Death benefits to children post 1 July

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1 Death benefits to children post 1 July 14 March 2017 This article summarises the modified rules and implications of the super reforms when death benefits are paid to a child from 1 July Note: This article only examines the impact of the reforms on child death benefits and the modified application of the transfer balance cap rules for child beneficiaries. It assumes knowledge of the core related reforms. For an in-depth explanation of related reforms, including the $1.6m transfer balance cap and calculation of associated excess transfer balance tax, refer to our articles in the 'Super reforms' tab in the Overview page of the Technical Section of Adviser Online. Background The super reforms impact the rules and options available to child super death benefit beneficiaries from 1 July This may prompt a need to review and adjust estate planning strategies, should super death benefit pensions no longer be a viable or single solution. Existing child death benefit pensions will also be impacted, and action may need to be taken prior to 1 July 2017 to avoid an existing child pension beneficiary having an excess transfer balance amount. Of all the super reforms, the $1.6m transfer balance cap 1 arguably has the most significant impact on super death benefits and estate planning strategies. Children of a deceased superannuant are subject to a modified form of the transfer balance cap. Contents Who the modifications apply to... 1 Rules for child death benefits payable from 1 July Parent without transfer balance account... 2 Parent with transfer balance account... 3 Cap increment where both parents die... 5 Child commences member pension... 6 Existing child death benefit pensions... 6 The modified rules mean that regardless of whether the value of the death benefit is relatively small or large, children who receive death benefits may be impacted and the total benefit they can use to commence a death benefit pension will be constrained. It will be important to consider the merits of child death benefit pensions in relation to the appropriateness of other structures and estate planning investment vehicles going forward. Who the modifications apply to The modified rules operate to effectively ensure that a child beneficiary does not have their own $1.6m cap eroded by the payment of a death benefit pension from their parent. The modifications apply where a child beneficiary is both a child and a death benefit dependant of the deceased, 2 for super and tax purposes. This includes: minor children under 18 children who are financially dependent, and disabled children of any age. 3 1 In this article, we often refer to the concept of the general transfer balance cap as the $1.6m cap for simplicity. In 2017/18, this cap is set at $1.6m but may be indexed in future years. The cap which will therefore apply to a specific client scenario will be adjusted to reflect the prevailing cap in the relevant year. 2 ITAA97, s SIS Reg 6.21(2A) provides that the child must be disabled within the definition provided in s8(1) of the Disability Services Act

2 The modifications do not apply to a child beneficiary who is not a child of the deceased. These may be eligible to receive a death benefit pension as a financial dependant or interdependant, but they will be subject to the general $1.6m cap rules rather than the modified rules applicable to children of the deceased. The most common examples of when this may apply include where: a member makes a valid nomination to their grandchild as a financial dependant in the case of a step child, the relationship between the natural parent and step parent had ceased prior to the time the death benefit becomes payable, 4 or a child was otherwise financially dependent on a deceased individual who was not (for SIS purposes) their parent. Rules for child death benefits payable from 1 July 2017 The available transfer balance cap in respect of a death benefit interest payable to a child will be determined by what is known as the cap increment. Any amount used to commence a death benefit pension reduces the remaining cap increment. 5 The cap increment will be calculated based on whether the: deceased parent had a transfer balance account deceased parent had an excess transfer balance at the time of death child is the sole beneficiary of the interest, and if they are not, what proportionate share (%) the child has in the interest, and death benefit is from an accumulation and/or pension interest. A child may have multiple cap increments which are added to determine the maximum amount a child may transfer to pension phase. A child s total cap will include the sum of cap increments in respect of: the death of one parent the death of both parents, and/or their own member pension (eg where a disabled child commences a pension with structured settlement contributions). Children are required to fully commute any remaining death benefit pension interest once they turn 25 (unless disabled). It is at this point the modified transfer balance cap will be extinguished. If the death benefit pension balance is exhausted prior to 25, the modified transfer balance cap ceases at this earlier time. If the child is disabled, the modified transfer balance cap will continue beyond 25 until the balance of the pension is extinguished. This ensures that the child s own personal transfer balance cap is preserved and not eroded by the receipt of a death benefit pension. Below we outline the way in which a child beneficiary s cap increment is calculated, based on a range of possible scenarios. Appendix A provides a flowchart to illustrate the options available. Parent without transfer balance account The child s cap increment will be equal to their interest in the deceased s super accumulation benefit (as a percentage of the total interest) multiplied by the general transfer balance cap that prevails in the financial year that a death benefit is paid ($1.6m in 2017/18). 