When a member dies, many superannuation funds may pay the death benefit as a lump sum. Once received in cash, the lump sum cannot be rolled over. If the recipients wish to hold the funds in a concessionally taxed superannuation environment, they must contribute the amount back into superannuation.
Although a death benefits dependant (defined under tax law) can receive superannuation lump sum death benefit tax-free regardless of the amount, in some situations it may be a better strategy to have the benefit paid as an income stream.
Some of the advantages of taking the superannuation death benefit as an income stream are:
- pension payments are concessionally-taxed or tax-free;
- the capital is retained in pension phase, a tax-free earnings environment; and
- the beneficiary has full access to capital.
A superannuation death benefit may be paid as an income stream if all of the following apply:
- the benefit is paid to certain beneficiaries;
- it is permitted by the trust deed of the fund; and
- the beneficiary has instructed the trustee to do so prior to receipt of the benefit.
If a reversionary pensioner is elected upon commencement of an income stream, the pension automatically becomes payable to the nominated beneficiary.
Who can receive an income stream?
The legislation restricts which beneficiaries can receive a death benefit as an income stream. An income stream can only be paid to a dependant of the member (i.e, spouse, child, financial dependant and interdependent). If paid to a member’s child, at the time of the member’s death the recipient must be either:
- less than 18 years of age;
- aged 18 to 25 and financially dependant upon the member; or
- a disabled child.
Outlined below are three situations where payment of a superannuation death benefit as an income stream may be appropriate.
Child account based pensions
Child account based pensions are a very tax-effective estate planning tool. Income from child account based pensions is taxed at adult tax rates. Assuming the worst-case scenario — that is, where the:
- income stream consists of taxable component only; and
- both the deceased and the recipient are under age 60, up to $44,200 per annum can be drawn from the pension without paying any tax. This amount takes into account the 15 per cent offset and the Low Income tax offset but excludes payable Medicare levy.
Other factors must be considered to determine if the income stream is the most appropriate option for your client:
- the child can access the capital at age 18. Parents of the beneficiaries with special needs (spendthrift, disabled or with gambling or alcohol addiction) may wish to prevent them from accessing capital; and
- an income stream is generally only payable until the child reaches age 25. At age 25 the income stream must be commuted and any residual capital is paid as a tax-free lump sum. A child who is permanently disabled can continue to receive an account-based pension until their death.
Some clients may find that these issues outweigh the tax effectiveness of the child account based pension option. In this case, other alternatives (such as a testamentary trust) should be considered.
Ineligible to contribute to super
If a lump sum death benefit is invested directly in the beneficiary’s own name, the earnings will be taxed at his or her marginal tax rate.
When the beneficiary receives the benefit as a lump sum, he or she may wish to contribute some or all of it back into the superannuation environment.
To be eligible to contribute to superannuation, the beneficiary must be:
- under age 65; or
- age 65 to 74 and satisfying the work test.
Certain beneficiaries may have used up their concessional and non-concessional contributions caps and are unable to make further contributions without attracting penalty tax.
Electing to receive the benefit as an income stream instead of a lump sum allows these beneficiaries to retain their benefits in a concessionally taxed superannuation environment.
Maximising Centrelink benefits
Superannuation benefits held in the accumulation phase are exempt from social security assessment if the client is under age pension age.
Clients eligible for social security entitlements may benefit from contributing the lump sum death benefit back into accumulation.
If a beneficiary under age 65 receives the amount as a lump sum and contributes it to superannuation, the contributed amount is preserved until a condition of release is satisfied.
An alternative strategy is to receive the death benefit as an income stream.
The income stream could be paid for a minimum period and then be rolled back into accumulation phase.
In order to change the status of the benefit from the superannuation death benefit (which must be cashed out) to a superannuation lump sum (which can be rolled over), the income stream should be commuted after the later of either:
- six months from the date of death; or
- three months from the date of probate.
Implementing this strategy ensures the benefits in accumulation phase retain the unrestricted non-preserved status.
This strategy may be relevant when a beneficiary under age pension age wishes to maximise his or her social security benefits while retaining access to the funds.
Once the beneficiary reaches age pension age, the superannuation benefit is assessed under the assets test and is subject to deeming under the income test.
Advisers can add value to their clients by recommending how the death benefit should be received.
For some clients, receiving the superannuation death benefit as a lump sum is the best strategy, while others may be better off receiving the funds as an income stream.
Alena Miles is a technical analyst at Zurich.
