25 August 2019
By Colin Lewis, August 2019
Back in November 2015, the then Treasurer Scott Morrison enunciated the view that “Super was never designed to be an open-ended vehicle for wealth creation.”
So, we now have a superannuation system that is designed to limit how much can go into it and ensure that money in it must ultimately come out. Thus, preventing the creation of ‘family dynasties’ with super.
This is cleverly done via two measurers. The total superannuation balance test which limits certain contributions and the transfer balance cap which restricts the amount that can be moved into the tax-free retirement phase, which extends to death benefits pensions.
Superannuation death benefits must be paid as a lump sum and/or income stream. A death benefit cannot be retained by a beneficiary in accumulation phase.
Having to payout a death benefit in the event of a member’s death may be an issue for an SMSF invested in property or other ‘lumpy’ asset(s). So, careful planning is required.
Who can receive a death benefit pension?
Only certain dependants can receive a death benefit pension. They are 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’s 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.
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.
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. The problem is that your spouse may be limited on how much they can retain in super.
Death benefits and the transfer balance cap
The $1.6 million transfer balance cap limits death benefit pensions. For beneficiaries eligible to receive a death benefit pension, this cap forces the withdrawal of benefits in excess of their transfer balance cap.
If the aim is to retain as much as possible in super, it may be possible to structure your estate plan, with appropriate death benefits nominations, that once your spouse’s transfer balance cap 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 transfer balance cap
If a child receives a death benefit pension, a modified transfer balance cap (‘cap increment’) applies to recognise the pension is only temporary – generally paid only until age 25 – and that the child’s transfer balance cap will come into effect for their own superannuation savings on retirement. Thus, their transfer balance account – the account set up by the Australian Taxation Office to track progress against their transfer balance cap – won’t be affected by benefits received as a child.
There can be a significant difference in value of a death benefit pension paid to an eligible child as the cap increment depends on whether the deceased parent had a transfer balance account, i.e. whether they had a retirement phase income stream.
A retirement phase income stream is a super pension/annuity, e.g. account-based pension, but does not include a transition to retirement pension that is not in retirement phase.
Where the parent had a transfer balance account, 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, Rochelle has an account-based pension of $1.2 million and an accumulation balance of $400,000. She has nominated her two children Milena (aged 17) and Brendan (aged 15) to receive her super on death, split 50:50. Rochelle has a transfer balance account due to her account-based pension, so if she dies each child has a cap increment of $600,000 (50 per cent of $1.2 million), being their share of Rochelle’s pension. 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.
However, where the parent didn’t have a transfer balance account – i.e. they’ve never had a retirement phase income stream – the child’s cap increment is their share of the parent’s transfer balance cap.
Take Richard who has an accumulation balance of $2 million with a death benefit nomination in favour of his two children Adam (aged 26) and Hannah (aged 17) split 50:50. If he dies, only Hannah is eligible to receive a death benefit income stream. As Richard never had a retirement phase income stream and thus didn’t have a transfer balance account, Hannah has a cap increment of $800,000 (50 per cent of $1.6 million). Thus, each child receives a death benefit of $1 million with Hannah’s benefit comprising a child pension of $800,000 and lump sum of $200,000.
While providing for children via your super is appealing, most wouldn’t appreciate the kids rushing out and spending it the moment they turn 18 – entirely possible even if they receive a death benefit pension as generally nothing prevents them withdrawing it at that age. However, directing your death benefits to your estate via your legal personal representative may allow for a testamentary (discretionary) trust to be established and give you more control in how your super proceeds and other assets are used. Junior might be forced to wait until say 28 years of age by which time may have found a sensible use for the money.