From July 1, super fund members - and their death benefit beneficiaries - face steep penalties if they breach the new $1.6 million transfer balance cap, Jeff Scott writes.
The maximum amount super fund members will be able to transfer into a tax-free pension account will be capped at $1.6 million, under changes in the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016.
While fund earnings are generally tax-exempted, retirees who exceed the transfer balance cap from July 1 will be required to commute, either in full or in part, their super income streams back to the accumulation phase and will be hit with excess transfer balance tax.
As an alternative to an excess balance transfer cap the member may also cash out a full or partial lump sum from super.
There has been healthy discussion about the impact of the $1.6 million transfer balance cap on individual retirees but little talk about the potential impact on beneficiaries receiving death benefits paid from superannuation.
Under the current rules, super fund trustees must pay a deceased member’s remaining super balance as either a lump sum death benefit or a super income stream. Fortunately, there are no changes to lump sum death benefit payments in the legislative amendments.
Unfortunately, death benefit income streams paid to eligible beneficiaries, including spouses and financially dependent children, will be subjected to the $1.6 million transfer balance cap rules.
The following examples look at the impact of the new rules on three different types of beneficiaries: dependent children; spouses; and reversionary beneficiaries.
1) Payments to children
Dependent children who receive a death benefit income stream from a deceased parent face modifications to their transfer balance cap. The modifications generally allow the child to receive their share of their parent’s retirement savings without prejudice to their future retirement, recognising that most child dependents are currently required to commute the death benefit income stream by age 25.
Effectively, dependent children have two opportunities to access the $1.6 million cap: once prior to age 25 as a death benefit dependent; and again upon retirement.
2) Payments to spouses or interdependency beneficiaries
The value of a death benefit income stream that is paid to a spouse or interdependency beneficiary will be credited to the dependant’s transfer balance account. If the combination of an individual’s personal super income stream and their deceased partner’s death benefit income stream, exceeds the balance transfer cap, they’ll need to commute one of the income streams.
Importantly, a super death benefit cannot be held in an accumulation fund, therefore the benefit must be cashed out of the super system as soon as practicable.
Case study: Death benefit income stream where the beneficiary hasn’t used up all their balance transfer cap
As at July 1, 2017, Wilma and her husband Fred are both being paid a super income stream from the XYZ Super Fund. Each has a super account of $1 million to support their super income streams. They each have a transfer balance of $1 million.
On December 1, 2018, Fred passes away leaving Wilma $800,000 in his super. Fred’s $800,000 death benefit income stream, on top of her $1 million super income stream, pushes her over the transfer balance cap by $200,000.
As a result, Wilma must either:
- Receive Fred’s super balance as a $600,000 death benefit income stream and a $200,000 death benefit lump sum. The $200,000 death benefit lump sum would need to be cashed out of the super system; or
- Receive Fred’s super balance as an $800,000 death benefit income stream and partially commute her personal super income stream by $200,000. The $200,000 lump sum she would receive from the commutation could be retained in super in accumulation phase.
- Both options would give Wilma a transfer balance account of $1.6 million, fully exhausting her transfer balance cap.
3) Reversionary beneficiaries
Reversionary superannuation income streams revert to the beneficiary immediately upon the death of the member, unlike other superannuation income streams which are at the discretion of a superannuation trustee. Reversionary beneficiaries are provided with deferred implementation dates. The variation in timing gives reversionary beneficiaries 12 months from becoming entitled to the superannuation income stream to arrange their financial affairs before any consequences arise.
It’s important for super fund members and their financial advisers to closely monitor their super income streams to ensure they don’t breach the new rules. It’ll be equally as important for super death benefit beneficiaries to do the same because in both cases, the financial consequences for breaching the $1.6 million transfer balance cap could be severe.
Jeff Scott is Head of Product at ClearView.