What to review for your clients post-reform
The new super rules post-reform, particularly with the transfer balance caps, require a fundamental shift in how we think about estate planning for SMSFs.
There are a range of things to review, including:
• whether existing binding death benefit nominations are appropriately worded, or even still desirable;
• reversionary pension arrangements – should existing ones remain and are there situations where they are now important;
• how control of the SMSF will pass;
• considering testamentary trusts where amounts will leave the superannuation system on the death of a member;
• how to use child pensions; and
• whether there are new structures the control of which must now be dealt with as part of the estate plan.
The answer will depend on each individual’s circumstances and wishes, and must be tailored to each person’s situation. There is no answer that can be applied across the board for everyone.
Reversionary pensions have been much discussed in this context, with some suggesting they are the solution to all estate planning dilemmas presented by these changes. It is not the only consideration but an important one.
How do transfer balance caps work with pensions?
One of the main influences on estate planning after 1 July 2017 is that a death benefit pension creates a credit in the transfer balance account of the recipient, and therefore counts toward that recipient’s transfer balance cap.
This means that if the recipient has already used up their transfer balance cap on their own pension, any amount paid to them as a pension because of the death of their spouse will cause them to exceed their transfer balance cap.
This applies whether a pension is reversionary or not – the main difference is the timing of the credit.
The main options for the recipient to ensure that they do not breach their transfer balance cap are:
1. commute some or all of their own existing pension back to accumulation phase or remove it from the superannuation system so the combined balance of their pension plus the death benefit pension do not exceed their transfer balance cap; or
2. if the pension is not reversionary, take enough of the deceased’s death benefit as a pension to get them to their transfer balance cap, with the excess of the death benefit as a lump sum death benefit payment.
So what is a reversionary pension?
On the death of a member, there are two ways the death benefit can be paid as a pension:
• the pension automatically continues to the new recipient; and
• the trustee decides to pay a death benefit as a pension.
It is the first of these where the trustee has no discretion that is a reversionary pension. Where the trustee has a choice, either as to the recipient or the form the benefit takes, it is not reversionary.
Reversionary pensions are normally documented in the pension terms. It is important to ensure the terms of the pension and the trust deed are properly drafted if a reversionary pension is an integral part of an estate planning strategy. Many pensions that people think are reversionary are in fact not, usually due to poor pension documents or trust deeds.
A properly worded binding death benefit nomination could also be a reversionary pension in this context. The binding death benefit nomination must not only specify the recipient, but also that the benefit must be paid as a pension. We are awaiting final confirmation from the ATO as to what they believe is necessary.
So are reversionary pensions the answer?
Reversionary pensions are fundamentally an estate planning tool, which forces the pension to the nominated person and removes the trustee’s discretion about the recipient and form of the death benefit. As such, they can be an effective tool to ensure a member’s superannuation is paid to a particular person on their death.
It is also important to ensure that if a pension is made reversionary, the person does want the proposed recipient to receive the death benefit. A pension that reverts to the pensioner’s spouse when the pensioner actually wants someone else to benefit from their superannuation when they die is problematic.
Making a pension reversionary also locks out other alternatives – for example a pension that is reversionary to a member’s spouse means the option of child pensions or a testamentary trust is no longer available. This means everyone should be comfortable they will not want to use any other options before implementing a reversion on a pension.
For a reversionary pension, the credit to the transfer balance account of the recipient occurs 12 months after death. For a pension which is not reversionary, the credit arises when the decision is made to pay the death benefit as a pension.
Where a pension is reversionary, the credit to the transfer balance account is inevitable at the end of the 12-month period. This means that it is critical that appropriate action is taken within the 12-month period to deal with any possible transfer balance cap excess. If the reversionary pensioner is unable to deal with these issues for some time after death (which we do see after the death of a spouse), or there are other issues that delay dealing with the death benefit then an excess amount may be triggered because of the failure to take action.
Where a person may delay in dealing with financial matters after the death of the other person (usually their spouse), it is likely to be better for the pension not to revert so the client chooses the time when the credit to the transfer balance account occurs.
The 12-month period before the transfer balance credit arises is not enough in itself to justify a pension being made reversionary, it is really an estate planning decision.
The other factor to take into account is the amount of the credit. For a reversionary pension, it is the account balance of the deceased at death, and for a pension that is not reversionary, it is the account balance at the time of then payment. This means where there will be significant investment returns between death and payment, a reversionary pension may result in a smaller credit to the transfer balance account, and vice versa. How insurance proceeds work with this is yet to be determined.
It is vitally important everyone with funds in superannuation (particularly SMSFs) review their estate planning now to ensure appropriate action is taken to update arrangements.
There is wide range of things to consider. What should occur will vary and reversionary pensions are not necessarily the answer for everyone.
Carly Fradgley, special counsel at Cooper Grace Ward and Scott Hay-Bartlem, partner, Cooper Grace Ward