Superannuation death benefit options for a surviving spouse

Jennifer Brookhouse outlines the options, issues and strategies to consider when paying a superannuation death benefit to a surviving spouse.

When a superannuation fund member dies, their surviving spouse may be able to receive the death benefit as a lump sum payment, income stream or a combination of the two.

Receiving an income stream can provide benefits such as tax-free income and capital gains in the fund, rebatable or tax-free income payments and potential social security concessions. The downside is any anti-detriment payment is forgone, as this additional amount is only paid when a death benefit is received as a lump sum.

When evaluating the options, it is important to:

• Determine whether the fund is able to make anti-detriment payments, as not all funds can or will.
• Identify the potential anti-detriment amount, which will depend on factors such as whether the fund uses the audit or formula method to determine the payment, how much of the total benefit relates to insurance, the tax components and the deceased’s eligible start date.
• Consider whether receiving an anti-detriment payment outweighs the ongoing tax and social security benefits an income stream may provide.

The tax implications for future beneficiaries should also be considered. While the surviving spouse is able to receive the superannuation benefit tax-free, the surviving spouse’s non-dependants for tax purposes (often financially independent adult children) will pay tax on the taxable component of the death benefit when the surviving spouse dies.

Strategies

1. Spouse aged 65 and over and not working

If the surviving spouse is age 65 or over and not working, they are unable to make superannuation contributions. For these clients, receiving the death benefit as an income stream will enable them to retain the capital in the superannuation environment. This strategy may be particularly attractive if the potential anti-detriment amount is relatively small, or the fund is unable to make anti-detriment payments, which is often the case with self-managed superannuation funds because of funding issues.

2. Death benefit greater than contribution caps

If the surviving spouse is eligible to make superannuation contributions and the fund will make an anti-detriment payment, they may want to receive some of the death benefit as a lump sum. This will enable them to qualify for an anti-detriment uplift for the portion received as a lump sum.

If the spouse then uses the money to make a non-concessional superannuation contribution (up to $450,000 in certain circumstances), they could ensure the full amount of capital is held in the superannuation environment and the contribution will be paid tax-free to all beneficiaries, including financially independent adult children.

The contributed amount will be preserved and the spouse must satisfy a condition of release to access the money as a lump sum or income stream. Also, no anti-detriment payment will be made on the amount received as an income stream, and this portion will inherit the deceased’s tax-free and taxable components, which may have tax implications for future beneficiaries.

3. Access to superannuation held in accumulation phase

If the surviving spouse is under age pension age and receiving income support, they may ultimately want to hold the death benefit in the accumulation phase where the money may be exempt from the social security income and assets test. To do this, the surviving spouse must first receive the death benefit as an income stream and then commute the income stream outside the later of six months from the date of death, or three months from the grant of probate or letters of administration.

A commutation outside these timeframes results in the spouse receiving a lump sum member benefit, which can be rolled to an accumulation fund. The amount rolled over is classified as an unrestricted, non-preserved benefit and the money can be withdrawn at any time or converted to an income stream. However, while in the accumulation phase, any earnings on this amount will become preserved.

Other issues to consider include:

• No anti-detriment payment is available.
• While commuting the pension may have tax or social security implications, these may be a short-term cost for longer-term benefits and flexibility.
• Any lump sum or pension paid from the amount rolled over will no longer be a death benefit. Where the recipient is less than age 60, this will mean a lump sum benefit may be taxed and pension income payments may be taxed with no 15 per cent tax offset available if the recipient is aged less than preservation age.

Conclusion

The above strategies illustrate when it may or may not be appropriate for a surviving spouse to receive a superannuation death benefit as an income stream. But just like a financial plan, an estate plan should be reviewed on an ongoing basis. While an estate planning strategy may be appropriate now, a change in circumstances may mean it will no longer be the most appropriate strategy.

Recent Draft ATO Ruling

The Australian Taxation Office proposed in Draft Tax Ruling TR 2011/D3 that effective 1 July 2007, account-based pensions and certain other pensions cease and become an accumulation benefit on the death of the member if there is not a member (or dependent beneficiary of a member) who is automatically entitled to receive the death benefit as an income stream.

This proposal has the potential to make it more attractive to have an income stream automatically paid (or continue) to an eligible beneficiary. This is because, once an income stream ceases, fund income, such as dividends and interest, are taxed at up to 15 per cent.

Also, when assets are sold to pay lump sum death benefits, discounted capital gains are taxed at 10 per cent. When you consider that lump sum death benefits are already taxable when paid to non-tax dependants, this measure also has the potential to impact estate planning strategies.

Jennifer Brookhouse is a senior technical consultant at MLC Technical Services.