Changes to the treatment of superannuation death benefits took effect on 1 July this year as part of the Government’s ‘fair and sustainable’ super reforms. These changes may significantly impact the alternatives available to a person who is eligible to receive a super benefit following the death of a super annuity or pension recipient.
The new rules for super death benefits offer more flexibility in some respects, and less flexibility in others.
Super annuity and pension death benefits
Following the death of a super annuity or pension recipient, the income stream provider is required to cash the super interests of the deceased as soon as practicable. Dependent beneficiaries can (subject to the conditions of the super income stream) receive super death benefits as:
- a super lump sum
- one or more death benefit income streams in retirement phase, or
- a combination of lump sum and income stream(s) in retirement phase.
Dependent beneficiaries eligible to receive a death benefit income stream include:
- a spouse
- a child under 18 years of age
- a financially dependent child under 25 years of age
- a disabled child, irrespective of their age, and
- a person who was in an interdependency relationship with the deceased.
While other beneficiaries or the estate of the deceased may be eligible to receive a super death benefit, such benefits can only be paid as a super lump sum.
There are a number of mechanisms that will determine how a death benefit is paid from a super income stream. These include any nomination of a reversionary beneficiary, nomination of a beneficiary (whether binding or non-binding) and any policy document or trust deed provisions relating to the payment of death benefits.
It is important to understand on a case-by-case basis how these mechanisms work for clients in different income streams. There may be very different financial outcomes from these different mechanisms in a post-1 July 2017 environment.
The transfer balance cap following the death of a super income stream recipient
The assessment of any death benefit paid from a super income stream against the transfer balance cap will depend on the form of the death benefit.
Where a super death benefit from an income stream is paid out of the superannuation system as a lump sum payment, there is no transfer balance credit to the recipient’s transfer balance account.
Reversionary income streams
Where a super death benefit from an income stream is paid as a reversionary retirement phase income stream, the value of the income stream at the date of death of the original recipient is counted as a credit to the reversionary recipient’s transfer balance account 12 months after the date of death.
In such cases earnings that accrue after the date of death will not count towards the reversionary recipient’s transfer balance account.
This 12 month delay in crediting the transfer balance account of the reversionary recipient could provide useful planning time to allow the recipient to adjust their super benefits to accommodate the future credit from the death benefit.
Non-reversionary income streams
Where a super death benefit from an income stream is paid as a non-reversionary income stream, a new death benefit income stream in retirement phase will commence. The value of the income stream at commencement is counted as a credit to the recipient’s transfer balance account at that time.
The table below highlights the key transfer balance cap differences for reversionary and non-reversionary income streams, commenced on or after 1 July 2017:
|Reversionary death benefit income stream in retirement phase||Non-reversionary death benefit income stream in retirement phase|
||12 months after death
||Date recipient commences the death benefit income stream
|Transfer balance credit amount
||Value of income stream at date of death
||Value of the death benefit income stream at commencement|
Death benefit income streams paid to children
Where a super death benefit from an income stream is paid to an eligible child as a death benefit income stream in the retirement phase, that child may have a modified transfer balance cap and different rules may apply.
Once a death benefit, always a death benefit
Before 1 July 2017 the prescribed death benefit period (the period ending at the latter of six months after death or three months after the grant of probate) generally limited the time available to receive a concessionally taxed lump sum super death benefit from a death benefit income stream. Previously, any lump sum commutation paid out of the superannuation system during this period would have been treated as a lump sum death benefit and taxed accordingly. Where it was paid outside this period it would have been treated as a member benefit and taxed as such.
However, since 1 July 2017 the prescribed death benefit period no longer exists. This means that where a dependent beneficiary receives a super death benefit as an income stream in retirement phase, any future lump sum commutations (at any later time) will be treated as a death benefit lump sum and will be paid out of superannuation tax-free.
