Managing the transfer balance account upon death

By Julie Steed, Senior Technical Services Manager

Many self-managed super funds (SMSFs) will have a transaction to the transfer balance account following the death of a member. In this article, we examine the issues that need to be considered and the most common problems that could arise. We explore the practical issues with reversionary income streams, child income streams and the timing of lump sum death benefit payments.

Transfer balance cap recap

The transfer balance cap restricts the amount that can be transferred into retirement pension phase where the investment returns are tax-free. The general transfer balance cap is currently $1.6 million.

A transfer balance account is created for a fund member when they first commence a retirement phase pension, or on 1 July 2017 for pensions in existence at that time. The transfer balance account ceases on a member’s death.

Breach of transfer balance cap

When a person exceeds their transfer balance cap, they are required to partially commute their pension to reduce their transfer balance account below the transfer balance cap. The commutation must include accrued excess transfer balance earnings which are calculated by the Australian Taxation Office (ATO). The commutation can be via either a roll back to an accumulation account or by cashing out as lump sum.

In addition, members are liable for tax on the excess transfer balance earnings. The tax rate is 15% for the first breach and breaches which occurred during financial year 2017/18, while it’s 30% for breaches in subsequent years.

Death benefit pensions

Death is the only compulsory cashing event for SMSFs. Upon the death of a member their benefit must be cashed as soon as practicable.

Provided that the fund rules allow, a death benefit may be cashed by paying a lump sum, an interim lump sum and a final lump sum, one or more pensions or a combination of both a lump sum and pension benefits. This ability applies regardless of whether the death benefit is being paid from an accumulation account, a non-reversionary pension or a reversionary pension.

Death benefits can only be paid as a pension to a death benefit dependant, including a spouse, a financial dependant, someone in an interdependency relationship or a child of the deceased. However, where the beneficiary is a child of the deceased a pension may only be paid if the child:

  • is under age 18
  • is age 18 to 25 and financially dependent on the deceased
  • has a disability described in the Disability Services Act 1986.

To meet the disability definition, the child needs to have a physical or intellectual disability that is permanent and results in a substantially reduced capacity of the person to communicate, learn or move  and means they need ongoing support services.

A child death benefit must be commuted by the time the child becomes age 25, unless the child is disabled.

In the remainder of this article we will refer to spouse pensions, however, the treatment is the same for death benefit pensions paid to a financial dependant or a person who was in an interdependency relationship. Additionally, minors who are not the child of the deceased but who are financial dependants, such as grandchildren, are treated in the same way as a spouse.

All death benefits pensions are retirement phase pensions.

Rolling over

From 1 July 2017, a death benefit pension can be rolled over to another fund at any time. A death benefit pension always retains its identity as a death benefit. Death benefit pensions cannot be intermingled with other pensions and cannot be rolled back to accumulation phase.

The ability to rollover can be a valuable option in an SMSF where the surviving spouse may not wish to continue managing the SMSF on their own.

Life insurance

The treatment of life insurance as part of a death benefit pension depends upon whether the insurance was held in an accumulation account or a pension account and if it’s held in a pension account, whether the death benefit recipient is a spouse or a child.

When insurance is held in an accumulation account, the insurance forms part of the death benefit which is used to start the death benefit pension. Accordingly, the insurance proceeds used to commence a death benefit pension count towards the transfer balance cap.

Where insurance is held in a pension account and a death benefit pension is being paid to a spouse, the insurance proceeds may be treated as an investment return and do not count towards the transfer balance cap.

Where insurance is held in a pension account and a death benefit pension is being paid to a child, the insurance proceeds are excluded from the child’s transfer balance calculations and as such are not permitted to be used to commence a death benefit pension. Any insurance amount must be paid as a lump sum benefit.

Spouse death benefit pensions

When a death benefit is paid as a pension to a spouse, the transfer balance treatment depends upon whether the pension is a reversionary pension or not.

Reversionary pension

When a pension is reversionary, the pension balance at the date of death counts towards the reversionary pensioner’s transfer balance cap. However, the credit to the transfer balance cap does not occur until 12 months after the date of death. The 12 months is designed to allow time for the reversionary beneficiary to manage their transfer balance cap.

Where the reversionary pension will cause a transfer balance cap excess, the surviving spouse may:

  • commute their own pension back to accumulation phase, in full or part
  • make a lump sum withdrawal from the reversionary pension, in full or in part.

The reversionary pension cannot be commuted back to accumulation phase.

It is important to appreciate that the transfer balance credit will occur on the 12-month anniversary of the death of the original pensioner. If the pension recipient has not arranged their affairs within the 12-month period, an excess may arise.

It is also important to ensure that the pension document correctly identifies if a pension is reversionary or not. Only pensions that automatically revert to a surviving spouse can be considered to be reversionary. If the trustee has any discretion, then the pension will be classified as non-reversionary for transfer balance cap purposes.

Non-reversionary death pensions

A non-reversionary pension counts towards the beneficiary pensioner’s transfer balance cap at the time the death benefit pension commences. The value at commencement is included as a transfer balance credit to the death benefit pension recipient at the date of commencement.

Although the surviving spouse won’t have the full 12-month grace period, they will have some time. The trustee of a fund won’t pay a death benefit as a pension unless the beneficiary requests a pension.

Case study

Arthur and Martha each had an account-based pension of $1 million as at 1 July 2017. Arthur died on 1 May 2019, at which time his account balance was $1.1 million. The benefit is payable to Martha and her current account balance is $1 million. Martha wishes to retain the maximum amount in super.

If the pension is reversionary, the $1.1 million will be credited to Martha’s transfer balance account on 1 May 2020. Before then, Martha needs to rollback at least $500,000 to accumulation phase but can retain $500,000 in her account-based pension.

