By Monica Rule

If you are approaching retirement, have you considered whether a reversionary pension or a non-reversionary pension, from your Self Managed Superannuation Fund (SMSF), is best for you? Do you know the difference between these two pensions? This bulletin will give you the answers.

Non-reversionary pensions

A non-reversionary pension is an income stream superannuation benefit paid to an SMSF member that ceases upon the member’s death. The pension stops upon the death of the SMSF member, and the deceased’s superannuation savings will then need to be paid out of the SMSF as either a lump sum and/or an income stream superannuation benefit. Death triggers a compulsory payment situation under the superannuation law, and therefore, the deceased’s superannuation cannot remain in the SMSF and must be paid as soon as practicable.

Reversionary pensions

A reversionary pension is an income stream superannuation benefit paid to an SMSF member and upon the member’s death; the pension continues to be paid to a nominated reversionary beneficiary. The pension does not cease upon the death of the original pensioner, but continues to be paid to the reversionary pensioner as though that reversionary pensioner was the original pensioner. The only thing that changes is that when the pension is paid the following financial year, the minimum pension payment requirement is calculated using the reversionary pensioner’s age, if their age is different to the deceased pensioner.

Trust Deed

Whether you are going to access a reversionary pension or a non-reversionary pension from your SMSF, you need to make sure that your SMSF Trust Deed allows for such payments and the procedures to access the pension are followed as per the Trust Deed.

Conditions of release

You need to make sure that you are eligible for the pension by meeting one of the conditions of release under the superannuation law: such as reaching your preservation age and retiring from the workforce; accessing a transition to retirement pension; or, reaching the age of 65.

Pension documents and minimum pension payments

To satisfy your SMSF auditor and the Australian Taxation Office (ATO), you need to make sure you have the relevant paperwork to prove that you have commenced a pension from your SMSF. The documents required, are things such as the notification to your SMSF trustee to commence a pension, trustee minutes, a pension agreement or a product disclosure statement.

In order for your SMSF to be entitled to a tax exemption on income from assets supporting your pension, your SMSF will need to pay the minimum pension payment each financial year which is based on your age and the percentage value of your superannuation pension account balance at either the commencement of your pension or at 1 July each financial year.

Reversionary Beneficiaries

You cannot nominate anyone to be a reversionary beneficiary. This is because under the Income Tax law only certain people are eligible to be paid a pension. People such as a spouse, a child under the age of 18, a child aged 18 to 24 who was financially dependent on the deceased, or a child over the age of 24 with a disability can be nominated. Other people such as an adult child who is not disabled or was financially dependent on the deceased cannot be nominated.

You can only nominate one reversionary beneficiary per pension. So if you have multiple beneficiaries that you would like to leave your superannuation savings to, then you will need to have multiple pensions with its own reversionary pensioner nominated.  You cannot do a single nomination to cover all of the pensions.

Advantages

There used to be a huge advantage in accessing a reversionary pension prior to 1 July 2012. This was because when an SMSF paid a pension, the investment income from the assets that supported the pension was exempt from income tax. Then, when the pension member died, the pension automatically reverted to the nominated beneficiary and the SMSF continued to receive the tax exemption on the investment income.

Whereas, prior to 1 July 2012, if a non-reversionary pension was paid, the pension would cease upon the death of the SMSF member and the SMSF would revert back to accumulation phase. This meant the income from assets that was supporting the non-reversionary pension was no longer exempt from income tax. So if assets needed to be sold after the member’s death, tax was payable.

The rules changed from 1 July 2012 so that the tax exemption would remain regardless of whether a pension was paid as a reversionary or non-reversionary pension as long as upon the member’s death a death benefit was paid as soon as practicable.

However, there are still other benefits in receiving a reversionary pension. They are:

1. Insurance proceeds: If insurance proceeds from the deceased member’s life insurance policy are paid to the reversionary beneficiary, then the proceeds retain the tax-free and taxable components of the reversionary pension. The components are not re-calculated despite the insurance proceeds having a taxable component. Whereas, if it is a non-reversionary pension, then the insurance proceeds are added to the taxable component of the pension as the pension has ceased upon the death of the original pensioner.

2. Social Security: To receive the age pension, a person must satisfy either an asset test or an income test. The amount of the age pension paid is the lower of the amounts worked out under these two tests.Prior to 1 January 2015, account based pensions (ABP) received concessional treatment under the income test. The full pension is fully assessed against Centrelink’s income test apart from the “deductible amount” which is calculated by dividing the capital of the pension by the person’s life expectancy (or a longer life expectancy of their spouse if the pension is reversionary). The deductible amount represents a return of your own contributions to fund your ABP. The deductible amount is excluded from the ABP and the balance is counted towards the aged pension income test. However, from 1 January 2015, the concessionary treatment was removed and all ABPs are treated the same as any other financial asset for the purposes of the income test. This means a deemed amount of income will be calculated based on the ABP balance regardless of the investment income actually earned by your SMSF. It will not recognise the return of your contributions and the level of ABP drawn becomes irrelevant in determining your eligibility for the age pension.

   Also, prior to 1 January 2015, the ABP enjoyed an exemption from the Commonwealth Health Care Card income test. From 1 January 2015, the ABP accounts are included in the means test for the card in the same way as other financial investments.

   However, ABPs started before 1 January 2015 were grandfathered from the changes to the income test provided the recipient SMSF member was entitled to an age pension at 31 December 2014. The change caused many SMSF members to commence reversionary pensions so that the benefit of the grandfathering extended to the reversionary beneficiary after their death.

   Therefore, changes to the income deeming rate of ABPs from 1 January 2015 mean that it may have been beneficial to establish a reversionary pension prior to that date. It depends on the ages of the original pensioner and their reversionary pensioner. The larger the age gap, the less likely that a benefit will result.

3. Estate security: Upon the death of an SMSF member, the trustee is not required to make a determination as to who should receive the death benefit as the pension will revert to the nominated beneficiary. It provides some level of certainty to the member as to whom their benefit will go to once they die.

A major disadvantage in receiving a reversionary pension is in situations where a member divorces or separates from the reversionary beneficiary. In these circumstances, the member will need to commute the pension and start a new one with new terms and conditions (i.e. such as naming a new beneficiary).

ATO representatives were asked at a technical meeting in March 2013 whether it was possible to change a non-reversionary pension to a reversionary pension. The ATO representatives stated at this meeting that it was possible to change the pension as long as the terms under which the pension is payable and the fund’s deed allowed for it. However, the ATO also stated that it cannot be changed after the death of the pensioner. As the ATO has not made their view widely public, I would suggest you seek the ATO’s approval if you are intending to change your non-reversionary pension to a reversionary pension at any time prior to your death.

Gold and Platinum Members please read on for examples demonstrating how a reversionary pension can benefit your beneficiaries as well as disadvantage them.

Monica Rule is an SMSF Specialist and author – www.monicarule.com.au

Related documents:

• Pension Pack for Self Managed Super
• Self Managed Superannuation Fund Deed
• SMSF - Deed Update
• SMSF Deed Update Subscription Service
• Investment Strategy for Self Managed Super 15/16