6 Therefore, in the case where a child of the deceased is the only beneficiary, their cap increment is equal to the general transfer balance cap and they may commence a death benefit pension with any amount up to that figure. Where the deceased had multiple accumulation interests this formula applies on a cumulative basis. Cap increment = % share of accumulation interest x general balance transfer cap 4 Includes where the natural parent has previously died, or where the natural parent and step parent have divorced. In the case where the step parent has legally adopted the step child, the child will be considered a child of the step parent for this purpose. 5 That is, the available cap increment may be more than or less than what is actually used to commence a death benefit pension. Any unused cap increment may be used at a later point, should the child subsequently commence a death benefit pension from the death of another parent, or in the unusual case where the child is eligible to commence their own member pension. 6 s

3 If the deceased client is survived by both a child and a spouse, for example, and the appropriate death benefit nominations are made, the spouse may choose to fully utilise their own transfer balance cap to commence a death benefit pension. In addition, the child may commence a child death benefit pension up to their available proportion of the transfer balance cap. This would maximise the amount of any death benefit interest from accumulation that could effectively be retained in the super environment. In this case, the spouse would have fully exhausted their transfer balance cap and would not be able to transfer additional amounts to pension phase 7, or benefit from any future indexation of the general cap. Note: The actual death benefit to which the child may be entitled may be greater than or less than the cap increment that arises in cases where the parent did not have a transfer balance account and the benefit is wholly from accumulation phase. In the case where a child becomes entitled to another death benefit from the death of the other parent, it may be possible to commence additional child death benefit pensions (see page 6). Example 1: No transfer balance account, benefit wholly from accumulation Sole beneficiary In December 2017, Mary passes away leaving her super accumulation interest of $1.9m to her daughter Rita as the sole beneficiary. Rita s cap increment is calculated as her interest in the $1.9m (100%) multiplied by the prevailing general transfer balance cap ($1.6m). Rita could therefore commence a death benefit pension with up to $1.6m. She would need to take the additional $300,000 as a lump sum death benefit as it exceeds her cap increment. Multiple beneficiaries If Rita was to instead be entitled to 50% of Mary s accumulation interest, with the other 50% payable to her father Tom, her cap increment would be calculated as follows: 50% x general balance transfer cap = $800,000. Rita could therefore commence a pension with $800,000 of her $950,000 entitlement and would need to take the remaining $150,000 as a lump sum death benefit. 7 Assuming that eligible debits to the transfer balance account do not occur, creating a future ability to make additional transfers. Parent with transfer balance account If a deceased parent had a transfer balance account, a death benefit to a child beneficiary may either be paid: wholly from a pension interest wholly from an accumulation interest, or partially from accumulation and pension. It is important to recall that the general $1.6m cap rules stipulate that when a person commences a pension, they will always have a transfer balance account, regardless of whether they continue to have a pension interest. 8 This means that if the parent had at some time in the past commenced a retirement pension, regardless of whether they continue to have a pension balance, or whether they have commuted the pension in part or in full, the way in which the cap increment is calculated is explained below. Transfer balance account and benefit paid wholly from pension Child is sole beneficiary If there is a single child beneficiary and the death benefit is wholly in pension phase at the time of the parent s death, the child beneficiary s cap increment is equal to the full balance of the pension interest at death, 9 regardless of whether the pension balance exceeds the prevailing general transfer balance cap at that point. 