Reversionary Pension Kit – SMSF Pension

Reversionary Pension Kit for SMSF Pension

Your Reversionary Pension kit for the SMSF Fund allows for Account-Based Pensions. When you build this Account-Based Pension you get:

1. Law firm letter of Advice – confirms what you need to do
2. Trustee Minutes – to adopt and accept the Deed of Variation
3. Deed of Variation – updates your SMSF Deed to allow for Pensions and Reversionary Pensions
4. Product Disclosure Statement – required to start a Pension
5. Member Nomination Instruction – allows the member to tell the trustee that the member wants to start a pension (and who gets the pension when the member dies)
6. Binding Trustee Resolution – to accept the Member Nomination Instruction

My SMSF is out of date. It does NOT allow for Account-Based and Reversionary Pensions

The Legal Consolidated Reversionary Pension kit, which you build on our website, updates your SMSF Deed as well. 

Your SMSF Deed is updated. This is so that you can have both Account-Based and Reversionary Pensions.

The updating of your SMSF Deed, as part of the kit, ensures that your SMSF allows for the pension and Reversionary Pension to operate. This is according to the Superannuation legislation.

What is a ‘reversionary pension’?

It is often difficult to get wealth into Australian superannuation.

Superannuation is a tax haven. It is primarily to support your retirement.

Upon your death, you no longer need money for your retirement. Therefore, the wealth in your superannuation fund leaves the tax-protected status of the superannuation fund. Your superannuation is paid out to your dependents or your estate.

Who can I nominate for an SMSF Reversionary Pension?

There are 3 groups of people you can nominate in an SMSF Reversionary Pension. However, you can only nominate one person as a reversionary beneficiary. You can nominate:

1. Your spouse or de facto partner (same or different sex).
2. An “eligible child” who is:
   • under age 18 age;
   • 18 to 25 and a financial dependent;
   • or has a disability under the Disability Services Act 1986.
   • (A child without a disability can only be paid an income stream until they reach age 25, and then the remainder must be paid out as a tax-free lump sum.)
3. Another “eligible dependent” is a reversionary beneficiary.

When you die your superannuation must leave your SMSF fund.

That is true. At death, your superannuation must leave the superannuation fund.

However, there is an exemption to this rule that super leaves your superfund at death.

Instead, you may direct your SMSF trustee to make your pension ‘auto-reversionary’. This means at your death automatically your pension transfers from you to your:

1. spouse
2. children under 18
3. children under 25 living with you
4. your disabled child of any age

This must be, at the moment of your death, ‘automatic’.

Spouse Loan Agreement

I am a director of the SMSF’s corporate trustee. Can I get the reversionary pension?

A person who is a director of the corporate trustee of your SMSF fund cannot take your reversionary pension just because they hold that position.

This is unless they are in one of the above 4 groups.

For example:

• Your brother is a director of the SMSF corporate trustee company.
• Your brother may also be a member of the same SMSF.
• But he cannot get a Reversionary Pension from you.
• This is because he is not one of the four above groups.

Can another member of my SMSF get my reversionary pension?

As above, it is not relevant whether a person is also a member of your SMSF.

Rather, it is only relevant if the person is your spouse, child under 25 or disabled.

Does the person getting my reversionary pension need to be a member of my SMSF?

There is no requirement that your spouse or children be members of your superannuation fund.

It is irrelevant for a reversionary pension whether the person who takes over your pension at death is a:

• trustee of the SMSF;
• director of the SMSF corporate trustee; or
• a member of the same superannuation fund.

It just makes no difference.

What happens to a reversionary pension once my child turns 25?

Over 95% of reversionary pensions are to the spouse. Rarely is a Reversionary Pension set up to go at your death to a child.

This is partly because when you die, on average, your children are well above 25 years of age. They are often in the 60s!

Even if you are unlucky enough to die when your children are young, they don’t get to keep your superannuation reversionary pension for long.

When your child eventually turns 25 the pension finishes (commuted).

Are the reversionary pension rules different if my child is ‘disabled’?

Yes, the rules are different for disabled children.

The reversionary pension finishes when your child turns 25. This is unless the child is disabled.

If your child is ‘disabled’ it can continue.

Is a reversionary an ‘income stream’ rather than a ‘lump sum’ amount?

Excuse the circular definition. But your reversionary pension is a ‘pension’.

