Simpler Super has streamlined the types of pensions that can be drawn from all types of superannuation funds. For any SMSF member starting a new pension, we now simply have an Account Based Pension (“ABP”) that can be paid.
Prior to 1 July 2007, a pension amount was assessable and a tax deduction provided to the individual based on the longer ‘life expectancy’. In most cases this was based on the female spouse (where there was less than 5 years age difference). As a result, it was common to see allocated pensions setup as non-reversionary to maximise the tax deduction available to the member.
With only the taxable proportion of a benefit now subject to tax and furthermore, benefits from age 60 no longer being assessable (tax-free), there are some distinct advantages to setting up all pensions with a reversionary beneficiary/ies.
There are five key reasons why I believe all pensions should have a reversionary beneficiary nominated:
1. Continuation of tax exemption in the event of the primary beneficiary
A key benefit of a reversionary beneficiary is that the benefits automatically pass across to the surviving tax dependent (i.e. spouse). The benefits do not roll back to accumulation phase (which is the case with no reversionary beneficiary) which means that the tax exemption will continue apply for the financial year.
2. Potential to become contaminated with accumulation benefits that may include taxable component
As mentioned above, where there is no reversionary beneficiary the benefits roll back into an accumulation account. Each member of a SMSF has only one (1) accumulation interest, so this benefit potentially gets ‘contaminated’ with other accumulation benefits.
Take an example of where John (75) had a 100% tax-free proportion pension ($500k) with no reversion; he dies and the benefits transfer to his spouse, Jane. She has $500k in accumulation made up of entirely taxable component. John’s money will get rolled back into Jane’s accumulation account which means any future benefits must be taken on a 50/50 split between taxable and tax-free component.
3. No minimum pro-rata pension required prior to death
Where a pension is set-up with a reversionary beneficiary and the member passes away, there is no minimum pension that must be taken prior to death.
4. No change to minimum pension for the current financial year (stays the same of the deceased and resets of 1 July of following year)
Where a member dies and the pension automatically reverts to the reversionary beneficiary, there is no requirement to adjust the minimum pension for the year, regardless of any variation in the minimum factors between the primary pensioner and reversionary beneficiary. From 1 July the following year, the minimum pension will be required to be adjusted based on the reversionary beneficiary’s minimum pension factor.
5. Less paperwork
The preparation of paperwork regarding the payment of a death benefits is one of the more difficult tasks to work through with the surviving trustee(s), so in my view the less paperwork to have to deal with the better. Where an income stream automatically reverts to a beneficiary, a set of trustee minutes noting the member’s death and reversion to the tax dependent beneficiary is all that is required (need to also consider trustee structure and potential changes). Where there is no reversion, the paperwork may need to include lump sum death benefits, or the creation of a new pension, along with potential actuarial involvement for year-end where the fund is not 100% tax exempt for the financial year.
What if the reversionary beneficiary doesn’t want to draw a pension?
Where a pension is established with a reversionary beneficiary, it is important to note that the beneficiary does have the ability to roll-back this income stream at any stage to accumulation should they choose to do so (or take a lump sum).
It is imperative that appropriate consideration is given to these and many other pension planning issues when looking to establish income streams for a member within a SMSF.