If the pension is non-reversionary, the $1.1 million will be credited to Martha’s transfer balance account on the date the death benefit pension commences. Before then, Martha needs to roll at least $500,000 back to accumulation phase but she can retain $500,000 in her account-based pension. Although Martha will not have the full 12 months grace period, she is likely to have several months to organise her affairs and request the death benefit as a pension.

It’s also possible for a death benefit pension to be commenced with more than $1.6 million if the recipient has a current pension account that has grown since it commenced, or since 1 July 2017 for existing pensions at that time.

Case study

Sharma and Jerry each had an account-based pension of $1.6 million at 1 July 2017. Sharma died on 1 May 2019, at which time his account balance was $1.7 million. This benefit is payable to Jerry and his current account balance is $2 million. Jerry wishes to retain the maximum amount in super.

Jerry can commence a death benefit pension of $1.7 million and can also retain $300,000 in his own account-based pension (ABP). He will need to roll $1.7 million of his account-based pension back to accumulation phase.

Jerry’s transfer balance account details are as follows:

Transfer Balance Account transactionCreditDebitBalance
ABP commencement $1,600,000   $1,600,000
ABP commutation  $1,700,000 -$100,000
Death benefit pension commencement $1,700,000   $1,600,000

Jerry has retained $2 million in retirement phase pensions and he does not have an excess transfer balance amount.

Child death benefit pensions

Child cap increment

When a death benefit is paid as a pension to a child, there is a special transfer balance cap amount which is called the child cap increment. The amount of the child cap increment depends upon when the death benefit pension commenced and whether the deceased had a transfer balance account at the date of death.

Importantly, the test is whether the deceased has a transfer balance account at the date of death, for example, if they had ever commenced a retirement phase pension, rather than whether the deceased had a retirement phase pension at the date of death.

A child can have multiple cap increments if multiple parents die.

Commenced before 1 July 2017

For each child death benefit pension that was commenced prior to 1 July 2017, the relevant transfer balance cap is $1.6 million. The transfer balance credit occurred on 1 July 2017 for the value of pension at 30 June 2017. Any amount above $1.6 million was an excess and had to be removed from the super system.

From 1 July 2017

From 1 July 2017, the amount of the child cap increment depends upon whether the deceased had a transfer balance account at the date of death.

If the deceased did not have a transfer balance account then the child cap increment is a pro-rated amount of the general transfer balance cap, based on the child’s proportion of the deceased’s total death benefit.

If the deceased had a transfer balance account at any time, the child cap increment is subject to a pro-rated value of the pension account/s as at the date of death, based on the child’s proportion of the deceased’s total pension benefits.

Investment returns from the date of death until the date the child pension commences are included in the pension account balance and therefore count towards the child cap increment.

A child death benefit pension above the general transfer balance cap of $1.6 million may also be possible without having an excess transfer balance amount.

Case study

Mick held $1.6 million in an account-based pension on 1 July 2017 and did not have an excess transfer balance amount. He died at age 62 with a pension account balance of $2 million which is to be paid to his only child Oscar who is 16.

Because Mick had a transfer balance account, Oscar’s child cap increment is his share of Mick’s pension account/s which is 100% of $2 million. Oscar can commence a death benefit pension of $2 million and does not have an excess transfer balance amount.

If a death benefit is payable from both accumulation and pension benefits then the child is still constrained by the child cap increment, which results in all accumulation balances having to leave the super system.

Case study

Ayana is 44 and is diagnosed with a debilitating degenerative disease but has a life expectancy of over 10 years. Ayana’s beneficiaries are her two children age 14 and 16. Ayana has $125,000 in an accumulation account which has a $800,000 insurance policy under which Ayana is claiming a total & permanent disability (TPD) benefit.

Ayana understands the benefits of tax-free investment returns on pensions and Ayana’s fund is satisfied that she has met a disability condition of release. Ayana commences a pension with $120,000 whist awaiting the outcome of her insurance claim.

Unfortunately, Ayana dies before her insurance claim is finalised. The insurance proceeds are received a few weeks after she dies.

Ayana had a transfer balance account at the date of her death, so her children’s child cap increment is their share of Ayana’s pension account which is 50% of $120,000 each ($60,000). The insurance proceeds that are received into her accumulation account cannot be paid as a death benefit pension and must leave the super system.

If Ayana had not commenced a pension and had died with $925,000 in an accumulation account, each of her children could have received a death benefit pension of $462,500.

End of a child death benefit pension

A child death benefit pension must be commuted at age 25, unless the child has a disability. The pension may end earlier if assets backing the pension are exhausted. The benefit may also be commuted when the child reaches 18 and requests a commutation, unless the fund’s trust deed restricts access to an age up to age 25.

When the child death benefit pension ends the child’s transfer balance account is effectively deleted. The child will then be eligible for the general transfer balance cap when they retire.

The following table illustrates the child cap increment determination for death benefit pensions commenced after 1 July 2017:

SourceChild cap incrementSurplus
Accumulation accounts
no transfer balance account
General transfer balance cap ($1.6 million) proportioned based on benefit received Lump sum to child
Accumulation accounts
had a transfer balance account
Nil Lump sum to child
Retirement phase pensions and accumulation accounts Retirement phase pensions shared between all beneficiaries
Nil for accumulation accounts
Lump sum to child
Retirement phase pensions only Retirement phase pensions shared between all beneficiaries No surplus

Conclusion

Understanding how death benefit pensions interact with the transfer balance cap is an essential element of a client’s estate plans and can assist practitioners in providing appropriate advice to clients.


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.