Another expression for a ‘pension’ is an ‘income stream’. It is a regular sum of money coming to you. The opposite of an ‘income stream’ is a ‘lump sum’ payment. For a ‘lump sum’ payment you get all the money at the same time.

A reversionary pension is an income stream.

SMSF – Vesting Deed. Wind up your Self-Managed Super Fund

Reversionary pensions often do not work. Is that true?

Yes, reversionary pensions are delicate. 

You set up your pension in your SMSF. You then make sure it is an automatic ‘reversionary’ pension in your SMSF.

To operate the reversionary pension must ‘automatically’ continue from the moment you die.

You are telling your SMSF what you want with your super when you die. You want your pension to continue after you die. But to now go to your spouse instead of you (as you are dead).

Do I need to have started a pension before I can set up a reversionary pension?

Yes. You need to have started a pension before you die.

A pension is an ‘income stream’. You need to have started a pension before you die, otherwise, you cannot provide a reversionary pension to your spouse or children.

SMSF Pension exemption

However, there is an exemption to this rule that super leaves your superfund at death. Instead, you may direct your SMSF trustee to make the pension auto-reversionary. This means at your death your pension transfers from you to your:

1. spouse
2. children under 25
3. a disabled child of any age

A person who is a director of the corporate trustee of your fund cannot take your reversionary pension just because they hold that position. This is unless they are in one of the above. Similarly, it is not relevant whether a person is a fellow member of your fund. Rather, it is only relevant if you are a spouse, child under 25 or disabled. There is no requirement that your spouse or children be members of the same fund.

When a child eventually turns 25 the pension finishes (commuted). This is unless that child is disabled.

A reversionary pension is an income stream. You set it up with your SMSF. To operate it must ‘automatically’ continue to (generally) your spouse when you die.

You are telling your SMSF what you want with your super when you die. You want your pension to continue after you die. But to now go to your spouse instead of you (as you are dead).

Obviously, you need to start a pension before you die. A pension is an ‘income stream’. You need to have started a pension before you die, otherwise, you cannot provide a reversionary pension to your spouse or children.

SMSF Pension must be ‘automatic’ at death

The ATO describes a reversionary pension in Taxation Ruling TR 2013/5 [29]):

A superannuation income stream ceases as soon as a member in receipt of the superannuation income stream dies. This is unless a dependent beneficiary of the deceased member is automatically entitled. This is under the governing rules of the superannuation fund or the rules of the superannuation income stream, to receive an income stream on the death of the member. If a dependent beneficiary of the deceased member is automatically entitled to receive the income stream upon the member’s death, the superannuation income stream continues.

The ATO provide further guidance in the Law Companion Ruling LCR 2017/3 [12]

A reversionary death benefit income stream is a superannuation income stream that reverts to the reversionary beneficiary automatically upon the member’s death. That is, the superannuation income stream continues with the entitlement to it passing from one person (the member) to another (the dependent beneficiary). [italics by Legal Consolidated]

 

Are SMSF Pensions automatic?

The new Deed of Variation to your Self-Managed Superannuation Fund allows for Reversionary Pensions. But they are not automatic. You set them up as part of the pension establishment. They also need to be set up for each pension. (They are obviously not part of the Binding Death Benefit Nomination.)

Rather they are part of a pension establishment. The recipient (assuming they fall under the definition of dependent) can either take the benefit as a pension or a lump sum. This decision is largely dependent upon whether they are already in receipt of a pension and also the liquidity of investments in the Self-Managed Superannuation fund.

This SMSF Pension allows for reversionary pensions. But you need to activate them. 

Does superannuation have to be paid out at death?

Yes, unless you have a Reversionary Pension in place or reserve accounts all your superannuation must leave your Superannuation. To labour the point, your super leaves the superannuation environment. It is paid out. This explains the rule:

1. The sole purpose of your super is for your retirement.
2. To encourage you to lock money away into your superannuation the Australian government offers generous tax incentives.
3. Therefore, many in the government see your Superannuation as a ‘tax haven’.
4. At death, you no longer have any need for ‘retirement’ money, as you are dead.
5. At your death, all your super leaves the superannuation environment. It is all paid out. (This may be according to a binding nomination or the trustee’s discretion – but it must all be paid out.) Your super balance at death goes to zero.
6. At death, the wealth in your super can no longer remain in this ‘tax haven’. It is paid out.
7. The people who get your super may be able to put some of it back into their own super. But probably not much. It is certainly not the case that your family can keep the super in the SMSF and just allocate it to themselves. That is a common belief. But it is wrong.
8. There is one major exception to your superannuation being paid out at your death. This is called a Reversionary Pension. This is the document you are building.

