Reversionary pension v BDBN: Which outcome is preferred?
Taking an approach where the pension documentation overrides the BDBN with SMSF estate planning could expose professionals to additional risk.
Imagine a conflict between pension documentation and a binding death benefit nomination (BDBN) in a self managed superannuation fund (SMSF) context. For example, the pension documentation states that the pension is reversionary to the surviving spouse; however, the BDBN states that the death benefits are to be paid to the estate. Generally, the question of which document takes priority is decided by considering both documents, as well as the governing rules of the SMSF. However, this article explores whether a BDBN taking priority over pension documentation should be the preferred approach for SMSF members, accountants and financial planners by considering some examples.
Which approach is more cost-effective?
Some accountants/advisers take the view that it is more cost-effective to have pension documentation overriding a BDBN. It is true that there are many document suppliers and even accounting software that can generate pension documentation for very little or even no cost. On a surface level, this view may seem quite attractive. However, consider the following example.
An SMSF member wants a pension that automatically reverts upon death. The existing pension documentation is silent as to whether it automatically reverts.
Where the SMSF’s governing rules do not provide that the BDBN overrides the pension documentation or if the SMSF’s governing rules provide that the pension documentation overrides the BDBN, a common approach is to fully commute each pension and commence new pensions with documentation that provides that the pension automatically reverts. However, this process requires further steps and consideration of issues. These include:
- satisfying pension minimums before commuting;
- determining market values of superannuation interests;
- Transfer Balance Account reporting;
- implications from mixing tax free and taxable components if the member also has an accumulation interest in the SMSF and/or multiple pensions; and
- documenting the commutation and commencement of pensions.
Further, advising on the commencement of a pension may also raise Australian financial services licence (AFSL) implications for the accountant/adviser.
Also, the Australian Taxation Office has expressed a strict view in TR 2013/5 on when a pension is automatically reversionary. Not all document suppliers and accounting software can generate pension documentation that guarantees that a pension is automatically reversionary. A brief resolution after the pension documentation is executed might not be enough to change the ‘reversionary’ status of the pension.
Accordingly, this common approach involves additional costs.
In contrast, consider the approach where the SMSF’s governing rules provide that the BDBN overrides the pension documentation.
An SMSF member wants a pension that automatically reverts upon death. The existing pension documentation is silent as to whether it automatically reverts. Assume that the SMSF’s governing rules provide that the BDBN overrides the pension documentation and can also allow for a BDBN to make a pension reversionary ‘mid stream’.
The template BDBN form (which DBA Lawyers includes with its package for its SMSF governing rules) provides an option to tick. If ticked, it means all the member’s account-based pensions and transition to retirement income streams that they are receiving just before their death are automatically reversionary to the member’s spouse. When completing the BDBN form, the member ticks this box to select this option.
As the BDBN covers all the member’s pensions, this strategy is both cost-effective and legally-effective.
Naturally, the wording in the documentation is extremely important to enable a BDBN to override the pension documentation. In particular:
- The SMSF’s governing rules must expressly provide for reversion and for a BDBN to be able to make a pension reversionary mid-stream.
- The SMSF’s governing rules must expressly provide that the BDBN overrides the pension documentation.
- The wording in the BDBN in relation to the ‘automatically reversionary’ option must comply with TR 2013/5, e.g., it must fetter the SMSF trustee’s discretion in relation to paying the member’s pensions upon the member’s death.
As Example 2 demonstrates, taking an approach where the BDBN overrides pension documentation can also be cost-effective. In particular, this approach is the more cost-effective approach where the member has multiple pensions.
Which approach involves more risk for the accountant/adviser?
Where the governing rules of the SMSF state that the pension documentation overrides the BDBN, this approach could place the accountant/adviser at risk whenever they assist SMSF members with pension documentation. We illustrate this with two examples.
Assume that the SMSF’s governing rules provide that the pension documentation overrides the BDBN. The SMSF member sees a lawyer for succession planning advice. The lawyer prepares the following documents for the SMSF member:
- A will;
- An enduring power of attorney; and
- An BDBN — the BDBN provides that all of the member’s superannuation death benefits are to be paid to the member’s legal personal representative, e.g., to form part of their estate.
Later, the SMSF member wishes to commence a pension using a large portion of his superannuation interest in the SMSF. The accountant prepares pension commencement documentation for the SMSF member. In particular, the documentation states that the pension is reversionary to the spouse. Assume that the SMSF member did not fully comprehend the consequences of this aspect and executes the documentation.
The SMSF member dies. The executor of the member’s estate has a duty to maximise the value of the estate and believes that the pension documentation prepared by the accountant has ruined the detailed succession planning undertaken by the SMSF member.
The accountant is faced with the following questions:
- Is the accountant liable to the estate?
- Has the accountant engaged in legal practice?
- Does the accountant’s professional indemnity insurance policy cover them for this circumstance?
These are tricky questions that no accountant/adviser would wish to face.
In contrast, consider the likely outcome where the SMSF’s governing rules provide that the BDBN overrides the pension documentation.
Assume the same circumstances as Example 3, but with the following variations:
- The SMSF’s governing rules provide that the BDBN overrides the pension documentation; and
- The BDBN stated that it covers all the SMSF member’s superannuation interests (including any pensions that they are receiving just before their death).
When the SMSF member dies, the amounts supporting the pension interest would be paid in accordance with the BDBN. The result would have been consistent with the intention of the SMSF member and the lawyer.
Accordingly, these examples demonstrate that taking the approach where the pension documentation overrides the BDBN could expose the accountant/adviser to additional risk.
The safest and best-practice approach is to check that the pension documentation and the BDBN are consistent. However, as the examples in this article demonstrate, a BDBN taking priority over pension documentation should be the preferred approach for SMSF members. Accordingly, there is merit in obtaining SMSF documents (including SMSF governing rules) that support this approach, which can act as a safeguard where there is any inconsistency between the pension documentation and BDBN.
Naturally, for advisers, the Australian financial services licence under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure advice is appropriately and legally provided.
Joseph Cheung, lawyer and Bryce Figot, Special Counsel, DBA Lawyers