In this article, all legislative references are to the Treasury Laws Amendment (Better Targeted Superannuation Concessions and Other Measures) Bill 2023 (the bill) unless otherwise stated.

Death benefit pensions under the proposed Div 296 tax

The starting point is that SMSF members and advisers should be aware that ARPs are not treated identically to non-reversionary pensions (e.g., a “fresh” death benefit pension paid to a surviving spouse) for the purposes of the recipient’s adjusted total superannuation balance (TSB) under the Div 296 rules. Accordingly, different Div 296 tax outcomes can arise based on whether a pension is made reversionary or non-reversionary to a surviving spouse or other eligible beneficiary.

Pension capital

Under s 296-55(1)(d), the pension capital supporting a death benefit pension is not counted as part of the recipient’s adjusted TSB for the first income year that the pension is payable to the beneficiary as a “retirement phase recipient”. This is pursuant to the formula in s 296-45 for calculating an individual’s adjusted TSB, which subtracts certain “contributions” in a year.

This means that:

• for an ARP, the pension capital is subtracted from the reversionary beneficiary’s adjusted TSB in the income year of the primary pensioner’s death (it, of course, counts for subsequent income years); and
• for a non-reversionary pension, the pension capital is subtracted from the recipient’s adjusted TSB in the income year that the new death benefit pension is commenced.

Thus, the reversionary status of a pension can potentially result in a timing difference regarding when the value of the pension capital is tested for Div 296 tax purposes. For example, if a member dies part way through an income year (FY-1), and the trustee commences to pay a fresh death benefit pension to the deceased member’s spouse in FY-2, the capital supporting the pension will not be counted for the spouse’s adjusted TSB until the following income year. Naturally, this is subject to compliance with the ASAP compulsory cashing rule in reg 6.21 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR).

Pension payments

Further, under s 296‑50(1)(d), pension payments in respect of a death benefit pension are included in the recipient’s adjusted TSB for Div 296 purposes. This is pursuant to the formula in s 296-45, which adds back certain “withdrawals” in a year.

This means that:

• for an ARP, the total amount of pension payments made for the pension in the income year of death (less any payments made to the primary pensioner pre-death) will be reflected in the recipient’s adjusted TSB; and
• for a non-reversionary pension, there are no required minimum pension payments needed in the income year of death. Thus, the recipient’s adjusted TSB will typically only need to include any pro-rated minimum payments for the newly commenced death benefit pension, i.e., subject to when the new pension is commenced (of course, this might occur in the following income year).

Example

Consider an SMSF with two members who are in a domestic relationship and who are 85 years of age. Each member has an account-based pension (ABP) with an account balance of $1.9 million and an accumulation account with an account balance of $2.5 million and no other superannuation entitlements. Both pensions are reversionary to the respective spouse.

In the event that one member dies during a year, the surviving spouse would have a raw TSB of around $6.3 million (i.e., $4.4 million + $1.9 million). However, for the purposes of calculating the recipient’s adjusted total TSB:

1. The capital supporting the reversionary pension is excluded in the income year that the pension reverts to the reversionary beneficiary. In the second year, the capital supporting the ARP will, of course, be counted when calculating the surviving spouse’s adjusted TSB, and there will be an increased exposure to Div 296 tax unless the situation is carefully managed.
2. The required pension payments for the ARP under sch 7 of the SISR that must be met in the income year of the deceased member’s death (say 9 per cent of $1.9 million = $171,000) are included in spouse’s adjusted TSB due to the “withdrawals” component that is added back pursuant to the formula in s 296-45.

The above position, based on having ARPs in place, may, in fact, be less favourable for Div 296 tax purposes than the outcome where non-reversionary pensions are in place as:

• the timing of when the capital supporting the fresh death benefit pension starts being counted in the recipient’s adjusted TSB may occur in a subsequent income year; and
• there is no add-back mechanism in relation to unpaid pension payments for the ceasing pension in the income year of death (i.e., pursuant to the ATO’s administrative concession).

Therefore, it is important that SMSF members and advisers recognise the importance of making the right decision regarding whether to make a pension reversionary as part of each member’s SMSF succession plan.

Other considerations

Naturally, there are other considerations that should also be factored into the decision of whether a pension should be made reversionary, such as:

• Implications under the Australian Financial Services Licence (AFSL) regime, e.g., in relation to any situation that may require a Statement of Advice to be obtained. This may weigh in favour of a reversionary position.
• Preserving grandfathering of more favourable eligibility testing rules for the Commonwealth Seniors Health Care Card and the Age Pension for pre-1 January 2015 ABPs. This may weigh in favour of a reversionary position.
• Transfer balance cap optimisation. Where the value of the assets supporting the pension is expected to increase in the 12-month period after the deceased member’s death, an ARP may provide an advantage as the recipient’s TBA credit for the ARP is locked in based on the (lower) market value of the pension capital at the time of death. However, in a declining market the non-reversionary position may be more advantageous as the TBA credit value will reflect the current market value of the pension capital at the time the pension is commenced.
• Strategic considerations in relation to insurance arrangements in an SMSF. In particular, where policy premiums (e.g., for a life policy) are being paid from a reversionary pension account, the policy proceeds paid to the fund and allocated to the reversionary pension account are not tested for transfer balance cap purposes (i.e., for the reversionary beneficiary) and also will effectively take on the same proportion of taxable and tax-free components as the underlying pension interest. This favours a reversionary position.
• Extra paperwork requirements, e.g., in relation to valuations and interim accounts. Typically, an ARP requires additional accounts to be prepared to confirm the value of the pension as at the date of death, as well as on the 12-month anniversary of the deceased member’s death, in addition to the usual 30 June requirements. In contrast, a non-reversionary pension may involve less work as interim accounts are focused on the value of the assets at the commencement of the pension. This may weigh in favour of a non-reversionary position.

The above factors give an overview of some of the key considerations in deciding whether to revert a pension or not. We emphasise that the above is also not an exhaustive list of all relevant considerations.

Conclusions

As can be seen from the above, the proposed new Div 296 tax is an additional factor that broadly weighs against ARPs, thereby providing a counter to the prevailing popularity that ARPs are the default or “one-size-fits-all” solution.

Instead of starting from the position that ARPs are always or usually the preferred option, advisers should be aware of the potential advantages and disadvantages that can arise in different circumstances, including in respect of the proposed Div 296 tax.