Death of a spouse when both members of a couple have pensions – how are these managed? | Heffron

The 1 July 2017 changes to superannuation pensions introduced a new rule of thumb – most people can only convert $1.6m to a retirement phase pension over their lifetime (this is the limit known as the Transfer Balance Cap or TBC). 

Unfortunately the new rules also included provisions that ensured people who inherited their spouse’s superannuation as a pension would have this amount counted towards their $1.6m limit as well. The timing and amount depends on whether the deceased spouse’s pension was reversionary or non-reversionary but one way or another it counts eventually if it is received by the survivor as a pension.

A challenge many practitioners have run into already is understanding exactly how this works when the spouse’s pension was reversionary and so immediately passed over to the surviving spouse on death. Won’t that mean the survivor potentially has two large pensions in place at the same time – resulting in an excess with dire tax consequences? In fact, no – providing the right action is taken at the right time.

It is easiest to explain the mechanics using examples. In all the examples below, we will assume that both members of the couple (Graham and Judy) originally had retirement phase pensions at 1 July 2017 of $1.6m in their SMSF (so both have “used up” their TBC). A few years on, Graham’s pension is worth $1.7m and he dies in July 2019. Judy’s pension is worth $1.75m at the time – the slight differences reflect different drawings they have made over the intervening years. The pensions were reversionary to each other.

When a pension reverts to a surviving spouse on the death of the original recipient, the income stream continues seamlessly to the survivor. 

In our example, this means that on Graham’s death, his pension immediately switches to Judy in July 2019. So:

• The fund will continue to receive a tax exemption on the proportion of its assessable income that is earned on assets supporting retirement phase pensions. If neither member had an accumulation account immediately before Graham’s death, then the entire fund continues to be exempt from tax on investment income.
• The trustee will have to ensure that a minimum payment is taken from both Judy’s own pension and the one she inherited from Graham during 2019/20. These amounts will initially have been calculated as at 1 July 2019 when Graham was still alive (so the minimum for his pension should be based on his age and balance at 1 July 2019). These minimum amounts will only be adjusted if Judy makes some changes to the pensions during 2019/20 (eg switching them off, cashing them out entirely etc). Her age and the balance at 1 July 2020 will determine the minimum amounts for the 2020/21 year.

For a time, then, Judy will be receiving two large pensions from her SMSF at the same time – apparently in contravention of the new rules. Won’t she receive an excess notice telling her that she has breached her Transfer Balance Cap?

Remember, however, that there are special rules for reversionary pensions when it comes to the TBC. 

Importantly, Judy will not have any amount checked against her TBC for Graham’s pension until the anniversary of his death in July 2020. That means she can actually continue running both pensions for the rest of 2019/20 – the full year’s minimum payments will be made from both pensions and the fund will receive a tax exemption on all its investment income throughout the year. If it looks like next year will see some large withdrawals from superannuation, this might be the year in which to sell some of the fund’s assets!

Judy’s SMSF must report the fact that she has inherited his pension to the ATO via a Transfer Balance Account Report (or TBAR). This SMSF is probably required to lodge its TBARs quarterly and the deadline for this report will be 28 October 2019 – note that the timing is based on the date Graham’s death occurred (July 2019), not the date on which his pension will count towards Judy’s Transfer Balance Cap (July 2020). The amount to be reported is the value of Graham’s pension at the time of his death, no matter what it has grown (or shrunk) to by July 2020.

If Judy takes no action at all she will have a problem in July 2020 – the running tally of her Transfer Balance Cap amounts (known as her “Transfer Balance Account”) will look like this:

In fact, what Judy will probably do immediately before the anniversary of Graham’s death is “roll back” some or all of her own pension (switch it off). This will make “space” for her to inherit Graham’s pension without breaching her $1.6m limit. This is becoming a common strategy for people with large balances because it allows Judy to leave the whole amount in her SMSF. Under current law she can switch off her entire pension and leave it in an accumulation account for as long as she likes. (Don’t forget that the usual rules for commuting pensions apply – if the whole pension is to be commuted, the pension must be paid up to date first, even if the payment is only small because the new financial year has only just started. Even if the pension is only partly commuted, the trustee must ensure the amount remaining is enough to pay the full year’s minimum pension.)

