Super strategies for death

SUMMARY: How the death of a spouse will impact on the $1.6m pension limit. And what to do about it.

In days gone by, a good old reversionary pension would generally do the trick. It’d cover most situations.

If a couple were truly getting old-and-grey together, then the whole pension fund could be left to the spouse. The money could stay in super for good.

And the fortune built together, or the good fortune had together, could continue on in tax-free perpetuity … or at least until the second of you died. (Then there might be a little tax problem for the kids.)

As we know, all that turns to pot on 1 July, 2017, for those couples who have done particularly well at getting considerable sums into super.

The new rules mean that not only will individuals be restricted to $1.6m in a pension fund, but you will also (with proper planning) get a headache when your partner dies.

So, what do you do?

For those with larger super balances, you’re going to need to make use of the two main tools available for “estate planning” inside your super funds.

And those two tools are the “automatic reversionary pension” and the “death benefit nomination” (but generally, preferably, their more serious sibling, the “binding death benefit nomination”).

The definitions of both are pretty much as they sound.

An “automatic reversionary pension” is a pension that has a nominated reversionary. When a pension dies, the pension automatically becomes payable to the reversionary pension. The pension doesn’t stop. It just switches from being paid to the deceased, to being paid to the survivor.

Obviously, this relates only to a pension that is being paid.

A death benefit nomination can be made over an accumulation or pension portion. If you’re using a reversionary pension for the pension itself, then the binding death benefit nomination will generally be used for the accumulation portion of your superannuation.

Death benefit nominations come in two forms. A non-binding death benefit nomination and a binding death benefit nomination (BDBN).

A non-binding nomination will name the deceased’s member’s preference for who the super goes to. However, if it is non-binding, the trustee of the super fund has the final discretion as to who the benefit is paid to.

A legal BDBN nomination takes away that discretion. If a legal BDBN is in place, the trustee must pay it to the nominated beneficiary. (We’ll come back to more on this issue in a moment.)

Back, for a moment, to what changes on 1 July.

Automatic reversionary pensions

The real decisions are going to come where both members of the fund (I will assume husband and wife for most of the following) are over the $1.6m. But there will also be considerations when the combined pension balances of a couple exceed $1.6m.

Let’s take a couple who currently both have $2m each in pension fund accounts in their super fund (total $4m). On 1 July, they are going to have to each send back $400,000 back to accumulation, leaving them with $1.6m each in pension.

What if one of them dies on 1 November, 2017? Let’s assume it was the husband. On the golf course.

In most circumstances, the best result is generally going to be that they have signed an automatic reversionary pension (ARP) to each other.

At this point the wife has her own $1.6m pension, but she has just inherited an ARP for $1.6m. She now has $3.2m in pension phase.

She can’t keep it there forever. The rules that have appeared with these new $1.6 transfer balance caps (TBC) mean that if you inherit a reversionary pension, you can’t keep the whole lot there, if it takes you over the $1.6m transfer balance cap, and therefore receive a double pension for life.

The government has effectively allowed a “grieving period”. In this case, the widow would have 12 months to make a decision on what you are going to keep in the pension fund and what you are going to put back into super.

Everyone’s situation is going to be different. But at this point, evaluating the two pension funds might suggest that one is better to maintain as a pension, while the other one is commuted back to accumulation.

This might make sense, if the couple also has some assets outside of super, in their personal names.

But within that 12-month period, the member will have to roll one of those pensions back to accumulation, potentially, or take it out of superannuation entirely.

As raised above, there could also be issues to discuss where neither member was over the $1.6m, but combined they are, or where the surviving member had a small pension, but the deceased member had a $1.6m pension account.

For now, understand that putting in place an automatic reversionary pension is something that you should consider, particulary for those who have higher pension balances, or sizeable combined pension balances.

Death benefit nominations

These are usually the tool to deal with accumulation balances (but can also be used to deal with pension accounts) ie, you can’t leave a reversionary income stream if you’re not actually in pension phase.

Again, let’s take the member above, who as of May 1, had $2m in pension. On 1 July, that becomes $1.6m in pension and $400,000 in accumulation. The BDBN nomination would generally be used to cover the $400,000 that remains in accumulation, if the pension fund was dealt with via a reversionary pension.

The first spouse dies on November 1. The $400,000 that was in accumulation will be covered by the BDBN. This will generally see the money paid directly out of super to the nominated beneficiary.

Defined benefit pensions

For those fortunate enough to be members of DB funds, the DB pensions are usually lifelong and often indexed until death.

And, upon the death of a member, they usually revert to payment to the surviving spouse, most commonly at the rate of 2/3 of the original member’s pension.

DB pensions are counted towards the $1.6m transfer balance cap also. Whatever pension you receive, multiply that by 16. Therefore, if you receive a DB pension of $75,000 a year, that counts towards your TBC as $1.2m.

DB pension don’t escape the rules here. If the original pension had a $75,000, a reversionary pension at 2/3 would be $50,000. This would then count as a transfer balance cap of $800,000 for the recipient. And this would need to be factored in when making the decision on what to retain in pension phase, from whatever pension forms had been left by the deceased to their surviving spouse.

Please note: Everyone’s situation is different. The above is looking at some very general situations. Don’t rely on this to form your own super estate plan. Seek professional advice.

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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 managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: bruce@brucebrammallfinancial.com.au . Bruce’s new book, Mortgages Made Easy, is available now.