10 This means that it is possible for a child beneficiary to effectively commence a pension with an amount greater than the transfer balance cap. 11 Multiple beneficiaries In the case where there is more than one beneficiary, the child s cap increment will be calculated based on their interest in the deceased s pension interest (as a percentage) multiplied by the value of the deceased s pension interest. Cap increment = % share of pension interest x pension balance 12 8 For example, a person who commences a pension and either exhausts the account, or otherwise commutes the interest, will always have a transfer balance account. A person s transfer balance account only ceases upon their death. 9 s (2) 10 If parent died with an excess transfer balance amount that they had not rectified, see page 5 for modifications to child s available cap increment. 11 Account earnings that accrue from the time of the parent s death up until the time the death benefit pension commences to be paid are also treated as if they were part of the pension interest at the time of death and are accommodated under the cap increment. The proceeds of life policies are specifically excluded. 12 Pension balance less excess transfer balance amounts the parent had at the time of their death. 3

4 Example 2: Parent had transfer balance cap, benefit wholly from pension Sole beneficiary Alex passes away in October At the time of his death he has an account based pension valued at $4m. He does not have an excess transfer balance amount. His minor daughter Paula is the sole beneficiary of the pension. Assuming the value of the pension at the time of payment is $4m, her cap increment is therefore equal to $4m and she can commence a pension with the full amount. Multiple beneficiaries Consider instead a case where Paula and her brother Liam are both beneficiaries of Alex s pension interest in equal proportions. Each would have a cap increment calculated as follows: 50% x $4m = $2m. Note that if Alex had instead passed away without a transfer balance account and the interest was instead paid wholly from accumulation, each child would only have a cap increment of $800,000. This means the maximum amount that they could hold in death benefit pensions would be $1.6m. The remaining $2.4m would be paid as $1.2m lump sum death benefits to each of the children. Transfer balance account and benefit paid wholly from accumulation When a parent commences a pension, the ATO creates a transfer balance account. This account can have a positive, zero or negative value but is only extinguished upon their death. This is regardless of whether the parent fully utilised their transfer balance cap, whether they fully commute back into accumulation or outside super, or otherwise exhaust their pension funds. If a parent who has a transfer balance account does not have a pension interest at the time of their death, regardless of what their accumulation balance is, or whether these funds were at any point held in pension phase and subsequently commuted to super, the child s cap increment will be nil. They will generally be unable to commence a death benefit pension with any of the proceeds. 13 The exception to this would be if the child had an unused cap increment which had previously arisen from the death of another parent or if the child beneficiary had commenced their own member pension and therefore had their own personal transfer balance cap. See pages 5 and 6 for further discussion on this. 13 s (3) Example 3: Transfer balance account, benefit wholly paid from accumulation Robert dies in March At the time of his death, he had an accumulation account with a balance of $250,000. Previously, Robert had commenced an account based pension but at the time of his death he had fully exhausted the pension. Eliza is the sole beneficiary of his accumulation interest. Because the entire benefit will be paid from accumulation, Eliza will have a cap increment of nil and will need to take the entire benefit as a death benefit lump sum. If Robert did not have a transfer balance account (ie he had never commenced an account based pension at any time in the past), Eliza would have been able to commence a death benefit pension with Robert s accumulation interest. Benefit paid from accumulation and pension If a deceased parent has an accumulation and pension interest, each child beneficiary will receive a cap increment equal to their share of the pension interest only and would only be able to commence a death benefit pension up to this limit. 14 This means that the child will be unable to start a death benefit pension with any of the deceased parent s accumulation interests 15. Cap increment = % share of pension interest x pension balance 16 Example 4: Pension and accumulation interests Junior dies on 9 June At the time of his death he has both an accumulation account with an account balance of $350,000 and an income stream with an account balance of $750,000. Junior has two dependants his wife Sybil and son Tony (5). If Tony was to receive all of Junior s accumulation and pension interests, he would be unable to commence a death benefit pension with the full amount. This is because Tony s cap increment would be equal to his share of the value of the pension interest at the time of Junior s death (100% x $750,000) and so the accumulation interest would have to be taken as a lump sum. 14 s (4) 15 An exception to this would be if a child had available cap increments from the death of a parent previously, or if the child had commenced their own member pension (for example where a disabled child has received a structured settlement). 16 Pension balance less excess transfer balance amounts the parent had at the time of their death. 4

