and Robbie (17), split 50:50. If he dies, only Robbie is eligible to receive a death benefit income stream. As Ian didn’t have a TBA, Robbie has a ‘cap increment’ of $800,000 (50 per cent of $1.6 million). Thus, each child can receive a death benefit of $900,000 with Robbie’s benefit being paid as a child pension of $800,000 and lump sum of $100,000.
There is a significant difference in the way a death benefit can be paid to an eligible child as it depends on whether the deceased parent had a TBA. This difference highlights an inequity in the system to potential child beneficiaries.
Take an extreme case for example. John and Ingrid both have accumulation balances of $1 million. John has a TBA because he started an ABP last September but has since commuted it back to accumulation phase. Ingrid has never started a retirement phase income stream and thus does not have a TBA. If they died, John’s children cannot take any of his death benefits as an income stream, whereas Ingrid’s only child could take a death benefit pension of $1 million.
While providing for children via your super is likely to appeal to many Australians, most wouldn’t appreciate the kids rushing out and buying a Porsche with the proceeds the moment they turn 18 – which is entirely possible even if they receive a death benefit pension as generally nothing prevents them withdrawing it at that age. However, directing your death benefit to your estate via your legal personal representative could allow for a testamentary (discretionary) trust to be established and allow you more control in how your super proceeds and other estate assets are used. Junior might be forced to wait until she’s 28 before she can buy that Porsche, and by that age may have found more sensible uses for the money.