Government to fix tax liabilities with death benefits
The assistant treasurer has announced plans to rectify the unintended tax liabilities arising from rollovers of certain death benefit pensions.
Earlier this year SMSF Adviser reported that due to an unintended consequence of the reform changes last year, some SMSFs could be hit with substantial taxes where the rollover of a death benefit contains an untaxed element.
Colonial First State executive manager Craig Day previously explained rolling over a death benefit technically involves paying a death benefit superannuation lump sum to the beneficiary under the Tax Act.
“While this wouldn’t normally cause an issue, if there are any insurance proceeds included in the rollover for which the fund has ever claimed the premiums as a deduction, things can really start to get nasty,” said Mr Day.
“In this situation, there is a provision in the Tax Act that requires a fund paying a death benefit lump sum, which now includes a rollover, to calculate an amount of untaxed element to include in the payment which will then be included in the receiving fund’s assessable income and taxed at rates of up to 15 per cent.”
The size of the untaxed element created on the rollover of a death benefit, he said, will depend on the size of the rollover, including any insurance proceeds, and the age of the original member when they died.
Mr Day said it could be particularly disastrous for a younger member such as the surviving spouse of someone who died in their 40s with a large amount of life insurance held in super.
Assistant treasurer Stuart Robert has now stated that the government will be changing the law to make sure that death benefits that include life insurance proceeds are not subject to tax when they are rolled over to a new superannuation fund.
“The government recognises this is anomalous with the tax treatment of death benefits taken out of superannuation and out of line with the policy that death benefits are tax free for dependants,” said Mr Robert.
“This measure ensures that death benefit lump sums remain tax-free for dependants, even if rolled over within the superannuation system.”
A welcome fix
Clients of larger super funds were being forced to take lump sum payments, according to Mr Day, making the federal government's fix "welcome news" for clients who were facing the same fate.
"There are some clients that were waiting, they were talking to their fund, which was agreeing to hold off on the payment requiring them to take a lump sum until this was sorted. It has given them the flexibility to keep the money within the system, and generate a tax effective income stream following the death of a spouse," Mr Day told SMSF Adviser.
SuperConcepts executive manager of SMSF technical services Mark Ellem likewise welcomed the announcement by the government.
“Death benefits are meant to be tax free to dependents and not a situation where emotional stress is compounded with financial stress, so it is good to see the Minister addressing this in his first public foray discussing superannuation,” said Mr Ellem.
“The effect of this new law ensures that death benefit lump sums stay tax-free for dependents even if they are rolled over within the superannuation system.”
Mr Ellem said this is the way the superannuation system was intended to work and ensures that it’s a smooth, functional and fair system during the tough times of dealing with the death of a family member.
Mr Robert also confirmed that the government will implement a permanent legislative fix for the ‘double counting’ issue for market-linked pensions.
Due to the way that market-linked pensions are valued under the transfer balance cap when they are commuted or rolled over, this results in a nil debit, he said.
“This nil debit is an issue because it doesn't accurately reflect the individual's transfer balance cap position, and may lead to an individual breaching their cap,” he explained.
While the ATO issued guidance to SMSFs in June on their approach to the issue, Mr Robert said the government wants to find a more permanent legislative solution to ensure that the value of a commuted market-linked pension is correct.
The government will also amend the law to maintain the treatment of market‑linked pensions under the transfer balance cap where they have been rolled over as a result of a successor fund transfer.
Market-linked pensions rolled over or commenced after 1 July 2017 are not treated as capped defined benefit income streams under the transfer balance cap and because of this market-linked pensions that are rolled over as a result of a successor fund transfer could lead to individuals inadvertently breaching their transfer balance cap, he explained.
“The measure I am announcing today will ensure the new market-linked pensions that commence as the result of a successor fund transfer will continue to be treated as a capped defined benefit under the transfer balance cap,” he said.