SMSFs warned on commutation traps affecting death benefit pensions
SMSFs will need to ensure they follow the correct commutation process or risk breaching cashing rules, said a technical expert.
Heffron technical specialist Annie Dawson said special rules about who can receive a death benefit pension also govern how to take a lump sum (partial commutation) or stop the pension altogether (full commutation).
She said that SMSFs must remember that they cannot partially or fully commute a death benefit pension and keep the benefits in the member’s accumulation account as it will breach the cashing rules.
“Instead, the benefit must be paid as a lump sum benefit to the member or rolled over to another complying super fund and a new death benefit pension commenced,” Ms Dawson said.
“If you are processing a rollover (as a result of a partial or full commutation of a death benefit), make sure the data sent via Super Stream correctly flags the member is rolling a death benefit.”
“This ensures the trustee of the receiving fund will know to keep these benefits separate from any other interests of the member and also to commence a new death benefit pension. The requirement to give information to members can be satisfied by giving them a paper copy of the death benefit rollover statement.”
Funds must also make sure there is no limitation on the number of permitted commutations made from a death benefit pension, said Ms Dawson. While trustees are restricted to paying a maximum of two payments per beneficiary per account, this rule does not extend to death benefit pensions.
“However, be sure to check the terms and conditions of the pension to ensure a commutation is otherwise allowed,” she said.
“For example, whilst it may be possible to commute a death benefit pension which is an account-based pension, restrictions may apply to other types of pensions, such as market-linked or life expectancy pensions.
“Do remember the trustee may be required to commute the death benefit pension if the pension is being paid to a child of the deceased member. Unless the child suffers from a severe disability, the trustee must fully commute the death benefit pension and pay a lump sum to the child by the time they reach age 25.
“Be sure to have a way to track this so this milestone is not overlooked. Benefits cashed in accordance with these rules will be tax-free to the child.”
Death benefit pensions also attract exempt current pension income whilst the pension continues.
Ms Dawson said it was important to ensure pension standards were met, as well as ensuring a death benefit pension isn’t stopped too early.
“For example, if a member wants to withdraw their benefits from the fund and fund investments are to be sold down or the member is going to take an in-specie benefit, taking a partial commutation first and then taking a residual pension payment will help to ensure the pension is still in place if any capital gains are triggered,” she said.
For more tips and tricks on cashing death benefits, Heffron will be running its Death Benefit Masterclass. Further details including how to register are here.
“This will be important if the fund is using the segregated method when calculating the fund’s exempt current pension income.”
Tony Zhang is a journalist at Accountants Daily, which is the leading source of news, strategy and educational content for professionals working in the accounting sector.
Since joining the Momentum Media team in 2020, Tony has written for a range of its publications including Lawyers Weekly, Adviser Innovation, ifa and SMSF Adviser. He has been full-time on Accountants Daily since September 2021.