Inheriting a pre-1983 eligible service period

When a member of a super fund dies, benefits which they have accumu-lated in the fund may be paid out to their beneficiaries in the form of either a lump sum or as a pension.

When a member of a super fund dies, benefits which they have accumu-lated in the fund may be paid out to their beneficiaries in the form of either a lump sum or as a pension. The way in which each of these benefits is treated by the tax system varies, with different results depending upon who receives the benefit, the form of the benefit and the amount of the benefit.

Benefits paid directly as a lump sum to a dependant on the death of a member are generally what are known as "death benefit eligible termi-nation payments (ETPs)". Death benefit ETPs within the deceased's pension reasonable benefit limit (RBL) are tax-free if paid to a de-pendant and taxable if paid to a non-dependant. Any amount in excess of the deceased's pension RBL is taxed at the highest marginal tax rate. Death benefit ETPs cannot be rolled over.

Beneficiaries can also access death benefits as a lump sum by commut-ing a benefit paid to them as a pension. Again, the resulting payment is an ETP. The question of whether that ETP is a death benefit ETP or not depends upon the timing of the commutation.

Commutations of death benefit pensions are only death benefit ETPs if payment is made either within six months of the death of the original member or within three months after the grant of probate or letters of administration in relation to the estate of the original member, whichever is longer.

Commutations made outside this period are not considered death bene-fit ETPs. Instead, they are normal ETPs, paid to the beneficiary of the original member.

This has a number of consequences:

* the payment can be rolled over and retained in the tax-effective superannuation environment;

* if paid to a tax non-dependant who is over 55, part of the post-1983 component will be tax-free. This is not available for death benefit ETPs;

* the service period associated with the original member's superannu-ation fund is passed through to the resulting ETP - any pre-1983 service is effectively transferred from the original member to their beneficiary. The commutation ETP can be rolled over and consolidated with other superannuation benefits of the beneficiary and the pre-83 service applied across all their benefits.

The above discussion is based on the individual with the pre-1983 service to pass on to their beneficiaries being in the accumulation phase of superannuation. If this person had instead already begun re-ceiving their benefit as an allocated pension, then the ability for their beneficiaries to rollover any commuted pension death benefit may be lost. Under section 27A(12C) of the Income Tax Assessment Act, the commutation of a residual pension by anyone other than the spouse of the member is not a qualifying ETP and therefore unable to be rolled over.

Break-out: Case Study

Ernie and Bert are the adult sons of Jim, who has super of $100,000 with no undeducted contributions. Jim's service commenced on 1 July 1973. Jim died on 1 April 1999, and benefits are payable equally to Ernie and Bert, Ernie's as a lump sum, and Bert's as an allocated pension. This occurs on 30 June 1999, after Probate has been granted. What are the tax situations of Ernie and Bert?

PUT ERNIE and BURT as two separate columns

Ernie

Death benefit ETP: $50,000

ETP can't be rolled over. ETP doesn't count to Ernie's RBL (as the total benefit is within Jim's pension RBL of $942,175, there is no excess benefit)

Pre 83 component: $19,229.15

Post 83 component: $30,770.85

Tax on Pre 83 component: $466.31 *

Tax on Post 83 component: $5,077.19 *

Net benefit: $44,456.50

*Assume marginal tax rate is 48.5 per cent and post-1983 tax-free threshold is $93,731.

Bert

Death benefit pension: $50,000

Bert starts his pension, but on 31/12/1999 and commutes it. As the commutation occurs more than six months after death and more than 3 months after the grant of probate, it is not a death benefit ETP.

Pre 83 component: $18,863.64

Post 83 component: $31,136.36

Tax on Pre 83 component: $457.44 *

Tax on Post 83 component: NIL *

Net benefit (if cashed out): $49,542.56

Resulting ETP can be rolled over instead. ETP counts to Bert's RBL.

It is clear that there is an immediate tax benefit available if the allocated pension death benefit is commuted - Bert can save over $5,000 tax on a $50,000 benefit. There is an additional tax benefit available to Bert by rolling over the commutation ETP and applying the pre 83 service period he's inherited from Jim to his other super benefits. If Ernie and Bert had accumulated $300,000 each of their own super (with only post 83 service), Bert could save $15,000 in tax.

Bert

Super benefit: $300,000

Pre 83 component: $0

Post 83 component: $300,000

Tax on Pre 83 component: $0 *

Tax on Post 83 component: $33,554.90 *

Net total benefit: $310,901.60

Ernie

Super benefit: $350,000

Pre 83 component: $129,621.74

Post 83 component: $220,378.26

Tax on Pre 83 component: $3,143.33 *

Tax on Post 83 component: $20,417.31 *

Net total benefit: $326,439.36

RBL Implications

The death benefit ETP that Ernie received doesn't count to his RBL, so his only RBL concerns are with his own super. In Bert's case, both the $50,000 commutation ETP and his own super count to his RBL. With this in mind, it is preferable that death benefits taken in the form of a pension, with the intention to commute at a later stage, should be kept to a minimum. In this way, access to the pre-1983 service is maintained, but RBL-assessed amounts are kept in check.

Deborah Wilson is technical services manager at Advance Funds Manage-ment.