The changes announced to superannuation from 1 July 2017 affect many individuals. Given this deadline and the need to reconsider strategy before then, many individuals and their advisors have been focussing on the changes to contributions, the transfer balance cap and other related issues. However, many have overlooked the hidden estate planning issues arising from the changes to the law upon the death of a member.
These changes mean that where the death benefit exceeds the recipient’s transfer balance cap (currently $1.6 m), the excess must be cashed out as a lump sum. The changes will particularly affect those who wish to retain benefits within superannuation by reverting or paying a pension to their dependants upon their death.
The following tables illustrate what happens on the death of a member where a spouse has their own pension benefits after 1 July 2017:
Please click here to view the tables.
The tables demonstrate that it is possible for the surviving spouse to commute their own pension to retain more of the deceased’s death benefits in superannuation. However depending on the amounts involved, part of the deceased spouse’s death benefit may have to be cashed out of the superannuation system entirely.
The estate planning issue is then where should this lump sum be paid. It will be necessary to review and if necessary update death benefit nominations and Wills:
- if significant sums will be cashed out, it may be appropriate to include a superannuation proceeds trust (where all the beneficiaries are death benefit dependents) and/or testamentary trust(s) in the Will(s) (depending on the tax position)
- in cases of second marriages where superannuation may have been used as an estate planning tool to provide for the spouse of the second marriage but to protect the capital for the children from the first marriage (for example, by paying a non-commutable pension), this arrangement may need to be unwound and an alternative arrangement should be considered (such as a superannuation proceeds trust with restrictions on access to capital)
- non lapsing binding death benefit nominations could be used to provide that on the death of the first spouse, the trustee has the power to pay the death benefit to the survivor or to their respective legal personal representative or a combination of both taking into account the transfer balance account of the spouses (which may be subject to indexation). However, care must be taken in drafting these, as case law is clear that the nominations must be clear, precise and in accordance with the terms of the trust deed, or else they will be invalid.
The distinction between whether a reversionary nomination is auto-reversionary or reversionary will also be important from an estate planning perspective. Auto reversionary means that the trustee has no discretion as to whether the pension is paid to the reversionary beneficiary (ie, it must revert). The trust deed and pension documents must be reviewed to determine this:
- if a pension is ‘auto-reversionary’, then the reversionary beneficiary has twelve months from the date of death to decide whether to cash the pension out of superannuation entirely or receive the pension. If no election is made, the pension will be added to the transfer balance account of the reversionary beneficiary and
- if a pension is not ‘auto-reversionary’, then the trustee must decide where to pay the deceased’s benefit in accordance with superannuation law and the terms of the deed. If the trustee decides to pay a pension, then it will add to the transfer balance account of the reversionary beneficiary as at the date of the decision. A binding death benefit nomination can direct where the trustee pays the pension in this scenario.
In addition, there are other hidden estate planning issues arising from the transfer balance cap including:
- the need to update SMSF deeds to bring them up to date with the new legislation and to allow estate planning objectives to be achieved, as often older deeds do not allow for non lapsing nominations
- members with balances exceeding the transfer balance cap may wish to consider setting up a new SMSF for their pension interest and retaining in their existing fund their remaining accumulation interest. In our view, this strategy should not trigger part IVA as using two funds does not create a tax benefit per se but rather achieves ‘segregation’ (which is a method of calculating tax), but appropriate tax advice should be sought
- tax advice should be obtained to determine the tax implications of each strategy, as there is different tax treatment for death benefit dependants compared to non-dependants (which will also differ depending on the taxed and untaxed elements of a member’s benefits in the fund) and lump sums compared to pensions. It may, therefore, be that the best strategy from an estate planning perspective is the worst from a tax perspective and
- if a death benefit is required to be paid as a lump sum this may force the sale of illiquid assets where there are insufficient liquid assets to satisfy the lump sum. To avoid this, it may be possible to cash part of the benefit in specie by transferring part of an asset out of the superannuation system (to the estate or a dependant) and retain the other part of the asset or benefit in the fund by paying it as a pension to the dependant. This would effectively require splitting the asset into parts.