In the recent Colonial FirstTech Strategic Update, head of technical services Craig Day and technical analyst Richard Chen said that advisers need to be extra cautious when planning strategies around commencing death benefit income streams ahead of the indexation changes.

In addition to the simple calculation of working out the potential amount of excess transfer balance, Mr Day noted advisers must also consider the impact that the past earnings of their existing ABP could bring, as well as the type of death benefit income stream being received.

“Generally, where the client only has capped defined benefit income streams, any excess attributed is simply taken to be equal to the transfer balance cap and disregarded,” he said.

“However, where the client also has other non-capped defined benefit income streams such as an account-based pension, care should be taken to ensure that only the required amount is commuted so that any pension balance representing past earnings is not unnecessarily removed from retirement phase.”

When a member dies and their spouse takes their death benefit in the form of a retirement phase income stream, there is a risk they could end up exceeding their transfer balance cap and will need to commute amounts from their income streams to resolve the excess, according to Mr Day.

“In this case, advisers will need to take care to ensure they properly calculate any commutation required, as the rules can be complex depending on the clients’ circumstances and the types of income streams they are receiving,” Mr Day explained.

Where a member dies and their spouse takes their death benefit as a retirement phase income stream, a credit will arise in a member’s transfer balance account. However, Mr Day said the timing and methodology for valuing the credit varies.

This includes where a member died in the accumulation phase or with a non-reversionary pension and the spouse takes a death benefit in the form of a new account-based pension (ABP), the value of the credit will become the commencement value of the pension and the credit will arise on the date the ABP starts.

“Furthermore, where a member died with a reversionary ABP, the credit will be the market value of the ABP at the date of death, with the credit arising in the reversionary beneficiary’s transfer balance account 12 months after the date of death,” Mr Day said.

“Where a member died with a reversionary capped defined benefit income stream (such as a term-allocated pension [TAP] that commenced prior to 1 July 2017), the credit will be the special value of the income stream, with the credit arising in the reversionary beneficiary’s transfer balance account 12 months after the date of death.”

As a result, Mr Day said an adviser assisting a deceased member’s spouse needs to take into account the transfer balance cap implications of taking their death benefit in the form of an income stream.

They will need to consider a number of issues including the value of the spouse’s personal transfer balance cap and how much of the spouse’s transfer balance cap they have already used, for example, the running balance of their transfer balance account.

This also includes the value of the death benefit that will be used to commence a new retirement phase income stream including any life insurance proceeds, he noted, and the value of the deceased member’s reversionary pension at the time of death or the special value of a capped defined benefit income stream payable to the reversionary beneficiary.

“Where a spouse will end up exceeding their transfer balance cap due to receiving a death benefit in the form of a reversionary pension, it will also be important to consider the type of income stream that has reverted,” Mr Day said.

“For example, where the reverted income stream is a capped defined benefit income stream, special rules may apply to limit the value of any commutations required to resolve an excess, as these income streams are generally non-commutable.”

Transfer balance cap and proportional indexation 

When undertaking any calculations, Mr Chen said it will be important to take into account any increase in the value of the member’s personal transfer balance cap due to the indexation of the general transfer balance to $1.7 million on 1 July 2021.

“For example, a spouse that has yet to commence their own retirement phase income stream will get the full benefit of the indexation of the transfer balance cap to $1.7 million where situations include the spouse commences to receiving a non-reversionary death benefit income stream on or after 1 July 2021, or the spouse received a reversionary death benefit income stream where the original member died on or after 1 July 2020,” Mr Chen explained.

“However, for a spouse that has already commenced to receive a retirement phase income stream, they will only be entitled to proportional indexation based on the highest ever balance of their transfer balance account.”

Where a beneficiary ends up exceeding their personal transfer balance cap due to the receipt of a death benefit as an income stream, Mr Chen said they will need to commute the amount of excess to reduce the running balance of their transfer balance account to below the value of their personal transfer balance cap.

“However, it’s important to note that from 1 July 2017, a death benefit must only be taken in the form of a death benefit income stream or as a death benefit lump sum (or a combination of both),” Mr Day said.

“Therefore, a spouse could not roll an amount from a death benefit income stream to the accumulation phase to resolve an excess. Instead, a spouse would need to pay the excess amount out as a death benefit lump sum or they could consider fully or partially commuting their own retirement phase income stream and rolling that amount back to the accumulation phase or taking it out as a lump sum to free up some of their transfer balance cap.

“The benefit of commuting their own retirement phase income stream is that it maximises the amount that can continue to be held in super. However, whether this provides the best outcome for a beneficiary will depend on a range of issues, including taxation and estate planning considerations.”