Division 296 tax and reversionary pensions

Including a reversionary nomination when you start a pension binds the fund trustees to pay your super death benefit that way, as a continuation of your existing pre-death pension.

If you don’t nominate a reversionary beneficiary, your pension will cease on your death and the remaining pension balance will be dealt with through any valid death benefit nomination you have in place, or at the remaining trustees’ discretion.

There may be specific SMSF fund rules for the effective establishment of a reversionary pension, so it’s important that you review your fund’s requirements.

Benefits of a reversionary pension

There are benefits in nominating a reversionary beneficiary, most of which centre around certainty in estate planning outcomes, including:

• Continuity – when the original pension member dies, the pension can automatically continue to the nominated beneficiary, usually a spouse or dependent child.
• Efficiency – because the pension is set up to revert automatically, it may avoid delays that can happen while super funds decide how to pay death benefits. It also removes the need to go through a new pension application process for the surviving beneficiary.
• Timing advantages – in some cases, the 12-month deferral of certain transfer balance cap impacts can provide the surviving beneficiary with planning flexibility.
• Dispute management – it gives clear direction on who is to receive the pension benefits, which can reduce estate and family disputes.

It is important to note that the person you nominate as your reversionary beneficiary needs to be an eligible superannuation dependant, usually your spouse or a dependent child.

If you do nominate a child, the pension will, in most cases, need to stop and be paid out as a lump sum benefit when that child reaches age 25.

It’s also important to consider the personal circumstances of the nominated beneficiary, especially around tax and Centrelink outcomes.

Division 296 tax and your total super balance

The remaining balance of any pension that automatically reverts to a nominated beneficiary is treated differently under the total super balance rules and the transfer balance cap rules (TBC).

• For the purposes of TBC, the pension balance when it reverts to the nominated beneficiary is not assessed or included under the recipient’s TBC until 12 months after it has reverted. This gives the beneficiary 12 months to make any required changes to their overall superannuation position.
• However, there is no 12-month grace period for the purposes of the total super balance (TSB) rules. The pension balance when it reverts to the nominated beneficiary is included immediately in any TSB calculation and remember, it’s the surviving spouse’s TSB that is used to determine any Division 296 tax liability!

As you can see, your year-end total super balance for Division 296 testing will be considerably higher if you are the recipient of a reversionary pension. For some higher-balance members, this timing could materially alter their tax outcome.

It could mean the difference between not being assessed under Division 296 and being hit with a hefty (personal) tax bill.

An alternative to using a reversionary pension nomination is to have your super death benefits paid out as a death benefit pension, a brand-new pension created after your passing.

Effectively, your pension would cease on your death and the remaining SMSF trustees would then follow any death benefit nomination that you have in place to pay any remaining super balance as a new death benefit pension.

By structuring a death benefit this way, the beneficiary’s TSB will only be affected when that new pension starts, which could be in the next financial year.

This additional time could then allow for any required restructuring and could effectively eliminate any Division 296 assessment in the year of death for the beneficiary.

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What SMSF members can do

If you have an existing reversionary nomination within your SMSF and you wish to make changes, take care. The process to make changes to an existing pension will differ between SMSFs and will depend on the wording and rules set out in both the initial pension application documents and your SMSF trust deed.

It’s essential that you refer to these fund documents and follow the required process.

Some SMSFs may have documentation that allows changes to be made to an existing pension by way of trustee resolution, whereas others may require the pension member to cease (commute) their existing pension and then recommence a new pension with or without the reversionary nomination in place.

Once again, it’s essential that you consider all issues that may be relevant to both you and your nominated beneficiaries.

The bottom line

Where SMSF members have a combined TSB with their spouse that is approaching or is already above the Division 296 threshold of $3 million, make sure you consider the tax outcomes on death, when you ‘inherit’ the other’s pension balance.

You may need to weigh up both the tax outcomes and the estate-planning benefits associated with reversionary pensions.

For some, the use of reversionary pensions will still offer significant benefits around estate planning and asset protection, but keep in mind these nominations should not be a set-and-forget solution. Make sure that trust deeds, pension documents and estate plans are all reviewed together, and that these documents align.