By Liam Shorte 22 Oct 2015

The case for reversionary super pensions

When it comes time to shift your super to pension mode, consider making it automatic.

Snapshot

  • Despite recent changes, reversionary pensions still offer benefits
  • We explain what a reversionary pension is and when you can have one
  • If you go down this path there are some potential drawbacks

Reversionary pensions were a hot topic a few years ago, when the ATO indicated that the tax-exempt status of pensions ended with the member’s death. Taking a reversionary pension avoided potential capital gains taxCapital gains tax (CGT) is the tax payable on capital gains. Where assets are held 12 months or more, individuals are entitled to a 50% discount when calculating the taxable amount of a capital gain. Super funds are entitled to a 33.33% discount. Where assets are held less than 12 months, capital gains are taxed at normal rates. Note also that some assets are exempt from CGT. issues for the super fund.

However, this problem was solved in 2013 when the Government changed the laws to allow the tax exemption to continue after a member’s death, until the death benefit has been paid.

But the change in law hasn’t ended the role of reversionary pensions. Let’s take a look.

What is a reversionary pension?

You should always look at the exit strategy of any product or investment and a pension is no different. Estate planning is an important component of any successful SMSF strategy.

When a pension commences, the member elects to receive an income stream from the pension, subject to a minimum based on their age and account value. When the member passes away, a ‘normal’ pension account will cease after the assets have been sold and distributed to the beneficiaries.

If no nomination exists, the trustee will use their discretion and make payment to the deceased’s dependants. Sometimes the trustee will simply pay the benefits to the deceased’s estate where it will be distributed according to the person’s will. This is not always a good outcome and requires lots of paperwork.

Unfortunately the paperwork and decisions are required at the worst possible time – when someone is grieving the loss of a spouse or parent. Binding death benefit nominationsAlso known as BDBNs. A BDBN is a document given by a super fund member to the super fund trustee. A valid BDBN legally compels the trustee to pay death benefits as directed by the member. (BDBNs) can help avoid these problems and they provide a high degree of certainty as to who will receive the benefits. However, just like a will, these nominations are susceptible to a challenge from, for instance, an ex-spouse or an estranged adult child.

If you’re sure of the beneficiary, a better approach can be to make the pension ‘reversionary’ upon its commencement. This means it automatically passes to a dependent (see below) upon the member’s death, providing certainty and minimising the risk of a legal challenge (on the basis that a transfer to a reversionary pension does not amount to the payment of a death benefit). It's worth noting that SMSFs are not regulated by the Superannuation Complaints Tribunal, adding an additional layer of protection.

Most SMSF funds revolve around a ‘couple’ – who usually want the pension balance to go to the surviving spouse – so in this case you might just make each member’s pension revert to the other.

Where a reversionary pension has been used, a simple set of trustee minutes noting the death of the member and reversion to a beneficiary is all that is required (avoiding the mass of paperwork). After that, the trustee will continue to pay the pension to the reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased..

Who can be a reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased.?

A reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased. of a pension can only be one of the following people:

  • A spouse (including de facto);
  • A child (including step-child) under the age of 18, or between 18-25 and financially dependent on the deceased just prior to death;
  • A person who lived in an ‘interdependency relationship’ with the deceased; or
  • A person who was financially dependent on the deceased.

If, at a later date, your reversionary nomination ceases to be valid because your circumstances change – for instance, because of a divorce – it is important that you update your reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased. nomination so it remains valid or consider switching to a BDBNThe acronym for a binding death benefit nomination. A BDBN is a document given by a super fund member to the super fund trustee. A valid BDBN legally compels the trustee to pay death benefits as directed by the member..

If your reversionary nomination is invalid, it falls back on the trustees to determine who is entitled to your remaining balance and how to divide that balance.

As with a regular superannuation fund, the trustees will generally consider your spouse, your children, a person in an interdependency relationship with you, or any other person that thinks they have a claim to your benefit. But, as this is an SMSF, the trustees have the final say.

Other benefits of a reversionary pension

We’ve said that a reversionary pension makes things simpler, and less open to challenge, upon a member’s death. But it also offers the following benefits:

  1. Easier management in the short term. With a ‘normal’ pension someone needs to act as soon as possible to make decisions on behalf of the fund. For instance, the pension payments should be stopped if no direction has been received as to who is entitled to receive future payments. This may sound simple but, with blended families, you may have a current and possibly one or more ex-spouses, children from each relationship and others who may believe they are entitled to support. The trustee and/or executor has the power to act, but also has a legal duty to act properly in making any decisions. This requires, at least, a comprehensive review of the trust deed and trustee powers (chewing up time and legal costs).
  2. Certainty. Using reversionary pensions allows for more certain tax and estate planning, especially with their ability to handle multiple pensions. Liam often works with SMSF trustees to set up more than one pension targeted to different beneficiaries to achieve the best financial outcome. Each pension may comprise different taxable and tax free components (see our earlier article Multiple pensions: Giving your SMSF a ‘sacrificial lamb’ for more on this point).

Nuts and bolts of a reversionary pension

To establish a reversionary pension, you must elect for this option in writing when starting a pension in an SMSF. In the application, the initiating pension member will nominate to whom they would like the pension to revert automatically upon their death. So if this person passes away, the balance and supporting assets will continue as is and the pension will simply be paid to the nominated individual.

If they wish, the reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased. can choose to stop (commute) the pension and take a lump sum. There may be tax consequences from doing this, depending on the age of the reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased. and how soon after the member’s death this decision is made. They can also just move the funds back to accumulation phase (which might be appropriate for some people relying heavily on government benefits). For these reasons, it’s critical that you seek tax advice if a member of your SMSF dies.

If you want to extend your influence after death by, for instance, protecting a beneficiary who may be a spendthrift or otherwise vulnerable, you have the option of making a reversionary pension non-commutable. This prevents a lump sum being taken, but requires detailed legal advice.

The negatives

The main drawback of a reversionary pension is that your personal circumstances may change. If, for instance, you have named your spouse, but then subsequently divorce or separate, you may want to change your reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased..

Some pension deeds – for instance, the Eviser Docs deed (to be launched shortly) – allow the pension to be amended, to add or remove a reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased.. However, some deeds may require you to commute your existing pension and start a new one.

In simple terms, this just means a bunch of paperwork, but if you’re thinking about changing a pension established before 1 January 2015, be aware that it could have other implications.

As we explained in Age pension: Keeping your super grandfathered, stopping or amending your super pension means it can no longer qualify for the ‘grandfathering’ from the new deeming rules that apply to the age pension Income TestOne of the two tests that determine eligibility for the Age Pension (the other is the Assets Test). The test that applies (dominates) is the one which gives the worst result. Details of how the Income Test calculations and limits can be found at the Department of Human Services website..

If you collect an age pension (or certain other Centrelink benefits), losing the grandfathering could cost you some or all of your age pension, either now or in the future. That’s because you’d no longer qualify for the old (and generous) ‘deductible amount’ approach.

Seek personal advice on the potential impact of switching to, or changing, a reversionary pension before making any decisions.

Final words

If you’re confident you know where you want your assets to go then a reversionary pension makes a lot of sense. Even if the benefits are only minor, they’ll often outweigh the negatives, and, if something unexpected happens, the benefits can be a game saver.

 

Liam Shorte is a principal of Verante Financial Planning Pty Ltd (www.verante.com.au), a corporate authorised representative of Magnitude Group Pty Ltd (AFSL 221557). This article is a general information article and to the extent it contains any financial advice it is general advice only. We recommend seeking personal advice on your own circumstances.

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