This article has been prepared for the benefit of our clients who have self-managed super funds and the content has been tailored for this context. The concepts covered may apply equally to members of industry and retail funds. In any case, you should always seek professional advice from your adviser or your super fund before making any decisions around your super.
When you die, any super you have becomes known as your super death benefit.
Many people don’t realise that your super death benefit doesn’t form part of your estate and is not automatically covered under your will. For this reason, it’s imperative that we think about what we want to happen with our death benefit.
This article focuses on one of those options: a reversionary pension nomination. We discuss what this is, how it works and why it might or might not be a good idea.
What is a reversionary pension?
If you’re planning to begin an account-based pension, one option is to make this a ‘reversionary pension’. This basically means that the pension passes automatically to a person nominated by you (usually a spouse) when you die. An important feature of a reversionary pension is that the original pension does not stop on the death of the original pensioner but ‘switches’ to the nominee automatically. The reversionary pensioner retains the same percentages of tax-free and taxable components that were calculated when the pension first commenced.
Can my reversionary pension nominee be anyone I choose?
No. There are rules for who can receive your super death benefit, including a reversionary pension. A reversionary pension can only be paid to:
- Your spouse;
- A child who is under 18;
- A child who is between 18 and 25, and financially dependent on you;
- A child who is over 18 years of age and has a disability;
- A person with whom you have an interdependency relationship, or
- A financial dependent (excluding a dependent child over 25 years of age).
How does a reversionary pension differ to a binding death benefit nomination?
With a reversionary pension the income stream from your super pension will automatically pass to your reversionary nominee. There is no decision to be made by the fund trustees other than confirming the reversionary pension nomination.
With a binding death benefit nomination (BDBN), the current pension must cease and the fund trustees must decide whether to start a new pension for the nominated beneficiaries (if they qualify) or to pay out the death benefit as a lump sum. So, there is no way under a BDBN to ensure your pension automatically continues to a beneficiary. However, a BDBN does provides some flexibility for executors dealing with complex estates to work out solutions that may not have even been available or considered when a nomination was drafted. Under a reversionary pension, this is generally not possible.
If you nominate your legal personal representative under a BDBN, then your super benefit will become part of your assets distributed by your will. If you don’t have a will, your super benefit will be distributed according to the laws that concern people who die without a will.
How do I establish a reversionary pension?Usually, a reversionary pension nomination is made at the time of setting up the pension, and is documented as part of the pension paperwork. In the case of self-managed super funds, this normally takes the form of a ‘minute’ that records the trustee’s resolution to revert the pension upon your death.
Can I change my nomination along the way?Super legislation is silent on whether or not a reversionary pension nomination can be put in place or amended after the account-based pension commences. For this reason, you need to refer to your super fund’s trust deed for guidance. A trust deed is an enabling or empowering document. If it says that the trustee has the power to do something, the trustee has the power to do that thing. If it is silent, the trustee does not have the power to do that thing. If the trust deed is silent on this aspect, the trustee could be subject to challenge for breach of trust if they allowed a pension to revert without the power to do so in the deed. However, some trust deeds allow the member to name or change a named reversionary beneficiary during the life of the pension without a need to stop the pension and start a new pension with a different beneficiary. Generally, the deeds in place for our clients allow for making a reversionary pension nomination during the course of the pension. It is not possible to make a reversionary pension nomination after the death of the pensioner. As with all aspects of estate planning, any change in your circumstances should trigger a review of your reversionary pension nomination. This is especially critical in the case of a divorce or separation.
How does a reversionary pension interact with the transfer balance cap?
Since July 1, 2017, reversionary pensions have had special treatment when it comes to how they count towards a person’s transfer balance cap. The transfer balance cap is a limit on the amount that can be put into a ‘retirement phase’ pension. The cap is currently set somewhere between $1.6 and $1.7 million depending on your situation.
A death benefit received in the form of a reversionary pension will count towards this limit. Unfortunately, making the pension reversionary does not solve that problem.
But it does buy some time to restructure the reversionary pensioner’s super arrangements if need be. When someone dies and leaves behind a reversionary pension, the value of that pension for the purpose of the transfer balance cap is frozen at the time of death. For the next 12 months, the pension continues as usual (except that the nominee receives the payments instead of the deceased) but nothing counts towards their transfer balance cap until the first anniversary of the pensioner’s death.
This sounds small but it can be valuable. It means that, for a time, the surviving spouse is often receiving two pensions (their own plus that of the deceased pensioner). The two may add up to far more than the maximum cap if they both had large balances. The reversionary pensioner has 12 months to re-organise their affairs so that they are within the cap in the end but any growth in the deceased’s pension in that period is ignored.