5 Similarly, if Tony was to be the sole beneficiary of the accumulation interest and Sybil was to be the sole beneficiary of the pension, Tony s cap increment would be nil, given that Junior had a transfer balance account, and Tony s only entitlement was to the accumulation interest. Instead, if Junior s pension was paid to Tony, and a nomination was made in favour of Sybil for Junior s accumulation account, Tony could commence a death benefit pension with the $750,000 17, and Sybil could commence a death benefit pension with the $350,000 from Junior s accumulation account. This would enable all of Junior s super interests to initially be held in pension phase. Adjustments if parent had excess transfer balance account If a parent dies with an excess transfer amount, the amount of the excess will reduce the child s available cap increment. 18 That is: Cap increment = % share of pension interest x pension balance where: Pension balance is the value of the pension interest at death 19, less excess transfer balance amounts In the case where a child is the reversionary beneficiary and the parent had an excess transfer balance immediately prior to their death, the child will need to at least partially commute the pension to avoid an excess transfer balance. As the value of the pension at the date of the parent s death will be credited to the child s transfer balance account 12 months from the date of death 20, the child will have 12 months to make the commutation before an excess transfer balance occurs. Cap increment where both parents die In the unfortunate event that a child finds themselves in a situation where both parents are deceased, their total available cap will be determined by: calculating their available cap increment for each parent as outlined above adding the available cap increments together, and adding to that any personal transfer balance cap the child has in respect of their own member pension. This means that in a case where both parents pass away with accumulation balances (assuming neither parent has a transfer balance account) it may be possible for a child to commence death benefit pensions with a total of $3.2m. 21 It may also be possible for a child beneficiary who has an unused cap increment from the death of another parent, to use this amount to commence a larger pension upon the death of a second parent, than what the second cap increment would otherwise allow. Example 5: Cap increment where both parents die Thomas passes away in December 2017 with $500,000 in an accumulation account. He has never commenced a pension. His son Mark (13) is the sole beneficiary of the interest. Mark s cap increment is calculated as: 100% x general transfer balance cap In 2017/18, the general transfer balance cap is $1.6m. Therefore Mark s cap increment is $1.6m. He commences a death benefit pension with the full $500,000 balance. In March 2019, Mark s mother passes away. She had $1.95m in an accumulation interest and has never commenced a pension. Mark is the sole beneficiary of his mother s super interest and his cap increment in respect of his mother s death is therefore equal to the general transfer balance cap of $1.6m. Mark s total transfer balance cap is calculated by adding the cap increment generated from his father s death to that received in respect of his mother s death. That is, his total cap is $3.2m. 17 Assumes that she does not have a transfer balance account and has not previously commenced a pension herself. 18 s (5) 19 Includes growth on death benefit amounts that have accrued from death up until the benefit is paid. 20 In line with the general transfer balance cap rules, where an automatic reversionary death benefit pension is paid, the beneficiary will have 12 months from the date of death to address their affairs and to commute an amount that exceeds their available transfer balance cap to avoid an excess transfer balance amount. 21 Based on $1.6m general transfer balance cap in 2016/17. Cap is subject to indexation. Assumes child doesn t have their own personal transfer balance account. 5

6 Because he only commenced the initial death benefit pension from the death of his father with $500,000, this means he could elect to receive the entire interest of $1.95m as a death benefit pension. This is because both the $500,000 pension and the $1.95m pension would not exceed his available cap increment. Child commences member pension In the unusual case where a child beneficiary commences their own pension (and therefore has their own transfer balance account) either before or after becoming entitled to a child death benefit pension, their total transfer balance cap is: the general transfer balance cap in the year in which they commence their own member pension, plus cap increments (calculated as above) in relation to the death of one or both parents. For the purpose of determining any future uplift in the child s personal transfer balance cap as a result of indexation, cap increments that relate to the commencement of child death benefit pensions are ignored, and the calculation is as per the ordinary rules. This means that if a child has their own personal transfer balance account, they can make use of any unused cap they have to commence child death benefit pensions with amounts