Death and Taxes with Super Benefits

There has been a significant amount of focus on the benefits of reversionary pensions since the ATO released draft tax ruling, TR 2011/D3.  The ruling considers the issue of where a pension will cease in the event of death where there is no automatic reversion to a beneficiary.  This reversion will only occur where either:

  • the terms and conditions of the original pension specify a reversionary beneficiary; or
  • a valid binding death benefit nomination exists (with explicit instructions to pay the benefit as a pension)

The ability to continue to pay an income stream to a tax dependant beneficiary will allow for the fund assets to continue to receive concessional tax treatment, rather than have to pay invest those monies outside of superannuation.

Whilst any amount paid as a lump sum to a tax dependant beneficiary is tax-free, regardless of age, the taxation of the benefit as an income streams is somewhat different.  Any taxation of the income stream being paid from the fund to a reversionary beneficiary (or tax dependant) will be based upon both the primary member’s age at death and the age of the beneficiary.

The table below outlines the different levels of taxation where a death benefit is paid as an income stream to a tax dependant:

It is important to remember that income streams can only be paid to tax dependant beneficiaries.  Non-dependants can only receive lump sum amounts, with the taxable components being subject to tax at 15% (taxed element) or 30% (untaxed element).

In addition, where an income stream is paid to a tax dependant child, the pension must cease at age 25, unless they have some prescribed disability).  At this time, the pension must be converted to lump sum and is paid as a tax-free benefit.

NB. According to the ATO website, the final ruling on when a pension commences and ceases (TR 2011/D3) is expected for release on 24 April 2012.

Releasing benefits only under the right condition

A recent case of Mason and the Commissioner of Taxation has highlighted the importance of how and when a member can access their superannuation benefits.

Benefits since 1 July 1999 are typically preserved (not accessible) until a member meets a condition of release.  Where the trustee(s) are satisfied that a member has met a condition of release with a nil cashing restriction, the member’s preserved benefits and restricted non-preserved benefits in the fund become unpreserved (accessible).

Conditions of release are the events that a member needs to satisfy to withdraw benefits from their super fund.  The conditions of release are also subject to the governing rules of the fund.  It may be possible that a benefit may be payable under the super laws, but can’t be paid under the rules of your SMSF.

Examples of conditions of release with a ‘nil’ cashing restriction:

  • Retirement on or after preservation age
  • Attaining age 65
  • Death
  • Permanent incapacity
  • Termination of gainful employment (restricted non-preserved benefits)
  • Terminal medical condition
  • Termination of gainful employment with a standard employer-sponsor of the regulated super fund on or after 1 July 1997 where the member’s preserved amounts in the fund at the time of the termination are less than $200; and
  • Being a lost member who is found, and the value of whose benefit in the fund when released, is less than $200

It is important to note that transition to retirement (TRIS) once a member has reached preservation age (currently 55), is a condition of release.  However, it still imposes a ‘cashing restriction’ and therefore the member’s superannuation components will remain unchanged (e.g. stay preserved).

Mason Case

The Mason case outlines the fund member (Mr. Mason) being of the belief that attaining age 55 was a condition of release that allowed him to access his super to withdraw lump sum amounts.  Whilst age 55 can be a condition of release when a member starts a Transition to Retirement Income Stream (TRIS), it still has imposed cashing restrictions until such a time as Mr. Mason had retired.  This was not the case at the time of either of these lump sum withdrawals, as he continued to work within his bookkeeping business.  He did however declare the amounts as lump sums within his personal tax return against his low rate cap amount.  The Commissioner after conducting an audit of the fund (after the auditor issued an Auditor Contravention Report) was found that the two lump sum amounts withdrawn during the 2008/09 and 2009/10 financial years were in fact illegal early access amounts.

The tribunal in its findings stated that Mr Mason …should have been aware that “retirement” was a “condition of release” if the MTSF was to pay superannuation benefits in a lump sum or sums and, further, that “cashing restrictions” would apply to the “attaining the preservation age” condition of release;

As a result the Tribunal affirmed the Commissioner’s decision to include the amount in question as assessable income within his personal tax return to be taxed at his marginal tax rates (not as a lump sum against his low rate cap amount).  It was fortunate for Mr Mason that the Commissioner used his discretion under section 42A of SISA to allow the fund to remain a complying fund.

With preservation progressively raising to age 60 for those born after 1 July 1964, it is an important to understand the rules and regulations about when you can access superannuation benefits.  The courts have shown that as a trustee/member, you are responsible for the actions taken in the fund and the penalties that will apply for non-compliance.

