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Self Managed Super Fund (SMSF) Article
Death benefits and pensions

By Tony Negline.

This article may be out of date.

21st September 2005

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If you are receiving a super fund pension what will happen to that pension when you die?  Who do you the money paid to and do you want it paid to them as a lump sum or a pension?

When the last question is asked, most super fund members nominate that they want their money to go to their spouse and when that spouse dies, they want any remaining funds to go to their children, in the most tax-effective way possible.  Some people want it paid to their grandchildren or to a charity.  Others ask if they can change their mind later on.

In broad terms the death benefit could be paid a lump sum or the same pension could continue or a new pension could be paid to them or you could apply a mixture of these options.

Not all of these options are available in every super fund.  The actual options available in a particular fund depends upon what a fund's trust deed says and also what administrative practices can do.

Before a lump sum is paid from a pension the income payments must stop.  The technical term for ceasing pension income payments is 'commutation'.  In some situations, the recipient of a pension will not want to stop the whole pension.  They may only want a small lump sum.  The pension continues but with a smaller account balance.  We call the withdrawal of a lump sum from a pension a 'partial commutation' – in other words some of the pension has been turned into a lump sum and the remaining balance will continue to pay a pension.

For example, suppose an allocated pension with an account balance of $500,000 was being paid to Bert James.  This year the pension was going to pay him $30,000.  Bert however died in July 2005 and his wife, Shirley James, needs $100,000.  Shirley is nominated as Bert's reversionary pensioner and the super fund's trust deed allows her to commute or partially commute Bert's allocated pension, so she decides to take the money she needs from this pension.

If this lump sum is paid within the later of six months of death or three months of the granting of probate then the $100,000 will be assessed against Bert's pension RBL (the ATO will adjust the amount counted for the allocated pension because of the partial commutation).  If the ATO determine that there is no excess benefit in this lump sum death benefit then Shirley will receive the lump sum tax-free.  If this lump sum were paid to a non-dependent and it doesn't include an excess benefit then it will be taxed at 16.5%.  The notional Post June 1983 portion of any excess benefit will be taxed at 39.5% and the remainder will be taxed at 48.5%.

Lump sums paid within the above time-frames cannot be rolled over to another super fund.  They must be withdrawn from the super system.

Lump sums paid from the partial or full commutation of a pension after the later of six months or death or three months of the granting of probate are taxed in a different way.  The amount of excess benefit is worked out using the 'rebateable proportion'.

We need to explain what this term means.  When a pension starts, the ATO work out if a super pension has any excess benefit in it.  If there is no excess benefit the pensioner will receive the full 15% rebate on each pension payment.  This rebate is very powerful in reducing the amount of income tax a retiree will pay on the income received.  However if the purchase price of a pension contains an excess benefit then the 15% rebate reduces.  For example, if twenty-five percent of a pension's purchase price is an excess benefit then the amount of rebate will be 11.25%.  The rebate payable, the “rebateable proportion”.

The amount of excess in a partial or full commutation is worked out using the rebateable proportion. Any excess benefit within these lump sums will be taxed at 39.5% and the remainder will be taxed at 48.5%.

If these lump sums are paid to a child under 18 then there will be no excess benefit and the whole amount will be paid tax-free.

If the person receiving the lump sum payment is the deceased's spouse, then the lump sum can be rolled over to another super fund.  The lump sum cannot be rolled over if the person is not the deceased's spouse.

If there is any Post June 1983 Component in and the person receiving the payment is over 55 then the Post June '83 Tax-free Threshold may be available.

Some people in the super industry believe that any underlying assets that have to be sold to pay a lump sum when a pension is partially or fully commuted upon death are subject to Capital Gains Tax.  These people believe that before the lump sum is paid the assets supporting the pension are moved from the zero tax area to the 15% tax area.  Others argue that the law is not designed to operate in this way.  Anyone looking for certainty should apply to the ATO for a Private Binding Ruling.

In another article we will deal with what happens when a pension is paid to a deceased retirees' survivors.

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This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.

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