Superannuation legislation is full of complexity which unfortunately disguises valuable financial planning opportunities. One example is the decision whether to commence a reversionary pension or a non-reversionary pension as part of estate planning. Both pensions can be paid from an SMSF provided the Trust Deed allows for these benefits, but it’s important to know the differences.
A reversionary pension is a pension that, upon the member’s death, continues to be paid to the nominated reversionary beneficiary as though the reversionary pensioner were the original pensioner. The reversionary pensioner retains the same percentages of tax-free and taxable components of the deceased’s pension account calculated at the beginning of the pension. Therefore, if the deceased pension account commenced with a 100% tax-free component, then the pension will continue as 100% tax-free.
A non-reversionary pension is a pension that ceases upon the member’s death. Because the pension stops, the deceased’s remaining superannuation at their death will need to be paid from the SMSF as either a lump sum death benefit and/or a new pension to the deceased’s beneficiaries as soon as practicable. If a lump sum death benefit is payable, assets may need to be sold to make a cash payment. If a new pension is to commence, the percentages of the tax-free and taxable components of the pension may need to be re-calculated as explained below.
Benefits of a reversionary pension
1. Favourable tax treatment of insurance proceeds
If insurance proceeds from the deceased member’s life insurance policy are paid to the reversionary beneficiary, then the proceeds also retain the tax-free and taxable components of the reversionary pension. The components are not re-calculated despite the insurance proceeds having a taxable component.
However, if the pension were non-reversionary, then the insurance proceeds are added to the taxable component of the new pension. This may make a difference to the amount of tax payable by the deceased’s beneficiary if they are under the age of 60.
2. Estate security
Upon the death of an SMSF member who was in receipt of a reversionary pension, the trustee is not required to make a determination as to who should receive the deceased’s superannuation as the pension will revert to the nominated beneficiary. This provides some level of certainty to the member as to whom their benefit will go to once they die. If the deceased member has a binding death benefit nomination, the nomination would need to state that the nominated reversionary pensioner is entitled to the receipt of the deceased’s pension.
3. Assets can be retained in the SMSF
As the reversionary pension automatically reverts to the nominated beneficiary, there is no need to sell assets to pay out a lump sum death benefit.
Disadvantage of a reversionary pension
Where a member divorces or separates from the reversionary beneficiary, the member will need to commute the pension and start a new one with new terms and conditions (i.e. such as naming a new beneficiary).
ATO officials were asked at a technical meeting in March 2013 whether it was possible to change a non-reversionary pension to a reversionary pension. The ATO said it was possible as long as the terms under which the pension was payable and the SMSF’s Trust Deed allowed it. However, the ATO also stated that a pension cannot be changed after the death of the pensioner. As the ATO has not made their view widely known, I would suggest you seek the ATO’s approval if you are intending to change your non-reversionary pension to a reversionary pension.