Transfer balance cap

Since the introduction of the 1 July 2017 super reforms, the interaction between the $1.6m transfer balance cap, the deceased’s total super balance and the rules applying to death benefits adversely affect pre-1 July 2017 super estate planning strategies because these are based on traditional assumptions when using Binding Death Benefit Nominations (BDBNs).

fishing pier

Death benefit income streams are now seen as credits to a beneficiary’s transfer balance account but how this affects the beneficiary depends on whether they receive a reversionary pension or a death benefit income stream. This article only details how the changes affect adults, additional and separate rules need to be considered for children.

The main change that may cause problems is the different treatment of reversionary pensions and a death benefit income stream, as explained below.

For an adult beneficiary receiving a reversionary pension:

  • the transfer value is generally the balance at the date of death - but the date of the transfer balance credit is 12 months after the date of death.

For an adult beneficiary who elects to receive a death benefit income stream:

  • the transfer value and the credit are both determined on the date the death benefit income stream commences.

What are the top considerations for a client who is the beneficiary of a death benefit income stream?

There are three main considerations:

  • Has the beneficiary already used some or all their transfer balance cap?
  • Death benefits cannot remain in the non-retirement phase of the fund - they must be paid either as a pension or as a lump sum out of super altogether.
  • Should the beneficiaries existing income stream be commuted in full or should part be put back to the accumulation division or should it be cashed out?

To help you understand the impact of the changes, consider the case of Derby and Joan, below.

Case study – Adult death benefit - Derby and Joan
  • Derby and Joan both have $1 million in a retirement phase pension account as at   1 July 2017 and their transfer balance account is $1 million each.

Derby then dies in December 2017 with an account balance of $900,000. The trustee determines that Derby’s benefit will be paid to Joan and she has the option to receive a death benefit pension.

What are Joan’s options?

  1. Receive a $900,000 death benefit income stream and commute $300,000 of her pension back to accumulation phase
  2. Receive a $600,000 death benefit income stream and a $300,000 lump sum death benefit
  3. Receive a $900,000 death benefit income stream and take a lump sum of $300,000 from her pension
  4. Receive a $900,000 death benefit income stream and have a $300,000 excess transfer balance cap, pay excess transfer balance earnings and await the Commissioner’s release authority (or commute earlier to reduce excess transfer balance earnings)

If Derby’s pension was reversionary to Joan then Derby’s $900,000 will not count to Joan’s transfer balance account for 12 months, however, the decisions that need to be made are the same.

Dealing with unique scenarios

Derby and Joan’s situation is relatively straightforward but what happens if there are other circumstances, such as:

  • Substantial life insurance proceeds intended to fund either a significant retirement income stream, retire debt or guarantees?
  • Would a testamentary trust provide effective long-term asset protection?
  • In the case of SMSFs and SAFs, are illiquid assets or undue asset concentration issues present?

An adult beneficiary has a cap of $1.6m. This is irrespective of the source of funds so it does not matter whether the pension is from their own super account or their deceased spouse’s account.

Presuming that the benefit is not a reversionary income stream, the transfer balance account credit will occur at the time the pension commenced. In this scenario, beneficiaries will still have several months to request the benefit and organise their financial affairs to avoid excess transfer balance cap issues.

Adverse outcomes are now amplified

The magnitude of changes to legislation now means the possibility of an adverse outcome is amplified. The complexity of meeting the unique estate planning needs of your clients’ increases because are now more possibilities that need to be considered.

To illustrate this, consider the following example:

Case study – Bill
Bill has remarried but he has two minor children who are age 15 and 12 from his previous marriage

Bill’s super consists of:

Super accumulation = $600,000 (100 per cent preserved)

Life insurance in super

  • Death cover = $2m (with a 12-month buy-back option)
  • TPD cover = $750,000

BDBN nomination = spouse 50 per cent children 25 per cent each

Bill then has a serious accident and the insurer admits the TPD claim crediting his super account with $750,000, the fund trustee also admits the super permanent incapacity claim.

Bill’s super now consists of:

Super accumulation = $1,350,000 (100 per cent unrestricted non-preserved)

Life insurance in super

  • Death   cover = $1,250,000 (with a 12-month buy-back option)

BDBN nomination = spouse 50 per cent children 25 per cent each

Bill’s adviser had wisely recommended the 12-month buy-back option and this means Bill has been able to restore his death cover from $1,250,000 to $2,000,000 by paying an extra premium.

Bill decides to take:

  • A disability lump sum benefit to pay off his mortgage = $350,000
  • A disability pension = $400,000
  • Bill’s transfer balance account = $400,000 (credit)
  • Bill retains in accumulation = $600,000 (100 per cent unrestricted non-preserved)
  • Bill retains life insurance (death cover) in super = $1,250,000 (with a 12-month   buy-back option)

BDBN nomination = Spouse 50 per cent and children 25 per cent each

Unfortunately, sixteen months later Bill dies, his buy-back option restored his death cover to $2,000,000.

At Bill’s date of death his total benefit is $2,966,000 consisting of:

  • Super accumulation = $2,600,000 (100 per cent unrestricted non-preserved)
  • Disability pension account balance at death = $366,000

BDBN nomination = Spouse 50 per cent and children 25 per cent each

How are death benefits allocated?

Spouse = 50 per cent = $1,483,000 and

  • maximum   possible death pension = transfer balance cap = $1.6m

Children 25 per cent (each) = $741,500 (each)

  • Maximum   death benefit pension (each) = $91,500 ($366,000 * 25 per cent)
  • Lump   sum benefit (each) = $650,000 ($741,500 - $91,500)

The maximum permissible child death pension of $91,500 is derived from the pension account balance at death ($366,000) pro-rated by their portion of the death benefit (25 per cent each., Irrespective of this, $650,000 must be paid as a death lump sum benefit.

Bill’s eldest child is now 16.5 years of age, in a further 18 months, legal ownership of the pension fully vests to them.

Does the surviving spouse already have a transfer balance account?

In such a case, you should consider the following:

  1. Consider rolling back their own personal pension, in full or in part, to the non-retirement phase to maximise the amount of the death benefit kept in the super environment, or,
  2. Opt for a death benefit lump sum (in full or part), and,
  3. Does the existing nomination achieve the desired objectives?

The 1 July 2017 super reforms have increased the complexity of estate planning through super. This article does not consider all the different scenarios you will now need to work through with your clients to ensure you meet their estate planning needs. The positive for you, as an adviser, is that the heightened level of complexity provides you with a great opportunity to demonstrate to your clients the value of your knowledge and skills in relation to estate planning and financial advice.