Changes to how non-reversionary pensions are treated when a pensioner dies will have far-reaching tax implications for self-managed super funds (SMSFs), according to Graeme Colley, director, technical and professional standards for the SMSF Professionals' Association of Australia (SPAA).
Colley said that changes to the super law, which allow the tax exemption to continue on the income from investments after the death of a non-reversionary pensioner until a lump sum had been paid or a new pension began, was a positive outcome for trustees.
"It is now possible to sell investments supporting a non-reversionary pension tax-free after the pensioner's death and before it is paid to beneficiaries as either a lump sum or a new pension begins," he said.
"These investments continue to be treated as remaining in pension phase although the pension payable to the deceased has ceased, and during the time the trustees are working out who should receive the superannuation death benefit proceeds."
According to Colley, another change to the rules for non-reversionary pensions is the calculation of the taxable and tax-free components.
At the time a superannuation pension begins in the fund, a calculation is made to work out the taxable and tax-free components of the pension.
"This is called the proportioning rule and the proportions remain with the pension until it ceases," he explained.
"Under the amendment to the rules for non-reversionary death benefit pensions, the taxable and tax-free proportions remain after the death of the pensioner and apply to any lump sum or new pension that commences from the death benefit.
"The rules allow any income earned on investments that support the pension assets after the pensioner's death to be included in the pension account balance that is subject to the proportioning calculation," Colley continued.
"However, any other amounts credited to the account from the proceeds of the insurance policy plus any anti-detriment payments are not included in the same calculation."
To illustrate his point, Colley used the hypothetical persona of George, who was receiving a superannuation income stream that was non-reversionary at the time of his death on 1 May 2013.
"The tax-free portion of his superannuation income stream was 45 per cent and the taxable proportion was 55 per cent," Colley said.
"At the time of George's death, the balance of his non-reversionary income stream account was $500,000."
"In addition, the proceeds of an insurance policy of $400,000 were added to the account after George's death," Colley continued. "Under the rules of the fund George's adult son, Harry, is entitled to a lump sum.
"So that lump sum of $920,000 will consist of a tax-free component of $225,000 (45 per cent of $500,000), the taxable component of $275,000, and the proceeds of the insurance component which will have different tax-free and taxable components."
Originally published on SMSF Essentials.