Her choices with the super she has inherited from Graham, however, are far more limited – she can either let it continue as a pension or cash it out of super entirely. Leaving it accumulating in the fund is not an option.

If Judy did decide to roll back her own super to solve her Transfer Balance Cap problem identified above, she would only need to do so with $1.7m. If her pension account was worth more at the time (let’s say $1.8m), she could leave the extra $100,000 in her pension account. The situation is more problematic if her pension account has shrunk. Let’s say returns are poor during 2019/20 and she has only $1.65m in her pension account by the time she takes action in July 2020. The balance is Graham’s pension account is even lower at $1.6m. 

A few points are relevant here:

• It doesn’t matter that Graham’s pension account is now lower than it used to be when he died. There will still be $1.7m added to Judy’s Transfer Balance Account in July 2020.
• Even if she rolled back ALL of her pension account, she still wouldn’t be able to “balance the books” – she needs to be able to report a commutation from “somewhere” of $1.7m.
• But she can achieve this if she also reports a commutation from Graham’s pension account – it’s just that this amount would need to be paid out of super entirely, not just rolled back to accumulation phase. In other words, it’s a real transaction that will have to be made before the deadline in July 2020, it’s not just paperwork.

The picture could then be as follows:

Note that all of these amounts would be reported in Judy’s name – even the $0.5m commutation from Graham’s pension.

The reporting would just need to be clear that this related to a pension other than her own. This is why the forms used for this reporting require trustees to give each pension a specific account number. The ATO use this to match up commutations etc to the original pensions. 

Importantly, it doesn’t matter (and in fact in this case it was important) that Judy reported a commutation from Graham’s pension before the $1.7m had officially become part of her Transfer Balance Account.

What if Graham’s pension was not reversionary to Judy? 

Under these circumstances the situation would have been completely different. Most significantly, his pension would have stopped as soon as he died. There would be no need to report her immediate inheritance of this income steam for TBC purposes in July 2019.

Graham’s pension account would only become a pension for Judy if the trustee chose to pay his death benefit that way – either using normal discretionary powers or at the direction of a binding death benefit nomination (if the binding death benefit nomination said that the pension was to be reversionary and automatically continue to Judy then the situation would be as for reversionary pensions above).

Importantly:

• Until the trustee decided how to deal with Graham’s death benefit, the fund would continue to receive a tax exemption as if his account was still in pension phase (in this regard the situation is much the same as if the pension was reversionary). The only caveat here is that the trustee must deal with Graham’s death benefit “as soon as practicable” to comply with the superannuation rules about cashing death benefits. The ATO generally interprets this as six months unless there is a good reason for the process to take longer.
• No minimum payment would be required from Graham’s account – the pension has stopped.
• An amount would only be reported for Judy’s Transfer Balance Cap if the trustee specifically chose to pay some or all of Graham’s account to her as a pension. If they do this, however, the amount reported will count towards her TBC immediately – there is no automatic 12 month delay. The amount will also be “whatever is given to her as a pension” – not the value of Graham’s pension at the time he died. If this is less than the full amount of Graham’s account at the time the decision is made, anything leftover must be paid out of the fund as a lump sum death benefit.
• If a new pension starts for Judy from Graham’s old pension account, the usual rules for minimum payments will apply from that time.

Under these circumstances, it will of course make sense for Judy to re-organise her own affairs before receiving any of Graham’s account as a pension.

Overall, very similar strategies and opportunities are available regardless of whether pensions are reversionary.  

The difference is important when it comes to timing, exact amounts and the precise process of dealing with the death benefit. Some trustees and practitioners will prefer reversionary pensions and others will not. The key is to ensure that all those involved in the planning know exactly what they have and take the right action at the right time.

Our online compliance tools will help you stay up to speed and lodge on time with full confidence. 

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