Reversionary pensions can offer ECPI opportunities

Ms Heffron said a reversionary pension automatically passes to a chosen reversionary beneficiary, and while it will eventually count towards that recipient’s transfer balance cap, this will occur 12 months after the date of death of the member.

“Importantly, even though this pension hasn’t officially been counted towards the spouse’s transfer balance cap, it’s still a normal retirement phase pension that gives rise to exempt current pension income or ECPI,” she told SMSF adviser.

According to the ATO, ECPI – ordinary and statutory income a small superannuation fund earns from assets held to support retirement-phase income streams – is exempt from income tax. Moreover, ECPI is claimed in the SMSF annual return, but before claiming all of a fund's assets must be valued at current market value.

Ms Heffron gave an example of Alex and Kim who both started their first retirement phase pensions in July 2023, and used up the full amount of their transfer balance caps of $1.9 million, each, at the time.

“Their pensions are reversionary to each other, and they don’t have any other super in their SMSF,” she said.

In the hypothetical scenario, Alex dies on 1 May 2026. At the time, Alex’s pension is worth $2 million.

“Alex’s pension will initially just continue to Kim. She’ll need to make sure she’s taken the full minimum pension by 30 June 2026 of whatever was calculated for Alex at the start of the year, as well as her own pension payments,” Ms Heffron said.

“In 12 months’ time – 1 May 2027 – an additional $2 million, the value of Alex’s pension at the time of his death, will be added to Kim’s transfer balance cap, so before that happens she will need to make sure she’s adjusted her affairs so that she has enough ‘space’ to absorb this additional amount.”

Ms Heffron said people in this situation often switch off their own pension and roll it back to the accumulation phase.

However, she said there is no need for this to happen immediately, and in fact, explained that it is better to wait the full 12 months.

“If Kim has both pensions running for the next 12 months, they will count in working out the fund’s exempt current pension for the year,” she said.

“This will mean a much larger tax break for Kim’s SMSF than if she re-organised her affairs earlier.

“Reversionary pensions are often popular for this very reason – the surviving spouse effectively doubles up on their ECPI for up to 12 months.”

There can be a few downsides to this strategy, she warned.

“A reversionary pension might take 12 months to show up in Kim’s transfer balance cap but it’s part of her total super balance immediately,” she continued. “Total super balance is important for working out whether or not someone is able to make non-concessional contributions, or in the future, is subject to the proposed new tax on those with super balances above $3 million.

“In this case, for example, inheriting Alex’s super as a reversionary pension in May 2026 would mean Kim’s super exceeded $3 million at the critical date of 30 June 2026.”

If Alex’s pension had been non-reversionary, it would have stopped immediately after his death and would have not had any impact on Kim’s transfer balance cap or total super balance until she used the money to start a new pension.

“That might not happen until the new financial year in which case only her own super would count in checking whether or not she’s over $3 million on 30 June 2026,” Ms Heffron said.

And it wouldn’t miss out on ECPI on Alex’s pension either, she said.

“These days, ECPI continues until Kim does something with Alex’s account, either starting a new pension for herself or taking out a lump sum, so in that sense, it’s just like a reversionary pension,” she said.

“The downside is that she has to ‘do something’ as soon as practicable which the ATO says is around six months, so she doesn’t have the same flexibility to do nothing for 12 months and enjoy additional ECPI for all that time.”