How a re-contribution strategy can save you and your family thousands of dollars

A recontribution (or recycling) strategy is a simple yet highly effective strategy in early retirement that when used effectively can save a member or their beneficiaries many thousands of dollars.

The strategy involves a process of withdrawing benefits from a member’s superannuation account and then making a non-concessional contribution (NCC) of the same money back into the fund.

The primary objective of this popular strategy is to convert all or part of a member’s taxable component into tax-free component.  In order to undertake a recontribution strategy, the member must:

  • have first met a condition of release (with a nil cashing condition) to withdraw benefits (or already have unrestricted non-preserved benefits), plus
  • be eligible to contribute into superannuation.

There are a number of reasons why fund members may wish to undertake a recontribution strategy, including:

  • improving the tax-effectiveness of a superannuation income stream paid up to age 60;
  • reducing the tax impost on death benefits paid to non-dependant beneficiaries; and
  • hedging against legislative risk (transferring benefits to a spouse)

Improving the tax-effectiveness of a superannuation income stream paid up to age 60

A recontribution strategy can be effective for a member receiving an income stream prior to age 60, as any pension is assessable income to the recipient.  Where a member has satisfied a condition or release, they have the ability to withdraw a lump sum and recontribute this amount to improve the tax-free component of the income stream.  From a strategy viewpoint, this taxable component withdrawal is typically taken up to the low rate cap amount ($165,000 for 2011/12), taken in proportion with any tax-free component.

Where an income stream is started after the recontribution, the proportions of the tax-free and taxable components are ‘locked in’ at the commencement date.  These proportions are then used to determine all future income payments and commutations that the member receives.  Subject to the member’s personal tax position and pension amounts to be taken, the recontribution amount may be more effective to operate as a separate interest.  That is, establish two separate pensions, one made up entirely of tax-free component. Reducing the tax impost on death benefits paid to non-dependant beneficiaries.

Since 1 July 2007, benefits received in the form of a lump sum or income stream from age 60 are tax-free in the hands of the recipient.  As a result, the primary driver for a recontribution strategy post age 60 is to improve the tax position of death benefits paid to non-dependent beneficiaries, whether directly or via an estate.  Where a non-dependant beneficiary (i.e. adult kids) receives a lump sum death benefit, they will be taxed on the taxable component at 16.5%.  Therefore, the use of a recontribution strategy can provide a tax saving of up to 16.5 cents in every dollar that is recycled.  For a fund member aged 60 – 64 (having met a condition of release), they could effectively withdraw up to $450,000 of their benefits tax-free and recontribute this amount back into the fund, providing an estate planning benefit of up to $74,250.  Again, it may be beneficial for the member to run a multiple pension strategy as the recontribution will be made up of entirely tax-free component.

Recontribution to a spouse

Prior to the introduction of Simpler Super (pre 1 July 2007), a recontribution from the member to a spouse account was an effective income-splitting strategy.  With the tax-free status of benefits post age 60, this strategy has been somewhat diminished.  It does however have limited application for members where one spouse may be significantly older than the other, for example where one member is under 60 and one member is over 60 years of age.  Centrelink may also be a consideration here with individuals who may qualify for an age pension.  Consideration of the spouse’s age and eligibility to accept the contribution must be considered as part of any recontribution strategy.

The issue of changing government policy is always at the back of people’s minds when it comes to superannuation.  Whilst a withdrawal post 60 as a lump sum or pension is currently tax-free, is it always going to be the case?  A recontribution to a spouse can be used to ‘hedge’ against future legislative risk.

Practically how it must work

To undertake a recontribution strategy, this money must be physically withdrawn from the fund, paid to the member and then deposited back into the fund as a contribution.  An accounting entry is not sufficient; there must be a debit and corresponding credit within the fund’s bank account.

A recontribution strategy can be undertaken when the member is either in accumulation or pension phase.  The tax treatment of any benefits taken need to be considered when determining whether the withdrawal as a lump sum or pension (i.e. under age 60).  Where there is insufficient cashflow to undertake a recontribution, this strategy could be undertaken as an in-specie lump sum (not as in-specie pension payments, unless done as a partial commutation according to TR 2011/D3).  Any recontribution of assets is subject to the exceptions outlined in section 66 of the SIS Act (acquisition of assets from a related party).  Where the lump sum or pension withdrawal is taken by a member under age 60, the appropriate statutory reporting to the Australian Taxation Office will apply, including reporting of benefits on the Fund’s Activity Statement, preparation of PAYG payment summaries, etc.

