Case studies: What to do and not to do with estate planning

Case studies: What to do and not to do with estate planning

Colin Lewis

This year, most clients will need to review their estate planning if they haven’t done so already. Some may only require minor adjustment, whereas others will need to completely rethink their current estate planning arrangements. We take a look in detail at what you should be considering for your clients.

This article focuses purely on estate planning implications resulting from the 1 July 2017 changes.

Death benefit income streams and the transfer balance cap (TBC)

The TBC limits the amount of death benefits payable as an income stream to the beneficiary’s personal TBC. Modified rules apply to children receiving death benefit pensions.

If a death benefit pension causes the beneficiary to exceed their TBC, the excess amount must be cashed as a lump sum benefit and ‘excess transfer balance tax’ applies.

If the beneficiary has an existing pension (that is not a death benefit pension), they could consider commuting it to accumulation phase to retain the death benefits in the super environment.

Reversionary vs non-reversionary pensions

The way the TBC rules work differs between reversionary and non-reversionary pensions.

With a non-reversionary pension, the credit to the beneficiary’s Transfer Balance Account (TBA) arises on the date of commencement and the amount credited is the balance at commencement.

With a reversionary pension, the credit to the beneficiary’s TBA arises 12 months from the date the pension reverts to them, i.e. 12 months from date of death. Thus, the beneficiary has time to deal with the pension to ensure the benefit does not cause them to inadvertently breach their TBC.

In addition, the amount of that transfer balance credit is the balance of the pension on the date it reverts, i.e. date of death. For example, if the balance of the pension on date of reversion is $900,000 and that balance grows to $1M after 12 months, only $900,000 is the transfer balance credit to the reversionary beneficiary’s TBA.

There are numerous benefits of reversionary pensions, including continuation of social security ‘grandfathering’, and favourable tax and TBC treatment where insurance proceeds are involved.

Unlike non-reversionary pensions where insurance proceeds paid as part of the death benefit income stream are a transfer balance credit, with reversionary pensions the insurance proceeds added to the reversionary pension are excluded from the TBC.

‘Capped defined benefit’ (CDB) income streams

The application of the TBC rules also differs between commutable, e.g. account-based pensions (ABPs) and non-commutable income streams, referred to as CDB income streams.

CDB income streams include complying:

 lifetime pensions commenced anytime, and

 lifetime annuities, life expectancy pensions/annuities and market-linked pensions/annuities in existence as at 30 June 2017.

Most CDB income streams do not have an account balance and with commutation restrictions, make the application of the general TBC rules inappropriate. Rather, a ‘special value’ is calculated and this amount is credited to the member’s TBA.

The modified rules ensure that amounts attributable solely to CDB income streams cannot themselves cause an individual to exceed their personal TBC, i.e. if the ‘special value’ of a CDB income stream is greater than the general TBC ($1.6 million for FY2017-18) then that person’s TBC is modified to equal the ‘special value’. For example, if the ‘special value’ is calculated as $2 million, then that individual’s modified TBC is $2 million.

The ‘special value’ of a complying lifetime pension is:

Annual entitlement x 16

The ‘special value’ of a complying life expectancy pension or term allocated pension is:

Annual entitlement x Remaining term

The ‘annual entitlement’ is calculated by annualising the first payment received after 1 July 2017 or date of commencement (if after 1 July 2017).

Annual entitlement = (First payment) x 365

Payment period

Example 1

On 30 June 2017, Anna is receiving $3,000 per fortnight from her complying lifetime pension. Thus, Anna’s annual entitlement is:

= ($3,000/14 days) x 365

= $78,214.29

The ‘special value’ of Anna’s lifetime pension credited to her TBA is:

= $78,214.29 x 16

= $1,251,428.64

CDB income streams cannot create excess TBC, but the ‘special value’ credited to an individual’s TBA limits their ability to commence another income stream that is not a CDB income stream, e.g. an ABP in an SMSF.

Child pensions

A separate cap applies to children receiving a death benefit income stream, referred to as the ‘cap increment’.

The ‘cap increment’ for child pensions started before 1 July 2017 is $1.6 million, i.e. general TBC for FY2017-18.

The ‘cap increment’ for child pensions commenced from 1 July 2017 depends on whether the parent had a TBA.

Where the parent did not have a TBA, the child’s ‘cap increment’ is their proportionate share of the parent’s general TBC.

Where the parent had a TBA, the child’s ‘cap increment’ is their proportionate share of the parent’s pension balance. Thus, the ‘cap increment’ only applies to ‘child pensions’ sourced solely from retirement phase interests of the parent.

Example 2

Darren has an accumulation balance of $1.8 million. He has a binding death benefit nomination (BDBN) dividing his benefit equally between his two children Mary (26) and Paul (17).