By contrast, if the pension is not reversionary, the surviving spouse generally has less time to re-organise their affairs (the ATO expects death benefits to be sorted out within six months). In addition, the amount credited against the widow or widower’s transfer balance cap when it comes to any pension they take from their deceased spouse’s super is the actual value at the time they start the new pension.
Does a reversionary pension nomination override a binding death benefit nomination?This depends on what the super fund’s trust deeds says. It’s very important to refer to the trust deed before putting either in place, and to be absolutely clear on the provisions. Some trust deeds may allow a binding death benefit nomination (BDBN) to override a reversionary pension nomination, however the vast majority do not. The trust deeds for our clients typically say that a reversionary pension nomination will override a BDBN.
What are the benefits of a reversionary pension?
Certainty: Both you and your nominee know what is going to happen with the remaining pension account when the you die.
Simplicity: Once the nomination is in place, there is little else to do, even after you die. Because the pension reverts to your nominee automatically, there are no decisions which need to be made and nothing is required of the trustee in the time immediately after you pass away. It’s relatively seamless.
Extra time to coordinate financial affairs: With a reversionary pension, there’s a 12-month delay before the reversionary pension counts towards the beneficiary’s own transfer balance cap. This can be especially useful if the beneficiary has their own pension and the sum of the two will exceed the cap.
Centrelink advantage: Some people choose reversionary pensions for social security reasons such as the Commonwealth Seniors Health Card (CSHC). There’s a special concession for people who started their pensions before 1 January 2015 that allows them to ignore any income from their pension when working out if they are eligible for the CSHC (remember there is an income test for this card – only those with incomes below the relevant thresholds can have it).
That special rule continues if the original member dies and his or her pension was reversionary. But it doesn’t continue if the original pension stopped (it wasn’t reversionary). If the deceased’s super was used to provide a new pension to the surviving spouse, any income from that pension would count towards the CSHC income test.
What are the drawbacks of a reversionary pension?
Less suitable for complex estates: A reversionary pension might be less appropriate for complex estates, such as those involving blended families. Let’s look at an example.
John is married to Marie. It’s the second marriage for both of them and they each have adult children from their first marriages. John and Marie have a self-managed super fund. John wants to provide for Marie in the event that he dies, but once Marie dies, John wants any remaining capital from his super to go to his own children.
If John were to put in place a reversionary pension nomination, then his whole pension entitlement becomes Marie’s upon his death. What happens to any remaining balance from John’s death benefit when Marie dies? Assuming there are no super dependents, any remaining balance would typically go to Marie’s estate and be distributed according to Marie’s will. If John wants any of his former super assets to go to his own children, he needs to rely on Marie doing that through her estate. You can see the potential complexity here.
There are steps John can take to bring certainty to his wish to have his assets go to his own children ultimately. But this can be a complex area of estate planning. Reversionary pension nominations lend themselves well to simple estate planning situations. If you know exactly who you want your remaining funds to go to, and they qualify to receive it, then a reversionary pension may be the best option.
Less flexibility: A reversionary pension offers little to no scope for the trustee and executors to manage super as part of the overall estate. This could present challenges if wishing to distribute the estate evenly amongst beneficiaries.
Limited beneficiaries: Each pension can only have one reversionary nomination. So, if you want more than one person to receive your death benefit as a pension, you might want to consider multiple pensions. You could, for example, have one pension revert to your spouse, and another revert to your legal personal representative and be distributed according to your will.
Will a death benefit reversionary pension be taxed?
The tax treatment of a reversionary pension depends on the age of the deceased and/or the age of the beneficiary.
In the case of SMSFs, if either you or your nominee are aged 60 or over at the time of your death, the pension will be tax free.
If you’re both under age 60 at the time of your death, the taxable portion of income stream payments will be counted as assessable income for your beneficiary, but they’ll be entitled to a tax offset equal to 15% of this amount. When they turn 60, the income stream will become tax free.
Must the beneficiary retain the pension?
The recipient of the reversionary pension has a level of flexibility over the death benefit pension. If you do not want to receive the death benefit as a pension, you can commute some or all of the pension and take that amount as a lump sum payment (that is remove it from super altogether).
You cannot, however, roll the death benefit pension out of retirement phase and back into accumulation. Under the rules for cashing out a death benefit, it must be either paid as a pension or taken as a lump sum.
This content is intended only to provide a summary and general overview of the subject matter covered. It is not intended to be comprehensive nor does it constitute advice. We attempt to ensure that the content is accurate and current but we do not warrant the content nor its currency. You should seek professional advice before acting or relying on any of the content.