Reversionary pensions: The good, the bad and the ugly

By Stuary Sheary, Senior Technical Manager

It’s becoming increasingly popular for clients to nominate their spouse as a reversionary beneficiary for their pension rather than nominating for their spouse to receive it via a binding death benefit nomination. The death of a spouse or partner is an important financial planning touchpoint event. Advisers have many strategy considerations when advising clients on who will receive a reversionary pension.

We have identified our three most frequent reversionary pension questions that have important implications for clients. These include:

  • the modification to the calculation of the ‘special value’ for capped defined benefit pensions
  • restrictions on rolling death benefit pensions back to accumulation, (including revisionary pensions
  • any timing issues that impact on the total super balance and transfer balance account.

The good – modifications to the calculation of the ‘special value’ for capped defined benefits

Reversionary pensions count towards the reversionary beneficiary’s transfer balance cap. The transfer balance cap is a limit on the amount of super that can be transferred into a retirement phase pension. The amount or ‘credit’ value on the reversionary beneficiary’s transfer balance account, which measures events counting towards the transfer balance cap, is equal to its balance at the time of the member’s death. This amount is credited to the beneficiary’s transfer balance account 12 months after the date of death.

Capped defined benefit (DB) pensions such as defined benefit schemes administered by the Commonwealth Superannuation Corporation, like Commonwealth Superannuation Scheme (CSS), Public Sector Superannuation scheme (PSS), Defence Force Retirement and Death Benefits (DFRDB) and MilitarySuper do not have a commutable value and instead a ‘special value’ is calculated.

The special value for a DB lifetime pension is based on the annual entitlement multiplied by 16. The annual entitlement is based on the first payment paid to the recipient since 1 July 2017, and is calculated as:

First payment / days in period it relates to x 365

For example, if a member’s first DB lifetime pension payment is $2,500 per fortnight, the special value is calculated as:

Annual entitlement

= ($2,500 / 14) x 365
= $65,178.57

Special value is the annual entitlement x 16 where:

= $65,178.57 x 16
= $1,042,857

Historically, an unfair transfer balance account assessment arose when pension payments reduced as a result of scheme rules. The special value was calculated on the higher first pension payment and no debit arose when pension payments were later reduced.

Examples of when subsequent pension payments might reduce, include:

  • when the DB lifetime pension reverts to a spouse and the first pension payment is equal to the deceased’s last payment and, after a certain period, payments reduce to a proportion of the deceased’s last payment
  • when a reversionary DB lifetime pension, for example a reversionary MilitarySuper DB pension, which pays an additional fortnightly amount for a dependant child living with the eligible spouse. The additional payment ceases when the child is no longer a dependant under the scheme rules.

Regulatory changes made in December 2019 allow a debit value to arise in the client’s transfer balance account where there is a reduction in pension payments from a capped DB lifetime pension.

These changes take effect retrospectively from 1 July 2017.

The steps to calculate the amount of the debit are:

  • Step 1: calculate the special value just before the pension payment is reduced.
  • Step 2: calculate the special value just after the pension payment is reduced.
  • Step 3: Take the difference between the result of Step 1 and Step 2. That difference is the amount of debit arising in the beneficiary’s transfer balance account.

If the payment received by the reversionary beneficiary just before the reduction is $2,500 for a 14-day period and then reduced to $1,675 (67% of the original amount) the transfer balance debit (Step 3) would be $344,143.

This is calculated below:

Step 1:

Calculate the special value just before the pension payment is reduced:

Annual entitlement

= ($2,500 / 14) x 365
= $65,178.57

Special value

= $65,178.57 x 16
= $1,042,857

Step 2:

Calculate the special value just after the pension payment is reduced.

Annual entitlement

= $1,675 / 14 x 365
= $43,669.64

Special value

= $43,669.64 x 16
= $698,714

Step 3:

Take the difference between the result of Step 1 and Step 2. That difference is the amount of debit arising in the beneficiary’s transfer balance account.

