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.
Aaron, in regard to your comment below, I wa of the understanding that a minimum pro rata pension did not have to be paid in the event of death – ref SIS Reg 1.07(D). Can you comment?
“This is in contrast to a non-reversionary income stream which must ensure that the pro-rata minimum is required to be drawn up to the date of death.”
Aaron, I too have also been of this view that the minimum pro rata pension is not required in the event of death. Would be interested to hear your views.
Hi Gabrielle (and Rebecca to whom I missed the first comment on this topic),
Thank you for pointing this out. In reading SIS1.07D, I agree that a minimum pro-rata pension is only required to be taken where there is a commutation not as a result of death. SISR 1.07D(1)(a) outlines that a commutation from an income stream can occur as a result of the death of the pensioner or a reversionary pensioner. The pro-rata minimum calculation contained in paragraph (2) only relates to paragraph (1)(d).
Thank you for highlighting this to me.
Regards,
Aaron
Hi Aaron, great blog! What strategy can be taken to replace say and exisitng lump sum death benefit nomination with a reversionary pension nomination, would this require a rollback to accumulation and restart of the pension or is there another way ?
Hi Drew,
Thanks for the feedback. If the original pension did not specify a reversionary beneficiary, then it would require a full commutation and re-purchase of the pension with a nominated reversionary beneficiary. Timing of the commutation may be critical – especially if multiple pensions are running as any rollback to accumulation becomes a single interest.
Cheers,
Aaron
Aaron, Where there is no reversionary beneficiary, you say that there must be a full commutation and re-purchase of the pension. How do we do that without involving the payment of a lump sum? If a lump sum death benefit is paid how would the surviving (non-working) dependant recontribute the lump sum into the fund in order to re-start a pension? Surely a brand new trust deed could overcome this problem while both members are still alive?
Hi Peter,
The commutation is simply a rollback to accumulation phase, it doesn’t require a lump sum to be taken.
The trust deed doesn’t fix the problem as the nomination of any reversionary beneficiary must be stated within the original terms and conditions of the pension, or otherwise via a binding death benefit nomination. Ideally, the two will marry up to ensure there is no ambiguity as to what takes precedence.
Regards,
Aaron
Aaron,
Thanks for the reply but one further question. Are you saying that the problem can be fixed by the member/s executing a BDBN (allowed for in the trust deed) instructing the trustee to pay his pension benefits as a reversionary pension to his dependant, in this case spouse?
Regards,
peter falconer
Hi Peter,
Potentially yes… In referring to TR2011/D3 the Commissioner states that where a definitive instruction to pay an income stream to a tax dependant spouse is provided, the pension does not cease. There is some conjecture in the industry as to whether a reversionary pension or a binding death benefit nomination take precedence, therefore it is suggested as best practice to ‘marry’ the two together.
Regards,
Aaron
Interesting note raised within Sept 2011 NTLG minutes regarding whether SISR 1.07(D)(1)(a) applies; as TR 2011/D3 suggests that a pension doesn’t cease where a reversionary beneficiary exists. Extract from NTLG Minutes, “Given that the pension does not cease on death (especially in light of TR 2011/D3), it would be argued that regulation 1.07D(1)(a) would not apply (which means that a minimum annual payment is still required). Furthermore, as the existing pension continues in the year of death, only one minimum pension amount would be required for the year of death.”
http://www.ato.gov.au/taxprofessionals/content.aspx?menuid=0&doc=/content/00298032.htm&page=10&H10
Could you please elaborate on your comment where the member dies and the benfits pass to the surviving spouse that the death beneift would be rolled back into the surviving spouses accumulation account? I have had many conflicting opinions regarding this. A legislative reference would be ideal…
Thanks,
Matt
Hi Matt,
It is the benefits of the deceased member that move back from pension phase to accumulation at the time of death (according to ATO’s interpretation in TR 2011/D3). The death benefit is then transferred to the tax dependant beneficiary as an internal rollover. This means that the benefits are then in accumulation for the beneficiary until such as time that they elect to receive an income stream.
Regards,
Aaron
Thank you for an excellent & very useful blog.
In the context of reversionary pensions, I had two quick questions
1) Can more than one reversionary beneficiary be nominated to a single pension interest and
2) what happens if the beneficiary is under pension age? Thanks,
Anuradha
Hi Anuradha,
Thanks for your kind comments about my blog, I’m glad you enjoy it.
In respect to your questions:
(1) Yes, you can have more than one reversionary beneficiary nominated as long as they are tax dependants. This could be reversionary based on a specific percentage across beneficiaries or a specific amount.
(2) Being under pension age is irrelevant to being able to draw an income stream. If they are a tax dependant beneficiary, they can take benefits as a pension or lump sum. The taxation of the pension for the beneficiary will ultimately depend on the deceased member’s age at death and the age of the beneficiary.
Regards,
Aaron
This may be a basic question, but it is my understanding that a reversionary pension is a pre-existing pension payable to a dependant and this reversionary beneficiary must be nominated at the time of creation of the original pension. Under which section of SIS Act (or Reg) are your require to do this? Where does it say that the reversionary beneficiary most be nominated with the creation of the pension. As far as I know section 59 SIS Act is only applicable to BDBN. Greg blog Aaron, great discussions!