What happens when a pensioner dies?

In a recent article (here) my colleague Annie Dawson provided her top 5 tips when it comes to commuting death benefit pensions.  But what are the tips and traps to watch right at the start – when the pensioner first dies?

When anyone dies, someone else will receive their super.

There are rules about who that can be (for example, for most people it will only be their spouse, children or their estate). The group that can receive that super as a pension is even smaller. In fact, it’s generally just the spouse and dependent children under 25. Super paid to the deceased’s estate or adult children must generally be paid as a lump sum. So for the purposes of this article, we’ll just refer to the spouse when it comes to the deceased’s super being paid as a pension.

And there are some important quirks to consider if the deceased had already converted the super to a pension.

When a pension is first set up, a key decision is made – will it be “reversionary” (continue automatically to the spouse when the original pensioner dies) or “non reversionary”.

A key difference between the two is that if the pension is reversionary, the pension just keeps running when the original pensioner dies – it simply has a change in ownership. In contrast, if the pension is not reversionary, it stops when the original pensioner dies. This has some important ramifications.

Pension payments for the year

It’s particularly important when it comes to what has to be paid from the pension during the year.

Let’s imagine Craig (currently 70) is receiving a pension from the CJ Superannuation Fund and dies on 1 May 2022. When he first set up his pension, he nominated his wife Jodi as his reversionary beneficiary. By the time he died, Craig hadn’t taken any pension payments (which is perfectly legal and in fact common in SMSFs). As the pension is reversionary, the trustee needs to ensure that the full year’s minimum is paid before 30 June 2022. It will all be paid to Jodi, not to Craig’s estate or split between them in some way to reflect the fact that she only “owned” the pension for the last 2 months of the year.

And the amount will be the whole minimum pension amount worked out at the start of the year – ie 2.5% (allowing for the temporary halving of minimum pension payments in 2021/22) of Craig’s pension balance at 1 July 2021. Note that we don’t need to know Jodi’s age to work this out – while the minimum will end up being paid to Jodi, it was worked out at the start of the year based on who owned the pension at the time (Craig). The minimum payment for 2022/23 will be worked out using Jodi’s age at 1 July 2022.

In contrast, if the pension wasn’t reversionary, it is considered to have stopped as soon as Craig died. There is no need for Jodi to take any payments from it in 2021/22. In fact the reverse is true – unless the trustee has very quickly decided to pay Craig’s super to Jodi as a pension, she can’t receive any pension payments from his balance. This can be tricky if, say, Jodi doesn’t have her own pension but there is a regular payment from the SMSF’s bank account to their personal bank account. The trustee should stop those payments until a decision has actually been made to pay the super as a pension to Jodi. (Of course all these decisions can be made very quickly in an SMSF.)

Transfer balance account reports (TBARs)

One of the special rules for TBARs is that if Craig’s pension is reversionary, the value won’t be added to Jodi’s transfer balance account until May 2023 (12 months after Craig’s death). But the trustee still has to lodge the relevant TBAR more or less immediately (for example, if the fund is required to lodge TBARs quarterly, this one would need to be lodged by 28 July 2022). The amount on that TBAR is also the value of Craig’s pension account at 1 May 2022 rather than 12 months later.

Sometimes people in Jodi’s position might take a commutation from their inherited pension. A common mistake is to assume that the commutation should be reported in Craig’s name (it’s a commutation from super that was his after all). In fact, it’s reported in Jodi’s name – because she “owns” the pension at the time it’s commuted. This is true even if Jodi takes a commutation before reaching the 12 month anniversary of Craig’s death.

In contrast, if the pension was non reversionary the trustee might not have to lodge a TBAR at all – these are only for pensions so it will depend on whether any of Craig’s super is paid to Jodi as a pension. If it is, a TBAR will be required just as it would for any other new pension. The amount will be whatever is put into a pension for Jodi (which might be all or just some of Craig’s pension balance). If Craig’s balance has grown in the meantime, a higher amount may well be reflected in Jodi’s transfer balance account than would have been the case if the pension had been reversionary. Of course the reverse is true if Craig’s pension account has fallen in value.

Exempt current pension income (ECPI)

One area where there is no difference between reversionary and non reversionary pensions is the tax treatment of investment income in the fund.

It makes sense that Craig’s pension account should continue to be counted as a “pension account” (and increase the fund’s ECPI) if it has automatically continued to Jodi. After all, it’s still a pension.

But in fact this key tax exemption even continues if the pension is not reversionary. It continues until the account is either converted to a new pension or paid out to his estate or another beneficiary. 

Dealing with the death of an SMSF member can always be slightly complex. It gets a little trickier again when the member was already in pension phase – but the key is to start by checking whether or not the pension was reversionary.

The ins and outs of pensions, commutations and ECPI are explained in several of our recent Education Bites modules – register today for your regular dose of high quality SMSF CPD.