 

= $1,042,857 – $698,714
= $344,143 (transfer balance debit).

Reversionary beneficiaries whose super contributions, such as non-concessional or catch-up concessional contributions, are affected by the total super balance may benefit from a reduction in the ‘special value’ which will result in a reduced total super balance.

The bad – reversionary pensions cannot be rolled to a member’s accumulation account

Since the removal of the ‘prescribed period’ on 1 July 2017, death benefit income streams, including reversionary pensions, cannot be rolled into a member’s accumulation account. Before this it was common practise to roll a death benefit income stream into a member’s accumulation account after the prescribed period. The prescribed period generally ended at the later of:

  • 6 months from date of death
  • 3 months from grant of probate.

As a member cannot roll a reversionary pension back to accumulation since 1 July 2017 this has had an impact on their ability to:

  • Manage their transfer balance cap – where their reversionary pension puts them at risk of breaching the cap, they may need to draw out a lump sum from the reversionary pension.
  • Shelter assets from Centrelink – where the beneficiary is below Age Pension age and otherwise eligible for benefits, such as Job Seeker payment or disability support payment and more.
  • Reduce taxable income – where both the deceased and the client are below age 60 and part or all of the pension is taxable.
  • Save money inside superannuation in accumulation – when the client does not want or need the additional cashflow from the reversionary pension.

The ugly – misunderstandings of the total super balance and transfer balance cap rules

There is sometimes confusion about when the credit for a reversionary account-based pension arises in the member’s transfer balance account and when it is added to the total super balance. This misunderstanding can have unintended consequences.

Total super balance

The balance of a reversionary account-based pension is part of the member’s total super balance (TSB) which impacts the member’s non-concessional contributions cap and their ability to use unused concessional contribution caps. As the last 30 June’s total super balance is used as a measure for a current financial year, an increase or decrease in the total super balance in the current year only impacts on contributions in the next financial year.

Transfer balance account

In relation to the transfer balance account, which impacts how much may be transferred into a retirement phase pension, the ‘credit’ event is 12 months after the date of death. For reversionary account-based pensions, the amount of the credit is the deceased member’s balance at the time of their death. The delay in the credit event for the transfer balance account means that a member’s TSB may be impacted well before it is ‘credited’ to the transfer balance account.

Case study: Robert and Maggie who have a reversionary account-based pension

If Robert’s spouse Maggie passed away on 30 June 2019 and Robert (age 60) begins to receive a $1,700,000 reversionary account-based pension, then his non-concessional contribution cap will be nil in the 2019/2020 financial year. This is because his TSB exceeds $1,600,000 on 30 June 2019.

If Robert mistakenly thinks the reversionary account-based pension is added to the TSB in 12 months’ time, as it does for the transfer balance account, and miscalculates his TSB at 30 June 2019 he will not realise his non-concessional contributions (NCC) cap for the 2019/20 is nil. If he then makes an NCC in the 2019/20 financial year he will exceed his NCC cap.

In relation to Robert’s transfer balance account he will need to commute $100,000 by withdrawing a lump sum from the pension before 30 June 2020 to avoid excess transfer balance cap issues.

Reversionary defined benefit pensions

Unlike a reversionary account-based pension the value of a reversionary capped defined benefit pension is not counted towards the member’s TSB until the time it is recorded on the transfer balance account (that is 12 months after the date of death). In Robert’s case, assuming he only has a reversionary defined benefit pension, he can make an NCC in the 2019/20 financial year as that capped defined benefit pension is not included in his TSB on 30 June 2019. Robert will not be able to make an NCC in the 2020/2021 financial year.

Conclusion

Compared to starting an ordinary retirement pension, advisers have more considerations when dealing with a client who begins to receive a reversionary pension on the death of a partner. The points made above are only three of many considerations and emphasise the value of advice both in retirement and upon important touchpoint events such as the death of a partner.


More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

Disclaimer
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.