By Colin Lewis, Head of Strategic Advice, Fitzpatricks Private Wealth
September 2022

The superannuation system is designed to prevent the creation of ‘family dynasties’ with super.

Contribution caps and the total superannuation balance test (TSB) restricting certain types of contributions limit how much can go into it.

The system also ensures that benefits in it ultimately get paid out. The transfer balance cap (TBC) which restricts the amount that can be moved into the tax-free retirement phase extends to death benefits pensions and this is where it may get you.

If your super is within your TBC – like most people – then you may not be worried, but it can be a different story if combined with your spouse’s super when one of you passes away.

On death, benefits must be paid as a lump sum and/or pension as soon as practicable, but generally within six months of passing. A death benefit cannot be retained by a beneficiary in super without it being paid as an income stream.

The advantage of a death benefit pension is the deceased’s super remains invested in an environment where earnings and capital growth are tax-free. It may mean not having to sell a property (or other ‘lumpy’ asset) in an SMSF to pay a lump sum death benefit.

Who can receive a death benefit pension?

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.

Your beneficiary nominations may be structured for your spouse to receive the lot, but if you’re hoping for them to keep as much of your benefit in super as possible – say because the SMSF owns a property you don’t want liquidated – then a problem could arise where they’re limited by their TBC.

This is where kids may come into play.

Death benefit pensions and the TBC

The TBC limits death benefit income streams. Any death benefit pension exceeding an eligible beneficiary’s TBC must be cashed out of super.

The general TBC is $1.7 million, but your TBC will only be this amount if you’ve never moved into retirement phase, nor received a death benefit income stream.

If you moved into retirement phase between 1 July 2017, and 30 June 2021, it will be $1.6 million where you used that amount (or more) to start a pension, but if you used less, your TBC will have been indexed to somewhere between $1.6 and $1.7 million.

If the aim is to retain the maximum possible amount in super, it may be possible to structure your death benefits nominations so that once your spouse’s TBC is exhausted, the excess goes to eligible children where they receive a concessionally taxed income stream from the tax-free environment.

Where a child receives a death benefit pension, a modified TBC – a ‘cap increment’ – applies to recognise the pension is temporary – generally paid only until age 25.

Example

Fred and Wilma have an SMSF which owns a property valued at $2.4 million and has $100,000 in cash.

Fred has an accumulation account with a balance of $2 million. Wilma has an account-based pension (ABP) valued at $500,000 – she started this pension with $400,000 on 1 June 2020.

On 1 August, Fred died with a binding nomination directing the trustee to pay his super to Wilma.

Wilma wishes to keep the property in the SMSF, so she aims to take Fred’s death benefit as an income stream.

Wilma’s personal TBC is $1.675 million – her TBC was indexed by $75,000 having used up only 25 per cent of the original $1.6 million cap.

Wilma transfers her ABP back to accumulation phase before receiving the death benefit pension, but – restricted by her TBC – can only commence a pension of $1.775 million ($1.675 million – $400,000 + $500,000), leaving $225,000 to be cashed out of super.

As the SMSF has only $100,000 in cash, the property may need to be sold.

But given the time of the year when Fred died, Wilma may be able to inject liquidity into the fund by making a non-concessional contribution – her TSB at 30 June 2022 was less than $1.7 million.

If Wilma is ineligible to contribute, the SMSF could make an in specie benefit payment – deed permitting – resulting in the property being owed tenants in common by the SMSF and Wilma.

Had Fred’s nomination been non-binding, the trustee would have had the flexibility to pay their daughter Pebbles (15) a small death benefit pension – thus keeping the property in the fund for the time being.

As Fred never commenced an ABP, Pebbles’ ‘cap increment’ is her share of his TBC.

Should Fred have had an ABP, Pebbles’ cap increment would have been based on her share of Fred’s pension balance – not TBC – which is higher in this case.

While providing for children via your super can be appealing, be aware that they could rush out and spend it the moment they turn 18 as generally nothing prevents them withdrawing it at that age.

The TBC rules differ between reversionary and non-reversionary pensions.

On death, a reversionary pension automatically continues being paid to a nominated dependant. By contrast, a non-reversionary pension stops. A valid dependant may then commence a new income stream from the resulting death benefit.

For TBC purposes, a reversionary pension is reported to the Australian Taxation Office (ATO) at date of death, but it does not count against the beneficiary’s TBC for 12 months. The amount counted at that time is the value of the pension at date of death when it ‘reverted’.

This delay gives the beneficiary – usually the spouse – time to adjust to life following the loss of a loved one and time to make changes, if necessary, to any pension of their own before the death benefit pension counts. That is, they may need to transfer enough of their own pension back to accumulation phase to accommodate the death benefit pension under their TBC.

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.

As you can see, careful planning is required.

*The information in this document (information) has been prepared by Fitzpatricks Private Wealth Pty Ltd (ABN 33 093 667 595, AFSL 247 429) (Fitzpatricks). The information is of a general nature only and does not take into account the objectives, financial situation or needs of any person. Before acting on the information, investors should consider its appropriateness having regard to their own objectives, financial situation and needs and obtain professional advice. No liability is accepted for any loss or damage as a result of any reliance on the information.