A super change to avoid death and taxes

PORTFOLIO POINT: A death-tax removed! A major tax win for super pensions was a pleasant surprise in the recent mini-budget.

How often would a government tell the Tax Office to back off on legitimate revenue raising?

In terms of animal species, it would certainly be classed as “rare”. It would probably be considered “endangered” if the instruction was coming from a government under severe fiscal pressure, needing every buck it could get.

Which meant the decision in last week’s Mid-Year Economic and Fiscal Outlook on the tax treatment of pensions upon death came as a bit of a shock to the super industry.

Last year (27 July 2011), I wrote a column based on ATO tax ruling TR 2011/D3. At the time, the ATO had hardened its stance on what happens when a person in pension phase dies.

In a nutshell, TR 2001/D3 said that the ATO’s position was that a pension ceases at the point of death and reverts back to accumulation. Given that the dead member’s fund would then have to be paid out, the hotly disputed ruling was, in essence, the introduction of a death tax via super.

This could be a particular problem for those who had built up assets in the SMSF after turning on a pension.

In that column, I used the example of someone who had turned on a pension at age 65 with $500,000 as the assets backing the pension. If the pension then rose in value to $1 million and the pensioner died, the $1 million would revert back to accumulation and all gains in the fund could become taxable.

One way to escape the death tax was to have an automatic reversionary pension in place at the time of death. It had to be automatic and not left to the discretion of the (remaining) trustees in the case of SMSFs.

The ATO said at the time that it didn’t believe its ruling was a change of the law, just its reading of the law that came into effect on 1 July, 2007. Many SMSF industry participants disagreed with the ATO’s reading and said the law would need to be tested.

But I’m happy to report, testing is no longer required.

The government has said it doesn’t agree with the ATO’s interpretation.

The government has effectively said that this was never the intention of the legislation. And as a result, they would rewrite the legislation to make sure that the ATO’s interpretation was invalid and pensions could stay as pensions after death, while trustees wind up the pension in a timely fashion.

The government’s statement – there is no legislation to look at yet – said the changes will be retrospective to 1 July, 2012. As the law had been in place since 2007, there is five years’ worth of deaths in super funds whose fate is unsure.

However, given the Government’s stated intention, the ATO would have to be truly mean-spirited to further impose the law going back too far. However, by limiting it to this financial year onwards is probably designed to minimise any challenges to ATO decisions from previous years.


Most of the industry had argued that the ATO had read the law wrong. The previous Howard Government had specifically created tax-free pensions for the over-60s. To then tax the pension on death amounted to a death tax.

(Super death benefits can be subject to tax when paid to non-dependants, but are tax free when paid to dependants.)

So, turn on your pension at age 60, enjoy tax free income and capital gains until you fall off your perch at age 85, then be taxed on, potentially, significant capital gains on death.

In any case, the government has ruled that no matter whether the ATO was reading the law correctly or not, it wasn’t the government’s intention (even if it was the previous Howard Government’s rule) to tax super pensions on death.

While the ATO’s ruling was not SMSF specific, it is more important for SMSFs because of the control they deliberately exercise around the purchase of assets, the management of pensions and the management of death benefits and estate planning through their vehicles.

Most of the industry believed that having a “reversionary pension” option in place to convert the pension from the, say, deceased husband to the surviving wife was fine. However, there was some quick rewriting and updating of trust deeds done post TR 2011/D3 to make sure that “automatic reversionary pensions” were included in trust deeds.

One of the main issues will be what’s considered reasonable under the “as soon as practicable” timeframe proffered in the government’s press release.

Some assets – particularly commercial properties – can take some time to sell. And if the only offered price is considered too low, how long would a trustee be able to wait for a better offer?

There are still many questions to be answered and they can’t be answered until legislation is on offer to read.

But the decision is a major relief. Particularly given that what we were expecting to come out of MYEFO, for a period, was fire and brimstone raining down specifically on the SMSF sector (see this column 3/10/12).

It’s always a good day when a death tax is abolished.


The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.