If you intend to leave your superannuation to a dependant (e.g. your spouse, child or children) by way of pension as opposed to a lump sum, then it is critical that you have your estate plan reviewed in light of the government’s superannuation changes commencing on 1 July 2017.
From 1 July 2017, a transfer balance cap (TBC) will be imposed on all fund members who are or will be in retirement phase. The TBC limits the amount that an individual may transfer into the tax-free pension phase to $1.6 million.
In addition to impacting the individual during their lifetime, the imposition of the TBC will also affect the beneficiary of the individual’s reversionary pension. This is because the reversionary pension will then count against the reversionary beneficiary’s own TBC, rather than that of the deceased individual.
Even if the deceased individual and their reversionary beneficiary have not each reached the $1.6 million cap, the sum total of their superannuation may exceed the TBC. For example:
Mr Smith dies leaving a reversionary pension to Mrs Smith in the amount of $900,000. Prior to Mr Smith’s death, Mrs Smith had commenced a superannuation income stream of $800,000. The $900,000 reversionary pension causes a credit to be added to Mrs Smith’s transfer balance amount, giving her a sum total of $1.7 million transferred. Mrs Smith has now exceeded her TBC by $100,000.
Where an individual breaches their TBC, the Australian Taxation Office will tax the notional earnings of the amount by which the individual has exceeded their TBC at the rate of 15% or more. In addition, the general interest charge will then begin accruing against any unpaid tax debt at a rate of 9% compounded daily.
The superannuation changes allow the commutation of superannuation funds held in pension phase to accumulation phase, which then acts as a debit towards the individual’s TBC. However, in the case of a death, the critical issue is timing.
Where the deceased individual’s superannuation trust deed provides the trustee with no discretion as to whether to pay the reversionary pension, the deceased individual is said to have held an automatic reversionary pension at the time of his or her death. In this case, on the deceased’s death, the reversionary beneficiary has three options:
The latter two options remove funds from the tax-friendly superannuation environment. The first option is the most desirable and, only in the case of an automatic reversionary pension, the reversionary beneficiary has a period of 12 months from the date of the deceased’s death to commute before the reversionary pension is counted towards their TBC. This affords the reversionary beneficiary with plenty of time to seek financial advice and commute an amount equivalent to that which would exceed their TBC prior to incurring any penalties.
In contrast, where discretion is given to the trustee of the superannuation fund (under the terms of the trust deed) as to whether to pay the reversionary pension, no 12 month ‘grace period’ is afforded to the reversionary beneficiary and the pension is counted against the beneficiary’s TBC immediately upon becoming payable – potentially leading to an excess of the TBC and consequent penalties, unless the beneficiary elects to take funds out of the tax-friendly superannuation environment and receive them as a lump sum.
In light of the above, it is important that anyone intending to leave their superannuation to a dependant by way of a reversionary pension on their death seek expert advice as to whether their current superannuation arrangements may cause their intended beneficiary to breach the new TBC.
If so, the preparation of a deed amending the terms of your superannuation fund and, further, careful structuring of their death benefit nomination form and entire succession plan, will help your beneficiary to avoid potential taxation liabilities and allow them the time to grieve before having to attend to complex legal and financial matters.
If you require any further information in relation to this update, please do not hesitate to contact Teresa Catalano (Partner and Victorian Accredited Wills and Estates Specialist) or James Birnie.