Tax Office’s view on recontribution strategies

The ATO’s view of recontribution strategies dates back to August 2004, where they issued a media release that stated various straightforward recontribution strategies would not attract the general anti-avoidance provisions (Part IVA) of tax law.

Since the introduction of Simpler Super on 1 July 2007, the ATO’s position on recontribution strategies has been addressed through an industry stakeholder Q&A document, that outlines that where a “…recontribution strategy that is carried out to minimise the tax that might be payable on a death benefit paid to a non-dependant, the Commissioner is very unlikely to apply Part IVA to such an arrangement”.   It is important to note that this view is not legal binding on the ATO and that they would assess each scenario on a case-by-case basis.

Recontribution vs. Anti-detriment payment

An alternative prior to undertaking a recontribution strategy, is to consider whether the beneficiaries would otherwise be eligible to receive an anti-detriment payment (refund of tax paid on contributions).  This is important because a spouse or child or any age (including non-dependent kids) are generally eligible for an anti-detriment payment when a death benefit is paid as a lump sum.  However, as the anti-detriment payment is only paid on the taxable component, using a recontribution strategy to recycle taxable component to tax-free component will reduce or eliminate any anti-detriment entitlement of a deceased member.

Everybody will adopt one of two strategies when it comes to superannuation:

  • the SKI model (spend the kid’s inheritance) or
  • inter-generational wealth transfer

With many people who have built wealth within superannuation now looking for an orderly of transfer of wealth to the next generation, the recontribution strategy can be a valuable tool to maximise the amount that is passed on to future generations.

Our latest video on pensions and lump sum

From the age of 55, you have the ability to pay yourself either a lump sum or pension out of your super fund.

Where you are age 60 or over, the payment of super benefits can be taken tax-free. They don’t form part of your income. You don’t pay tax on them.

If you are not retired, but not yet 60 and are paid super benefits, you have to pay tax on these payments.  But the tax laws help to reduce tax whether the super payment is taken as a pension or lump sum.

Super benefits are subject to preservation requirements, which means that there are strict rules about when you can access your super.  A condition of release must be reached before you can touch your super – such as retirement.

Depending upon what age and when you start getting paid your super determines how much you can take in any year.  An example of this is “Transition to Retirement”.

Lump Sum Payment

When getting a payment from a self-managed super fund as a lump sum, it doesn’t have to be in cash.  It can be in kind or what is referred to as “in specie”.   The lump sum benefit could be shares or property, so long as the asset transfers from your super fund.  The trust deed must also allow for a lump sum to be made in-specie.

Pensions/Income Streams

Amounts from super can also be paid as a pension. These are now called “income streams”.  These payments can only be made in cash.  The law only allows an SMSF to pay what is called an account based pension.

The minimum level of pension that can be taken depends on your age.  This pension amount is calculated based on your age when you commence the pension and then at the beginning of every financial year.  You can stop all or part of the pension at any time you like.

An account based pension lets you nominate a reversionary beneficiary. This is someone who you want to get the benefit of your super when you’re gone such as a spouse.  They will continue to receive payments in the event of your death. This will be exactly the same as you got when you were alive.  Remember though, you cannot use a pension cannot be used as a security for any borrowings.

Once you commence a pension, all of the income that was taxed in your SMSF before (@ 15%) is now exempt from tax (0%). This is regardless of value of the fund’s assets.   There are some funds that have members who are receiving a pension and still accumulating.  These funds may require the assistance of an Actuary to determine the level of tax exemption for the fund.

Transition to Retirement

You can work and draw a pension from your super fund; this is called “Transition to Retirement” or “TTR”.

TTR allows a person to receive a payment from their super fund, an income stream, whilst making contributions into super at the same time. This gives people the ability to contribute more to super without having less money to live on each week.

How does TTR work?

A transition to retirement income stream is a restricted form of account-based pension, which has both a minimum pension and also a maximum amount that can be taken.  The maximum amount you can draw is 10% of the fund’s account balance each financial year.  Typically, when using this strategy, the contributions made each financial year will be consolidated with the pension account to boost pension balance and improve the tax-free status of the fund.

When paying a transition to retirement pension, you cannot access the capital of the pension.  You can convert from transition to retirement to an ordinary account based pension upon meeting a cashing condition, such a retirement.

Re-contribution Strategy

There are strategies available to you as part of building your retirement plan that can be of real benefit.   For example, it is a possible to undertake what is called a recontribution or recycle strategy.  This is when you take a lump sum or pension from your SMSF and re-contribute it straight back as a non-concessional contribution to your Fund.

The benefit of this strategy can be two-fold.  Firstly it can reduce the tax on your pension received whilst under 60 years of age, plus it can also benefit your longer-term estate planning when your death benefits are paid to non-tax dependants such as adult children.