greater than the applicable death benefit cap increment would otherwise allow. This is most likely to occur in the case of a disabled child, where they have received a structured settlement and made a contribution to super. Example 6: Child beneficiary has personal transfer balance account On 1 August 2017, Barbara received a structured settlement of $5m as a result of an injury she suffered. On 1 September, she contributes the full amount to super and commences an account based pension with this amount, as well as $400,000 she has in her accumulation account. As per the general transfer balance cap rules, her cap is $1.6m in 2017/18. She receives a credit to her transfer balance account of $5.4m, and immediately also receives a debit of $5m to recognise the structured settlement contribution. She therefore has a transfer balance account of $400,000. Barbara is able to commence a death benefit pension with the full amount of Bob s death benefit (see page 4). Her total cap is calculated by adding her own personal transfer balance cap ($1.6m) to the cap increment received in respect of Bob s death ($1.8m), totalling $3.4m. Because Barbara has a transfer balance account of $400,000 (remember, $5m was debited as it was a structured settlement payment), she still has $1.2m of cap space remaining. For the purpose of future proportional indexation, the death benefit pension is ignored. Barbara s highest transfer balance is $400,000. Assuming no additional transfers to pensions are made, she will therefore receive 75% of any future indexation to the general transfer balance cap. 22 Existing child death benefit pensions Child death benefit pensions running prior to 1 July 2017 will have a transfer balance cap increment equal to the $1.6m general transfer balance cap on that day. 23. This reflects the maximum cap the deceased parent could have had at that time, should they have still been alive. For example, if Grant had an existing child death benefit pension with an account balance of $1m on 30 June 2017, he would have a cap increment available in respect of this pension of $1.6m on 1 July This means Grant would have a remaining unused cap increment of $600,000. If the account balance of an existing child death benefit pension exceeds their cap increment of $1.6m from 1 July, an excess transfer balance will occur and excess transfer balance tax will be incurred. An exception to this would be where a death benefit pension to a child was a reversionary pension. In this case, the credit to the child s modified cap would occur on the later of 12 months from the date of death of the parent or 1 July Existing child pensions should therefore be reviewed prior to 1 July On 1 January 2018, Barbara s father Bob passes away, leaving his entire $1.8m pension interest to Barbara as the sole beneficiary. Bob did not have an excess transfer balance. 22 As Barbara has used 25% of her transfer balance cap ($400,000/$1.6m) she will receive 75% of any future uplift. 23 s

7 Conclusion While child superannuation death benefit pensions may still be an attractive, practical and cost effective option, advice will need to be carefully formulated going forward, due to the limitations imposed by the transfer balance cap, and the modified rules applicable to children. Super alternatives will in some cases need to be considered. Clients should seek specialist advice from a legal practitioner where appropriate, to ensure that any financial advice provided and implemented is well supported by appropriate and executed estate planning arrangements. Contact details For further information, please contact MLC Technical Services on Important information and disclaimer This publication has been prepared by Technical & Development, a division of GWM Adviser Services Limited (ABN , AFSL ) ( GWMAS ), a member of the National Australia Bank group of companies ( NAB Group ), Miller Street, North Sydney Any advice and information in this publication is of a general nature only. It has been prepared without taking account of individual objectives, financial situation or needs and because of that you should consider the appropriateness of the advice before acting. It is solely for use by financial advisers and any distribution to customers is prohibited. GWMAS and the NAB Group do not accept any liability which arises as a result of dissemination of this publication to customers by financial advisers or a customer s reliance on this publication. Information in this publication is accurate as at March 2017 and subject to change without notice. In some cases the information has been provided to us by third parties. While it is believed the information is accurate and reliable, the accuracy of that information is not guaranteed in any way. Opinions constitute our judgement at the time of issue and are subject to change. Neither GWMAS nor any member of the NAB Group, nor their employees or directors give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document. Any investment returns shown in any case studies in this publication are hypothetical examples only. They do not reflect the historical or future returns of any specific financial products. Any general tax information provided in this publication is intended as a guide only and is based on our general understanding of taxation laws. 7

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