Is it illegal to keep my dead spouse’s super in our Self-Managed Superannuation Fund?

Death of an SMSF member is one of the few times that you must act. It is illegal to leave superannuation in the fund after someone dies. If the dead person’s superannuation cannot be turned into a pension it must be paid out.

Does an SMSF have additional issues when a spouse dies?

Yes, an SMSF has extra jobs to do, like adding another ‘related’ human if there is now only one human left as a trustee. Or, remove the dead spouse as a director. (Legal Consolidated Special Purpose Companies allow you to operate an SMSF with only one director in the company.)

Why cannot the surviving spouse leave the dead person’s money in the Self-Managed Superannuation Fund?

This is not possible, superannuation is for your retirement. Your spouse is now dead. The dead spouse no longer needs retirement money! The only exception is a Reversionary Pension. With a Reversionary Pension, the remaining spouse drip feeds the dead person’s superannuation out of the SMSF as a pension. This may be more tax advantageous. Without a Reversionary Pension, the dead person’s superannuation is ‘immediately’ paid out of the superannuation fund. 

What is bad about a Reversionary Pension?

A Reversionary Pension (in fact most pensions) count towards your own transfer balance cap (TBC). A TBC is the limit on how much you can put into a pension when it starts. The surviving spouse may already have a pension; they may have no TBC left.

Even if you have not yet started a pension you may find that the amount you get from your dead spouse is higher than the TBC. This is even more of a problem if there is life insurance in the SMSF.

You need to talk with both your accountant and financial planner as to whether a Reversionary Pension works for your unique situation.

What is the value in wanting my dead spouse’s super to remain in my SMSF?

Australian superannuation is a tax haven. You generally pay reduced income tax and capital gains tax. For people who are retired, the tax rate can be zero.

When Dad dies can his super stay in the SMSF and be allocated to my super account?

Most people die without a Reversionary Pension in place. In those instances, the superannuation is paid out. It completely leaves the superannuation environment. For example, Dad dies with $1m. He only has his son. His son is over 25 years of age and not disabled.

His son gets the whole $1m (minus the 32% tax on his dead Dad’s super). But the son actually wants his Dad’s super to remain in the super fund and just be allocated to him. Well, you cannot do that. Instead, the son gets the $1m in his personal bank account or he gets the shares or the land. If the son now wants to contribute $1m into his super fund then he has to follow strict rules. Just like everyone else. At best it takes the son many years to get $1m into his super fund. Well, that is just the way it is.

Can the father set up a Reversionary Pension for his son? No, of course not. Reversionary Pensions are only for a spouse, children under 25 or disabled children. Since the son is none of those it is not possible for him to have a Reversionary Pension from his Dad.

Instead, Dad builds a 3-Generation Testamentary Trust Will. This contains a Superannuation Testamentary Trust. This often reduces the 15% or 30% death taxes to zero.

Does this Reversionary Pension Kit damage old pensions and reversionary pensions?

Q: The Death Benefits 7.1 states “… and any pension account residue either as a lump sum, or as one or more pensions or annuities, or both”.

Does the wording of the Legal Consolidated Reversionary Pension Kit recognise that the nominated Reversionary pension beneficiary (documents established prior to the new Deed Update) takes precedence over the new Death Benefit Agreement or Death benefit nominations?

A: All Legal Consolidated SMSF Deed updates seek to preserve pre-existing pensions. Accordingly, the Legal Consolidated Reversionary Pension Kit seeks to grandfather and protect earlier pensions. This includes Reversionary Pensions. You just need to check with your accountant and financial planner that you indeed have operational pensions and correct reversionary pensions.

The Legal Consolidated Reversionary Pension Kit cannot fix up old or failed pensions. It is designed for future reversionary pensions. And, as stated above, not to stop old operational pensions.

You ask whether old pensions ‘take precedence’. I do not think that is the correct question.

The Reversionary Pension Kit is just an update to your SMSF deed and the paperwork to put in place a reversionary pension. After you build the kit then you set up as many or as few reversionary pensions as you wish. As often as you wish.

