By Colin Lewis, Head of Strategic Advice, Fitzpatricks Private Wealth
August 2024

To revert, or not to revert, that is the question

When the time comes to access your super, starting a pension – after paying off the mortgage, funding renovations, replacing the car, taking a holiday, whatever – is one of the smartest things you could do.

Unless you’re going to receive a defined benefit pension from say a government scheme, there’s decisions to make like when to start the pension, e.g. deferring it to 1 July may mean getting more into the tax-free retirement phase if the transfer balance cap (TBC) is indexed, how much pension income to draw, the frequency of payments, and importantly, what to do with it when you pass away.

Assuming your super fund gives you the choice, do you make it reversionary where your pension automatically continues on death to a beneficiary, or non-reversionary where it’ll cease, in which case the pension balance becomes a death benefit which will then be paid out under the fund’s death benefit payment process.

This decision is made when starting an account-based pension, e.g. where you’ve turned 65 or retired from age 60, or transition to retirement (TTR) pension, where you’ve reached 60 but still working.

But first, should you wish to make your pension reversionary, you need to know who may be nominated as a beneficiary as only certain people can receive your super as an income stream on death.

They are your spouse, a financial dependent, a person with whom you’re in an interdependency relationship, a child under 18, or under 25 if financially dependent and a child with a disability. A child pension must be withdrawn (tax-free) no later than the child’s 25th birthday, unless they have a disability.

So, what’s the difference between a reversionary and non-reversionary pension?

Reversionary pensions

A reversionary pension is established from the outset – noted in the pension documentation.

It’s a contract – binding arrangement – between you and the fund trustee to continue making regular pension payments on death to your nominated beneficiary (in all likelihood your spouse).

The beneficiary has peace of mind knowing they’ll continue receiving income into their bank account.

There’s no death benefit because the income stream doesn’t stop – the pension ceases and a death benefit arises on the subsequent death of the reversionary beneficiary.

Whilst your beneficiary is spared from having to chase your super, the fund will still want to establish that you’ve died and need things like a death certificate.

Account-based pensions (and TTR pensions) require a minimum pension payment each year based on the pension balance and your age, and a reversionary pension still requires a payment in the year of death because the pension hasn’t ceased.

From 1 July of the following year, the minimum payment will be based on the beneficiary’s age.

If circumstances change, e.g. your spouse dies before you or you divorce, you need to alter your beneficiary nomination. To do this, you may have to start a whole new pension with an updated beneficiary nomination, or you might be able to simply change the nomination on your existing pension, but this hinges on the requirements of your fund’s trust deed.

Non-reversionary pensions

A non-reversionary pension ceases on death – a grieving spouse may find they’re suddenly without income.

The pension balance forms a death benefit, so you’ll need to make a death benefit nomination – binding or non-binding.

Having a valid binding nomination means the fund trustee must pay your death benefit to the nominated beneficiary after they’ve got all relevant documentation.

Whereas the trustee exercises its discretion with a non-binding nomination which may take time while the rightful beneficiaries to the benefit are established under the fund’s death benefit payment process.

Dealing with super is the last thing a spouse who’s just lost a loved one wants to do, but necessary if they wish to establish a pension to receive regular income.

A minimum pension payment is not required for an account-based pension (or TTR pension) in the year of death.

Where a death benefit pension is commenced from the resulting death benefit, a minimum payment is required based on the starting balance and beneficiary’s age.

Both reversionary and non-reversionary pensions are flexible when it comes to accessing money – just withdraw it – unless it’s a TTR pension not in retirement phase.

With a reversionary pension, you can make lump sum withdrawals and after death, your beneficiary can do the same.

With a non-reversionary pension, you can make withdrawals. After death, if your beneficiary has taken an income stream, they can make withdrawals from the new pension.

Transfer balance cap (TBC)

Another important consideration is the TBC which limits how much can be moved into retirement phase and includes income streams paid on death.

Currently, the cap is $1.9 million unless a lower personal TBC applies because a pension has previously been commenced.

With a reversionary pension, its value at date of death is counted towards your beneficiary’s TBC on the 12-month anniversary of your death – great if markets go up but not so good if they go down.

Where your beneficiary will exceed their TBC, the 12-month grace period gives them time to arrange their affairs to prevent this happening.

With a non-reversionary pension where your beneficiary takes a death benefit pension, it’s the value of the new pension when it commences that counts against their TBC.

Death benefits must be paid as soon as practicable. With a rule of thumb of six months, there isn’t as much time to plan, but it allows your beneficiary to better target their TBC – start a pension with the right amount rather than pulling money out of an existing pension.

Take Frank and Marie who both started reversionary pensions with $1.2 million when the general TBC was $1.6 million.

On 1 May 2024, Frank died and his pension worth $1.4 million, reverted to Marie.

On 1 May 2025, $1.4 million will count towards Marie’s TBC even though the pension is worth $1 million after their SMSF made a bad investment.

Marie’s personal TBC is $1.675 million (with indexation).

To avoid exceeding her TBC, Marie must commute $925,000 ($1.2M + $1.4M – $1.675M) from her pension back to accumulation phase (or withdraw it) before Frank’s pension counts.

On 1 May 2025, Marie has $925,000 in an accumulation account and two pensions running – her pension worth $75,000 ($1M – $925,000) and the reversionary pension worth $1 million.

Had Frank’s pension been non-reversionary, Marie could have commenced a death benefit pension with $475,000 ($1.675M – $1.2M) and taken a $525,000 lump sum death benefit. With her pension of $1 million, Marie would’ve had $1.475 million in retirement phase – $400,000 more in the tax-free environment.

Death benefits cannot be combined with non-death benefit money, so Marie’s pensions cannot be combined.

Insurance

Most people in retirement don’t have life insurance in super but there are circumstances that still warrant having it – e.g. a husband in a second marriage with a younger wife and young children wanting to look after the family in the event of death.

It’s particularly attractive to have insurance with a reversionary pension because the proceeds on death are added to the pension without being counted against the beneficiary’s TBC.

Assume the husband on death had a reversionary pension worth $1.5 million plus insurance of $800,000. The pension balance is $2.3 million but only $1.5 million counts to the wife’s TBC. Whereas if it was non-reversionary, the wife could only commence a death benefit pension with $1.9 million – $400,000 less, which must come out of super.

Making a pension reversionary shouldn’t be automatic and done as a matter of course. It needs careful consideration as part of your overall estate plan to get the outcome you want.