Once you have reached age 60 and draw a pension from your self-managed super fund, there is no tax.  No tax when paid to you as a pension and no tax within the super fund.  Tax nirvana right here in Australia possibly?  There simply is no better tax environment in which to hold assets.  If your fund invests in Australian listed shares and receives fully franked dividends, the franking credit of 30 cents in the dollar is fully refunded each year as part of the fund’s annual tax return.  This can potentially add 1% or more to the overall performance each year.

Whilst you are able to be paid a pension from your SMSF, it is not compulsory for you to do so. You can’t be forced to get paid from your SMSF. You can leave your money to accumulate in super and draw lump sums when it suits you. Some people use their SMSF as an estate planning vehicle. They accumulate their children’s inheritance in a 15% tax environment.

NB.  More information will be released shortly as part of the launch of the SMSF Academy website.

Click here to register your interest if you have already done so…

Cheque your timing with benefit payments

Don't rely on an unpresented cheque at 30 June to meet your minimum pension payment.

The Australian Taxation Office has recently issued its first SMSF determination for 2011, SMSFD 2011/1.  This determination confirms that a benefit payable by cheque or promissory note is “cashed” at the time it is received by the member or beneficiary.

This issue is very common when dealing with drawing minimum pension levels before 30 June each financial year.  There has long been debate over whether an unpresented cheque at 30 June was sufficient to meet the minimum pension requirements and therefore allow for partial or full tax exemption on income within the SMSF.

The Regulator has indicated in SMSFD 2011/1 some parameters around forming this view, which includes:

  • at that time, money is payable immediately and available for payment;
  • the trustee takes all reasonable steps to ensure that the money is paid promptly;
  • the money is paid; and
  • the requirements of the Superannuation Industry (Supervision) Regulations 1994 (SISR)1 are otherwise satisfied.

SMSFD 2011/1 provides some concise examples of how this determination is to apply.  I have provided two of these examples below:

Example 1

Jenny is a member of the Blue SMSF.  As at 30 June 2011, the Blue SMSF is required to make a benefit payment to Jenny of $15,000.  The trustee writes a cheque for $15,000. Jenny receives the cheque on 30 June 2011, but does not present it for payment until 5 July 2011 (2011/12 financial year). The cheque is subsequently honoured.

The benefit was cashed on 30 June 2011, when Jenny received the cheque. Objectively, the trustee intended to transfer funds from the SMSF to Jenny at that time by issuing the cheque and money was paid promptly.

If the cheque was not honoured because there were insufficient funds held in the account of the SMSF, the benefit would not be cashed on 30 June, financial year.

Alternatively, the SMSF may have had sufficient funds, but proceeds from the cheque may not have been transferred to Jenny because of a failure in the bank’s systems.  In such a case, the benefit would be cashed on 30 June 2011, provided that all reasonable steps are taken to ensure that the funds are transferred to Jenny once the bank’s systems resume normal operation.

Example 2

Alana is a member and trustee of the Pink SMSF.  As at 30 June2011, the Pink SMSF is required to make a benefit payment to Alana of $5,000.  The SMSF does not have sufficient available funds to make this payment to Alana at that time.  However, a term deposit held by the SMSF is expected to provide the necessary funds on 30 September 2011 (2011/12 financial year).  The SMSF writes a cheque for Alana for $5,000.  Alana receives the cheque on 30 June 2011, but does not present it to her financial institution for payment until 1 October 2011.  The cheque is subsequently honoured.

The lack of available funds as at 30 June 2011 indicates that Alana, as trustee of the Pink SMSF, did not objectively intend to immediately transfer funds from the SMSF at the time the cheque was issued.  Therefore, Alana’s benefit was not cashed on 30 June 2011.

Alternatively, the SMSF may have had sufficient funds available, but Alana delayed presenting the cheque to her financial institution as she did not require the funds immediately. The delayed presentation of the cheque indicates that there was not an objective intention to immediately transfer funds from the SMSF. Therefore, Alana’s benefit would not be cashed on 30 June, financial year.

How the law works

Division 6.3 of the SIS Regulations outlines that “cashing” involves a member’s benefit from within a fund being paid.  This indicates that cashing involves a payment which reduces the member’s benefit within the SMSF.   Therefore, in determining this view, the key factors that need to be considered on a case-by-case basis are:

  • Characterising what is provided to the member; and
  • the timing of the cashing

Click here to read more details relating to SMSFD 2011/1.

See related articles:

(C) The SMSF Academy 2012
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