What indexation means to inheritance
By Colin Lewis, Head of Technical Services, Fitzpatricks Private Wealth
We have a superannuation system designed to limit how much can go into it and ensure that money in it must ultimately come out. It prevents the creation of ‘family dynasties’ with super—something cleverly stamped out in 2017 with the introduction of two measures.
One is the total superannuation balance test limiting certain contributions and the other is the transfer balance cap (TBC) which restricts the amount that can be moved into the tax-free retirement phase—and this extends to death benefit pensions.
From 1 July, both these measures—and the contribution caps—are increasing which may give you the opportunity to get more into super and keep more in it.
Keeping money in super after death
Superannuation death benefits must be paid as a lump sum and/or income stream and cannot be retained by a beneficiary in accumulation phase.
The advantage of a death benefit pension is the deceased’s super remains invested in an environment where the underlying earnings and capital growth are tax-free. And if the deceased was, or their beneficiary is, aged 60 or more then the pension payments are tax-free. You cannot get better than this.
Who can receive a death benefit income stream?
Only certain beneficiaries can receive a death benefit pension. They are your spouse, a person with whom you are in an interdependency relationship, someone financially dependent on you and a child under 18 years of age, or 18 but less than 25 and financially dependent on you, or 18 or more with a disability.
A child receiving a death benefit pension must withdraw it as a tax-free lump sum no later than their 25th birthday, unless they suffer from a disability.
Generally, a spouse is front of mind to receive the lot, but the amount they can receive as an income stream is limited and this is where the kids could come into play if there are any of the right age.
Death benefit pensions and the transfer balance cap
The TBC limits death benefit income streams. Any death benefit pension exceeding an eligible beneficiary’s TBC must be cashed out of the super system.
This is where indexation of the TBC helps because it may lead to a dependant being able to receive more as a death benefit pension—thus keeping more in super.
From 1 July this year, the general TBC is being indexed from $1.6 million to $1.7 million. However, everyone will have their own personal TBC between these amounts.
Your TBC will be $1.7 million if you have not transferred any super into retirement phase, nor received a death benefit income stream before 1 July.
It will continue unchanged at $1.6 million where before 1 July you’ve had that amount or more in retirement phase any time between 1 July 2017 and 30 June 2021.
If you’ve never reached $1.6 million and thus have not fully utilised your cap, your TBC will be proportionally indexed based on the highest ever amount you’ve had in retirement phase and it will be between $1.6 and $1.7 million.
If a child receives a death benefit pension, a modified TBC—a ‘cap increment’—applies to recognise the pension is only temporary, generally paid only until age 25.
The TBC rules differ between reversionary and non-reversionary pensions
A reversionary pension automatically continues being paid on death to a nominated dependant—the pension does not cease. By contrast, a non-reversionary pension ceases on death and where a dependant commences an income stream from the resulting death benefit then an entirely new pension commences, e.g. a pension with a binding death benefit nomination to a dependant who takes the death benefit as an income stream is not a reversionary pension.
For TBC purposes, a reversionary pension is reported to the Australian Taxation Office (ATO) at date of death (DOD), but it does not count against the beneficiary’s TBC until the 12-month anniversary of the deceased’s death. The amount counted at that time is the pension value when the income stream ‘reverted’ to the beneficiary, i.e. DOD.
This delay gives the beneficiary—usually the spouse—time to adjust their life after the death of a loved one. From a financial planning perspective, the dependant can retain any pension of their own and the deceased’s pension in a tax-free environment for a year during which time they can make any necessary adjustment to their own pension before the death benefit pension is counted. For example, they may have to transfer enough of their own pension back to accumulation phase to accommodate the death benefit income stream.
Take Fred who has an account-based pension with his wife Wilma being the nominated reversionary beneficiary.
Fred died on 15 June 2020 and his pension—valued at $1.65 million—reverted to Wilma. On 15 June 2021, the pension is counted against her TBC. The balance has grown to $1.8 million, but only $1.65 million counts—reversionary pensions work well in a rising market, but not so good in a declining market.
The death benefit pension causes Wilma to exceed her TBC—$1.6 million in 2020/21—and she receives an excess transfer balance determination from the ATO for $50,000 (not $200,000) which must be cashed out of super.
Barney on the other hand died on 15 July 2020—a month after Fred—with a reversionary pension to his wife Betty. His pension was valued at $1.69 million. On 15 July 2021, when the pension is counted against Betty’s TBC, the balance is $1.9 million, but only $1.69 million counts.
Betty has never had her own super pension, so she gets the full $100,000 indexation of the TBC and her personal TBC from 1 July 2021 is $1.7 million. With the benefit of this indexation, the death benefit pension does not cause Betty to exceed her TBC, so unlike Wilma, nothing needs to be cashed out.
A non-reversionary pension, on the other hand, is counted against the beneficiary’s TBC on the date the death benefit pension commences for its value at that date.
If Fred had a non-reversionary pension instead, it would be up to Wilma to commence a death benefit income stream.
Say Wilma used $450,000 of Fred’s $1.65 million death benefit to pay off the mortgage and used the remainder to commence a death benefit pension on 1 November 2020, then $1.2 million is counted against her $1.6 million TBC. This leaves Wilma with an unused cap amount of $400,000 which may be used to start a pension from her own super.
If Wilma waits until the new financial year to commence a pension, her unused cap percentage will be 25 per cent of $1.6 million and her TBC will be indexed by 25 per cent of $100,000. Accordingly, her personal TBC will be $1.625 million from 1 July and she’ll be able to commence a pension with $425,000, not $400,000.
Indexation of the TBC on 1 July may give you the opportunity to keep more in super.