Transfer Balance Cap can damage an SMSF Pension

SMSF pensions allow your spouse’s super to remain in super after they die – but there are problems. You can have more than $1.6m in your Superannuation fund. However, your pension is limited to $1.6M: Division 294 ITAA 97 (transfer balance cap).

A matter of concern for your adviser and accountant about the use of Reversionary Pensions is the Transfer Balance Cap (TBC). This is for each pensioner. We believe that modelling is required. This is regarding the impact on the beneficiary potentially receiving a Reversionary Pension.

When someone leaves a reversionary pension for their spouse, the value of the pension for the $1.6 million pension cap is frozen at death.

What do my financial adviser and accountant consider for the Transfer Balance Cap?

• Would this cause the recipient to go over the TBC?
• Is the recipient already receiving a pension?
• Is there the capacity to commute any existing pension to manage the TBC?
• Would a death benefit pension created using a BDBN be more appropriate?

Items 1 and 2 in section 294-25(1) Income Tax Assessment Act 1997 state that a transfer balance credit arises for a reversionary beneficiary’s transfer balance account. But when does it arise? It arises 12 months from the date the pension reverts to you. This is 12 months from the date of your spouse’s death. At that moment in time, the transfer credit’s value is the value of the income stream as at the date of death (date of reversion).

What if your own superannuation income stream together with your reversionary income stream exceeds your transfer balance cap? If so then this is time-critical. In this case, you must deal with the reversionary income stream (reversionary pension) within 12 months of death. Otherwise, you suffer an excess transfer balance.

Are death nominations, including non-lapsing binding nominations, subservient to a Reversionary Pension?

Usually, a fully compliant legally prepared Reversionary Pension overrides a Death Benefit Binding nomination (Binding Nomination). But that is not always the case. You need to read the SMSF trust deed.

However, Legal Consolidated documents and variations are drafted so that a Reversionary overrides Binding Nominations. These documents are structured so that the Binding Nomination is subservient to the Reversionary Pension:

SMSF Deed – built over 18,000 times
Special Purpose Company – to be the trustee of SMSF
Convert the old Company into a Special Purpose Company – to be the trustee of SMSF
Investment Strategy – ATO audit friendly
Vest and Wind up SMSF – wind up, end and close down old SMSFs – get rid of your SMSF
SMSF Loan to Third Party
Commercial lease for SMSF – where the SMSF owns the commercial property
Reversionary Pension Kit – keep your dead spouse’s super in the Superannuation Fund
Power of Attorney for SMSF Corporate Trustee – if the director dies or has dementia, compliant with Fund Manager release forms
SMSF Training Course – includes the SMSF Deed

Update your SMSF Deed for:
1. Everything – Update Trustee, Upgrade Deed, Binding Nomination and PDS (Recommended)
2. Trustee only
3. Upgrade Deed only
4. Binding Nomination only – updates SMSF Deed as well
5. Product Disclosure Statement only – fully compliant with budget
Other SMSF updates
Change SMSF name – no CGT or stamp duty issues
Replace a lost SMSF Deed – no Court order required

Do Reversionary Pensions always override an SMSF Binding Nomination?

It is not correct to assume that an SMSF reversionary pension, even one prepared by a law firm, always applies before a Binding Nomination. Some SMSF deeds are silent. Silence prevails. Therefore, it is prudent to upgrade your SMSF Deed to a Legal Consolidated SMSF deed.

Four things to watch out for if you stop your SMSF Pension

I sat with a wise Sydney financial planner as he gave advice to his client. His client was about to stop the superannuation pension. A full commutation. These are the four things to watch out for:

1. Stopping the pension mid-year
   • Make sure the pension is up to date. Your financial planner and accountant have the formulae. The year’s minimum payments are made first.
2. Stopping the pension stops the tax-free status
   • The main reason that you go to the trouble of setting up a pension is for the tax-free investment income. A fully commuted pension stops this. The tax exemptions are gone.
   • For example, you may want to wind up one of your SMSFs. If you transfer in specie the SMSF asset to another fund this can trigger CGT. So you go from a tax-free status to wearing a CGT. Your financial planner and accountant may be able to stop this.
3. Special problems when commuting pensions that started before 1 January 2015
   • These pre-2015 account-based pensions were ignored for the Commonwealth Seniors Card. There was no asset test. So wealthy people were still able to take advantage of this benefit. Transferring superannuation assets or stopping the pension may mean you lost the Seniors Card.
4. Transfer Balance Cap is reportable when you commute the pension
   • Your accountant needs to prepare and report the Transfer Balance Cap to the ATO. This should be done promptly, otherwise, the ATO’s computer system may double count your superannuation assets if you transfer the assets to a new superannuation fund. This is because the new fund has to report straight away.