Rolling over super death benefits to another income stream
Prior to 1 July 2017 the ability to rollover a death benefit income stream was significantly limited. Generally, a rollover was only possible for a spouse receiving a death benefit income stream outside of the prescribed death benefit period, or for immediate cashing. However, since 1 July 2017 it is possible for any dependent beneficiaries receiving a death benefit income stream (subject to the conditions of the super income stream) to rollover that death benefit to another retirement phase income stream.
This will be particularly useful where the existing income stream is not best suited for the new recipient. For example, an SMSF member, who was interested in maintaining their SMSF, dies and leaves a beneficiary who may not be so interested. Or, a beneficiary who is looking to access different types of benefits, such as guaranteed lifetime income via a super lifetime annuity.
When rolled over to another income stream, that new income stream will also be treated as a death benefit income stream and will be taxed accordingly. That is, it will retain its tax-free status if the deceased at the date of death or the recipient is aged 60 or over, or the 15% tax-offset in other circumstances.
No rollover to accumulation (or non-retirement phase income stream)
Since 1 July 2017, it is not possible to rollback a super death benefit income stream to:
- the accumulation phase of super
- commence a transition to retirement income stream where the recipient has not otherwise met a condition of release
- an income stream (such as a deferred lifetime annuity) in the deferral phase where the recipient has not otherwise met a condition of release.
Also such benefits cannot be mixed with the dependent beneficiary’s other super interests.
Notably, where a beneficiary receives a super death benefit income stream that results in them exceeding the transfer balance cap, the death benefit income stream cannot be transferred back to the accumulation phase of super to rectify this situation. Appropriate prior planning will be required in these circumstances to manage this impact.
Bringing it all together
In the ATO’s Law Companion Guideline 2017/3 (LCG 2017/3), the ATO provide the following example (example 7 from paragraph 70) demonstrating the new rules applying to death benefits.
Heather is in receipt of a pension of which the supporting superannuation interest is worth $1,000,000 at the time of her death on 1 August 2017. This pension reverts to Heather’s spouse, John, who is already in receipt of his own pension and who had a transfer balance of $800,000 prior to Heather’s death.
On 1 September 2017, John is advised that he became the recipient of Heather’s reversionary pension at the time of her death. As a reversionary beneficiary, a transfer balance credit of $1,000,000 will arise in his transfer balance account in respect of the reversionary death benefit income stream on 1 August 2018 (12 months from Heather’s date of death). If John does nothing, his transfer balance on 1 August 2018 will be $1,800,000 and will exceed his transfer balance cap ($1,600,000).
To prevent an excess transfer balance, John can (subject to the terms and conditions governing the pensions):
(a) partially commute the reversionary pension by $200,000 (the amount that will exceed his transfer balance cap) and take this as a death benefit lump sum out of the superannuation system, or
(b) partially commute his own pension by $200,000. In respect of this $200,000, John has the choice of either;
taking this as a superannuation lump sum out of the superannuation system, or
transferring the amount to an accumulation phase interest and leaving it in the superannuation system.
On 1 July 2018, John partially commutes his own pension by $200,000 and chooses to transfer that amount to an accumulation phase interest. On that date, a debit arises in his transfer balance account for that amount bringing his transfer balance down to $600,000.
The $1,000,000 credit in respect of the reversionary pension arises in John’s transfer balance account on 1 August 2018 bringing his transfer balance to $1,600,000. Consequently, John has not exceeded his transfer balance cap. The value of the credit that arises in John’s transfer balance account will be the value of the superannuation interest supporting the reversionary pension when he started to be the recipient of the reversionary pension on Heather’s death ($1,000,000) regardless of the value of the superannuation interest supporting the reversionary pension on 1 August 2018.
The new rules for super death benefits offer more flexibility in some respects and less flexibility in others.
Appropriate planning before the commencement of any super income stream can make a significant difference to the outcomes available to beneficiaries following the death of the original annuity or pension recipient.