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Can you establish a reversionary pension after a pension has commenced?

The impact of  ATO draft tax ruling, TR 2011/D3 has sparked a significant amount of interest in how income streams are structured for SMSF members, in particular with those who have not originally included a tax dependant reversionary beneficiary in the original terms & conditions of the pension.  The draft ruling states that a pension will cease upon the death of the member unless a:

  • reversionary beneficiary has been included within the original terms & conditions of the pension; or
  • valid Binding Death Benefit Nomination (BDBN) existed.

There is some debate within the industry as to which take precedent? A reversionary pension or a valid binding death benefit nomination (BDBN)?  Industry views vary based on some of the following arguments:

  • The is a view that reversionary pension documentation is not actually binding on the trustee?  If the reversion is not binding, the argument is that the BDBN is therefore more likely to bind the trustee and take precedence over the reversionary pension;
  • A valid reversionary pension will override the BDBN because the act of reversion automatically transfers the pension to the reversionary beneficiary.  A BDBN cannot apply because no death benefit arises; and
  • A BDBN will not be effective where making the pension reversionary (i.e., because it represents a fundamental change to the terms & conditions of the pension).

According to the Australian Taxation Office, as outlined within the minutes of the March 2010 NTLG Superannuation Technical Sub-group:

“There are no SIS Act or SISR provisions that are relevant to determining which nomination an SMSF trustee is to give precedence where a deceased pension member had both a valid reversionary nomination and a valid BDBN in existence at the same time of the member’s death.  

While section 59 of the SIS Act and Regulation 6.17A of the SISR place restrictions on superannuation entity trustees accepting BDBNs from a member, as explained in SMSF Determination SMSFD 2008/3, the Commissioner is of the view that those provisions do not have any application to SMSFs. It must also be remembered that section 59 of the SIS Act and regulation 6.17A of the SISR are necessary because of the general trust law principle that beneficiaries cannot direct trustees in the performance of their trust. 

 “If the governing rules of a SMSF authorise a death benefit nomination, the trustee must follow the fund’s rules and the general trust law and any other legislation which may be relevant.

 Notwithstanding those observations, the ATO’s view is that a pension that is a genuine reversionary pension, that is, one which under the terms and conditions established at the commencement of the pension reverts to a nominated (or determinable) beneficiary must be paid to the reversioner. It is only where a trustee may exercise its discretion as which beneficiary is paid the deceased member’s benefits and/or the form in which the benefits are payable that a death benefit nomination is relevant.”

Comments made within these ATO NTLG Super Sub-group technical minutes as outlined above state that a reversionary beneficiary must be nominated at the commencement of the income stream.  It is a requirement for a reversionary beneficiary to be specifically identified at the time the pension commences.   Currently we have no further guidance (nor law) from the Commissioner on this issue.  There are a range of pensions-related matters including exempt current pension income (ECPI) that the ATO is currently considering to provide further guidance on.

I’ve setup a pension with no reversionary beneficiary, how can I change this?

I see many SMSF pensions established without a reversionary beneficiary.  Much of this has to do with either:

  • the legacy of the RBL system whereby the majority of pensions had no reversionary – this was predominantly due to lower deductible amounts (the tax deduction was lower as the deductible amount was calculated on the longer life expectancy, typically the wife); or
  • a lack of understanding around pension-related matters (competency).

You cannot simply add to or amend the original pension documentation to include a reversionary beneficiary.  It is my belief that the pension must cease (rollback / full commutation) and then a new income stream be commenced.  

If the fund is running multiple pensions for a member, you do need to consider the timing of when to rollback these pensions.  Remember that a SMSF member when in accumulation can only have one superannuation interest (i.e. the components of the multiple pensions will amalgamate back into one), so you do not want to ‘contaminate’ any high tax-free proportion income streams.

If you want to rely on a binding death benefit nomination for the pension to revert, you must meet some very strict requirements in the form and substance with which this nomination form must take…  In my view, making amendments to an existing income stream seems like a simpler way to go.

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Comments

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5 thoughts on “Can you establish a reversionary pension after a pension has commenced?

  1. Aaron

    You have picked up a very good point here.

    I often see that :
    Trust Deed – Governing rules of the fund; and
    Binding Death Nomination; and
    Pension Documents,
    never are in sync with each other. I my opinion the advisor must look at all documents when pensions are commenced.

    Sometimes for re-contribution and for roll back of pensions to accumulation – it is a good idea to have two smsf’s for one client – so that mixing with accumulation account does not happen – the idea is roll out the accumulation account to a new smsf and then roll back your pension and when fix the reversionary problem – you can then roll over the accumulation account back for the original fund…

    • Hi Manoj,

      You raise quite a good comment here regarding potentially running two funds, however you would need to justify the cost based on the quantum of money involved.

      Regards,
      Aaron

  2. This draft tax ruling, nor the final ruling (when released) is not law. It does/will not bind the courts, tribunals, super fund trustees or members.

    Given that SIS law is regulatory, if the trust deed had a provision that allowed reversionary status to be added after commencement, it is arguable that it is allowable.

    • Yes your comment is true Adam… however I’m guessing that the ATO would feel they would have a strong case to argue against if a trustee wanted to challenge them on this issue. Also, I am unaware of a trust deed that provides for an ability to make a pension reversionary post establishment? SMSF deeds are typically this specific? I’d be interested if you have come across this?

      Regards,
      Aaron

  3. Hi Aaron,

    Not a SMSF, but my retail super fund has such a provision. I don’t believe the trustee (my employer) has ever used it but the provision is there should the trustee ever be in a position to rely on it.

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