- Death benefits and estate planning are hugely impacted by the $1.6million Transfer Balance Cap which came into effect in July.
- There is no going back to the accumulation stage with a death benefit payment which can only be taken as either a lump sum or as a death benefit pension.
- Where the pension is reversionary, clients have 12 months to make these decisions.
“With all the noise around the $1.6 million Transfer Balance Cap (TBC), the impact of these changes on death benefits and estate planning issues is yet to receive the scrutiny it warrants,” said Keat Chew, Head of Technical Services, Netwealth.
“As of 1 July 2017, the new and old world of super rules intersected, which means the best outcomes will require a good understanding of both the old and new rules, and how they interact in the new environment.”
What are the key changes impacting estate planning?
From 1 July 2017, the three key changes which came into effect were:
- A death benefit payment will always be a death benefit payment and as such, is always available tax-free as a lump sum to a death benefit tax dependant
- A death benefit payment can be a rollover by an eligible dependant to another fund to commence a death benefit pension
- If the death benefit payment is taken as a pension by a spouse for example, it counts against the receiving dependant’s TBC.
According to Chew, in practice this means in the case of a reversionary pension to a dependant spouse, the credit to the Transfer Balance Account (TBA) arises 12 months after the date of death, whereas for a non-reversionary pension it arises as soon as the beneficiary spouse is entitled to it.
An ideal way to better understand the impact of these changes is to see them play out in case studies, as outlined below.
Client Scenario one – simplicity is rare
A husband and wife have pensions of $700,000 each, both reversionary to each other. The husband passes away.
In this situation, there is no issue as the husband’s pension reverts to the wife and 12 months later of death, this will add a credit to her TBA based on the value of his account at date of death. Assuming that she started her own pension with $700,000 and she inherited his pension at the date of death with a value of $700,000, his brings her total TBA to $1.4m, which is under the TBC amount of $1.6m.
According to Chew, the simplicity of this situation is rare to find in reality. Often couples exceed the TBC, and this is where advisors need to research and apply the right strategy in order to optimise their client’s situation.
Client Scenario two – no way back to accumulation
A husband has a pension of $1.3m and the wife has one of $700,000, both reversionary to each other.
In this case study, the husband dies leaving the wife to make some financial decisions as she can’t have both the $1.3m reversionary pension and her own $700,000 pension as it will take her well above the TBC when it is added as a credit 12 months later.
Chew said while there a range of decisions to be made, they must all respect the fact that you can’t rollover a death benefit back to the accumulation stage.
He explained: “A death benefit payment can only be taken as either a lump sum (exit super) or as a death benefit pension, and it can be rolled over to another fund, but only to start another pension.”
The wife can choose to roll back $400,000 of her own pension to accumulation (making future earnings taxable at 15% as opposed to the tax free environment), leaving her with $300,000 in her own pension.
Chew said this is possible as her pension is not a death benefit pension. If she does this, she could then keep the full death benefit pension from the deceased husband of $1.3m as his pension plus her $300,000 pension is $1.6m, which is within the TBC. An important result with this exercise is that she is able to keep the entire $2m in the tax concession superannuation environment.
Alternatively, the wife could keep her own $700,000 in pension and take part of the death benefit as a reversionary pension – $900,000 – and part as a death benefit lump sum (exiting super) of $400,000. Once again, the $900k death benefit pension added to her own $700,000 pension gives a TBA of $1.6m. In this case though, only $1.6m is retained in superannuation.
It’s important to remember that where the pension is reversionary, clients have 12 months to make these decisions. This could be an advantage given that clients could potentially have both their own and reversionary pensions totaling more than the $1.6m cap for the 12 months before the need to readjust to ensure the limit is not exceeded at the end of the period.
However, the timeframe is much shorter for non-reversionary pensions, which means you need to act in a timely manner to avoid a potential excess TBA issue.
Chew said it is also quite feasible that clients may find themselves in an excess TBA situation even if the dependent spouse has no pension.
For example, if the same husband had $2m in pension and the wife had nothing, she could only take up to the $1.6m as a pension, and the remaining $400,000 as a death benefit lump sum to avoid exceeding the TBC.
Other sleeper issues
Chew said while the changes to death benefits warrant advisers attention, there are actually numerous issues advisers need to watch out for over the coming 6-12 months.
This includes further fallouts from the changes to the pension issues. Advisers need to get a good handle on the Transfer Balance Account to ensure they don’t exceed the Transfer Balance Cap and that they correctly manage the CGT relief particularly if they are dealing with SMSFs.
Other areas include observing and not exceeding the new contribution limits. Evaluation of whether TTR’s should continue for specific clients given their tax exemption status is no longer available.
Finally, given the availability of the 5-year rule for the carry forward of unused concessional contributions from 1 July 2018, there should be advance planning on how best to utilise the contribution limits.
Chew is sympathetic to the workload and ripple effect these changes have made for advisers and clients.
“Much like the CGT changes, the overarching impact of any super updates is one that weighs heavily on advisers. From navigating optimal options for clients, to revising estate planning approaches, assisting clients to better understand the impacts of their choices through to the supporting paperwork, it creates arduous yet necessary work for advisers and their teams so they can better support their clients.”
The secret is to be prepared, to understand what the rules were and how they have changed, and to think about the impacts from all perspectives.
For more articles and white papers on the new super rules, check out our special report, Winning in the new super era.