Must the pension nomination be made when the income stream is established and is binding?

Yes. The nomination must be made when the income stream is established and is binding. This is important to consider as it gives that person the ability to continue to receive your income stream as a reversionary income stream after you die.

Consider these options before your income stream is set up as you cannot add a reversionary beneficiary once the income stream has started. The only way to change your reversionary beneficiary once the income stream has started is to roll back the existing income stream to accumulation and then start a new income stream. This is expensive in terms of paperwork and reporting. It may also affect the government benefits you are receiving, such as age pension.

So it is better to make the decision at the start. Another issue you need to bear in mind is that a reversionary income stream counts towards the spouse’s transfer balance cap 12 months after the reversion occurs after your death. If the reversionary beneficiary dies before you the nomination lapses. At that time, you may choose to make a binding nomination to one or more of your other dependants. The nomination can be binding on the trustee where the trustee must abide by the nomination, or can be a discretionary nomination, in which case the trustee considers it and then has the discretion to pay it to the persons nominated or to one or more other dependants.

Example of how a Reversionary Pension works

Meet Alex and Morgan. They are members of the same SMSF. It has a combined super balance of $4 million. Alex dies. This presents Morgan with challenges. Even though the transfer balance cap (TBC) increases over time, the specific rules mean that Alex and Morgan do not benefit from the incremental increases.

Morgan wants to keep the entire $4 million in super. However, they cannot simply take Alex’s super as a pension because they’ve already used up their cap. Yet, they can fully commute their pension, essentially giving them back $2 million of their cap. When reported to the ATO, Morgan’s records show a negative $400,000 of their cap, allowing them to turn all of Alex’s super into a pension without exceeding their limit.

While Morgan cannot leave Alex’s super idly in the SMSF, they can do that with their super. This means Morgan ends up with a $2 million pension from Alex’s super and a $2 million accumulation account from their super.

If Alex’s pension had been set up to continue to Morgan automatically (a “reversionary” pension), they have $4 million in pensions right after the death. The rules give Morgan a window to make adjustments, such as switching off their pension to retain Alex’s balance in the fund.

But what if Alex had an accumulation account of $300,000? Here, Morgan cannot create enough space in their TBC to take all of it as a pension. Some would need to be withdrawn as a lump sum.

Your accountant and financial planner may tell you that when Morgan switches off their pension, they must follow certain rules, including ensuring their payments are up-to-date. If they normally do not take any pension until the end of the financial year but want to switch it off in December, they must ensure they take around 50% of the normal minimum payment first.

If Morgan has never started their pension before inheriting Alex’s super, they can the maximum TBC, with the rest paid out as a lump sum. However, this would mean they could not later start a pension from their super.

Interestingly, Alex’s death is the one time when Morgan could start a pension from their super, even if they’re typically too young or not retired. While dealing with the death of a spouse can be complex, seeking good advice can make a significant difference, offering steps that lead to a better outcome.

This is a general example. Speak to your accountant and financial planner. Legal Consolidated does not advise in this area. We only sell the Reversionary Pension Kits.

Can I get free legal advice as I build my SMSF Pension Kit?

There are hints as you build your Pension Kit. The building process is free. For more legal advice telephone us or Chat with us – but start the free building process and read the free hints first.

Reversionary Pensions in summary

When a spouse dies, self-managed super fund members face unique challenges, especially concerning the potential forced withdrawal of funds from super.

This becomes particularly complex for funds with assets like property, making selective transfers challenging. While it might seem logical for the surviving spouse to leave the money in the super, complications arise due to the common practice of couples leaving their super to each other. Unlike other beneficiaries, a spouse can receive the deceased’s super as a pension rather than a lump sum.

However, this pension counts toward the surviving spouse’s transfer balance cap (TBC), limiting the amount that can be put into a pension. If the surviving spouse already has a pension, they may exhaust their TBC, and those without a pension might inherit an amount exceeding the standard $1.9 million TBC, making converting the entire inherited super balance into a pension unfeasible at times. Steps can be taken to optimise the retention of funds in your SMSF, but these intricacies highlight the need for careful planning. Speak to your accountant and financial planner.