Darren died on 1 September 2017.

Only Paul is eligible to receive a death benefit income stream.

As Darren did not have a TBA, Paul has a ‘cap increment’ of $800,000 (50% x the general TBC of $1.6 million).

In accordance with Darren’s BDBN, each child receives a death benefit of $900,000. The trustee determines to pay Paul’s benefit as a child pension of $800,000 and a lump sum of $100,000.

Example 3

Helen has an ABP of $1.2 million and an accumulation balance of $200,000. She has BDBNs on both super interests in favour of her two children Jane (17) and Jim (16) split 50:50.

Helen died on 1 September 2017.

As Helen had a TBA, each child has a ‘cap increment’ of $600,000 (50% x $1.2 million) being their proportionate share of Helen’s retirement phase income stream. They cannot take any of the accumulation interest as a pension.

In accordance with Helen’s BDBN, each child receives a death benefit of $700,000. The trustee determines to pay each beneficiary a child pension of $600,000 and a lump sum of $100,000.

Taxation of CDB income streams

The tax treatment of CDB income stream payments depends on the individual’s ‘defined benefit income cap’ (DBIC), which is the general TBC divided by 16. Thus, the DBIC for 2017-18 is $100,000 ($1.6 million/16).

Only ‘concessionally taxed payments’ count towards the DBIC. These include payments to individuals:

 aged 60 or more, or

 under age 60 from a death benefit income stream where the deceased was age 60 or more at date of death.

If total ‘concessionally taxed payments’ from a defined benefit pension exceed the DBIC, then:

 for payments from a taxed source, i.e. tax-free component and taxable component (taxed element), 50% of the excess amount is included in the individual’s assessable income and taxed at their marginal rate

 for payments from an untaxed source, i.e. taxable component (untaxed element), the excess amount is ineligible for the 10% tax offset

 for payments from both taxed and untaxed source, any tax-free component is assessed against the DBIC then the taxable component (taxed element) and then finally the taxable component (untaxed element). If the excess includes:

o an amount of taxable component (taxed element), 50% of this amount is tax-free and 50% is included in the individual’s assessable income and taxed at their marginal rate

o an amount of taxable component (untaxed element), this amount is ineligible for the 10% tax offset.

Example 4

In FY2017-18, John received $180,000 from his lifetime pension. His pension comprised:

 $30,000 tax-free component

 $90,000 taxable component (taxed element), and

 $60,000 taxable component (untaxed element).

The tax treatment of this income is:

 the tax-free component of $30,000 plus $70,000 of taxable component (taxed element) is received tax-free

 of the remaining $20,000 of taxable component (taxed element), $10,000 is tax-free and $10,000 is included in John’s assessable income and taxed at his marginal rate, and

 the taxable component (untaxed element) of $60,000 is included in John’s assessable income and taxed at his marginal rate, but is ineligible for the 10% tax offset.

Withdrawals from a death benefit pension

The old ‘death benefits period’, i.e. later of:

 six months from date of death, or

 three months from date that either probate was granted on the estate or letters of administration issued, no longer applies. Thus, a lump sum commutation from a death benefit pension is always treated as a super death benefit.

Death benefits must be paid out either as a pension or lump sum. Where the beneficiary (normally the surviving spouse) has already maximised their TBC, they need to consider receiving the death benefit as either a lump sum, or commuting enough of their existing pension(s) back to accumulation phase to accommodate receiving a death benefit income stream.

Rolling over a death benefit income stream

Removal of the ‘death benefits period’, together with amendments to the definition of a ‘rollover superannuation benefit’ for tax purposes, prohibits the commutation of a death benefit pension back to accumulation phase unless it’s for the purpose of rolling that benefit to another fund to immediately commence an income stream. The new income stream retains its ‘death benefit’ status and associated tax concessions for beneficiaries under age 60.

Summary of key implications of the super changes to estate planning

1. ‘Cap’ on death benefits payable as an income stream forces the withdrawal of benefits over a beneficiary's TBC

2. Renewed focus on ‘reversionary’ vs ‘non-reversionary’ income streams

3. Non-tax dependent beneficiaries are likely to receive a reduced death benefit

4. Important to have comprehensive death benefit nominations that deal with all super interests

5. Ability to rollover a death benefit provides greater flexibility and choice to beneficiaries eligible to receive a death benefit income stream

6. Shift of family wealth to alternative structures, e.g. inter vivos and testamentary discretionary trusts, need to consider transfer of ownership and/or control of any new entities

Colin Lewis, head of strategic advice, Perpetual Private 

Case studies: What to do and not to do with estate planning
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