The new rules that govern when a transition to retirement income stream (‘TRIS’) enters retirement phase give rise to a number of complex issues in the context of reversionary nominations and death. This article examines the retirement phase rules and reversionary TRISs in detail, based on the law and the latest ATO view.
Broadly, this complexity arises due to the ATO view that the retirement phase rules for TRISs do not recognise a member’s death as a relevant condition of release that confers retirement phase status on a reversionary death benefit TRIS (ie, a TRIS that has reverted to an eligible dependant of a deceased member such as a surviving spouse). Accordingly, to receive a TRIS as a death benefit income stream, the recipient must satisfy the retirement phase rules in their own right. If the recipient does not satisfy these rules at the time of the TRIS member’s death, the TRIS must be commuted to comply with the payment standards.
The requirement to cease a reversionary TRIS if it is not in the retirement phase for the reversionary recipient can trigger a number of undesirable outcomes, including loss of the 12-month deferral in the timing of the transfer balance account credit and valuable tax concessions. Due to these issues, it is critically important that SMSF trustees and advisers come to grips with the latest ATO view on the succession planning and tax implications of the retirement phase rules, particularly where there are fund members receiving pensions that were commenced as TRISs.
For simplicity, we will assume the superannuation deed and rules that govern the TRIS or pension have appropriate flexibility and do not limit any of the strategies discussed below.
Background
The starting point is that from 1 July 2017 TRISs are expressly excluded from being in the retirement phase under s 307-80(3) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’). Due to this exclusion, the earnings on assets supporting a TRIS are generally not eligible for the exempt current pension income (‘ECPI’) exemption.
However, TRISs can subsequently enter retirement phase if the person to whom the benefit is payable:
attains age 65; or
meets the retirement, terminal medical condition or permanent incapacity conditions of release and notifies the fund trustee of that fact.
The critical point to emphasise here is that the above conditions of release are tested in respect of ‘the person to whom the benefit is payable’ (ie, the person from time to time receiving the TRIS).
This effectively means that a TRIS that has entered retirement phase has not done so permanently, and the TRIS retirement phase rules will be applied by the ATO in respect of the recipient from time to time, including any future reversionary recipients. Accordingly, a reverted TRIS can lose its retirement phase status if the recipient of the TRIS (eg, a surviving spouse) has not satisfied a full condition of release and other relevant notification requirements. This is notwithstanding the fact that death itself is a condition of release with a nil cashing restriction.
We now consider the implications of these rules with reference to different scenarios where a TRIS automatically reverts to an eligible dependant based on the latest ATO view.
Deceased’s TRIS was not in retirement phase
If a member with a non-retirement phase TRIS that is automatically reversionary dies, what happens depends on whether the recipient has satisfied a full condition of release and other relevant notification requirements.
Recipient is not in retirement phase
If the recipient of the TRIS has not met the requirements in s 307‑80 of the ITAA 1997:
- The TRIS technically reverts for tax purposes, but payment of the TRIS as a death benefit pension is inconsistent with reg 6.21 of Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) which requires death benefit pensions to be superannuation income streams in the retirement phase.
- To comply with the payment standards in reg 6.21, the recipient will need to, as soon as practicable, commute the TRIS and:
- start a new account-based pension in place of the TRIS;
- withdraw the death benefit as a lump sum; or
- pay the death benefit using a combination of the above two options.
- The TRIS will cease for super and tax purposes when it is fully commuted and there will be mixing of tax-free and taxable components if the recipient has an accumulation interest.
Recipient is in retirement phase
If the recipient of the TRIS has met the requirements in s 307‑80 of the ITAA 1997:
- The TRIS reverts to the reversionary beneficiary for tax purposes.
- Payment of the TRIS as a death benefit pension is consistent with reg 6.21 of the SISR which requires death benefit pensions to be superannuation income streams in the retirement phase.
- The fund can claim the ECPI exemption in respect of the assets supporting the death benefit TRIS from the date of the deceased’s death.
Deceased’s TRIS was in the retirement phase
We now analyse what happens if a member with a retirement phase TRIS that is automatically reversionary dies.
Recipient is not in retirement phase
If the recipient of the TRIS has not met the requirements in s 307‑80 of the ITAA 1997:
- The TRIS technically reverts for tax purposes, but payment of the TRIS as a death benefit pension is inconsistent with reg 6.21 of SISR which requires death benefit pensions to be superannuation income streams in the retirement phase.
- To comply with the payment standards in reg 6.21, the recipient will need to, as soon as practicable, commute the TRIS and:
- start a new account-based pension in place of the TRIS;
- withdraw the death benefit as a lump sum; or
- pay the death benefit using a combination of the above two options.
- The TRIS will cease for super and tax purposes when it is fully commuted and there will be mixing of tax-free and taxable components if the recipient has an accumulation interest
- The fund’s ECPI exemption in respect of the assets supporting the TRIS ceases on the death of the deceased.
- The extension of the pension exemption under regs 995-1.01(3)–(4) of the Income Tax Assessment Regulations 1997 (Cth) (‘ITAR’) is unavailable as it only applies where ‘the superannuation income stream did not automatically revert to another person on the death of the deceased’ (see reg 995 1.01(3)(c)).
- The 12-month deferral in the timing of the credit to the recipient’s transfer balance account will not apply as the TRIS was commuted.
Recipient is in retirement phase
If the recipient of the TRIS has met the requirements in s 307‑80 of the ITAA 1997:
- The TRIS reverts to the reversionary beneficiary for tax purposes.
- Payment of the TRIS as a death benefit pension is consistent with reg 6.21 of the SISR which requires death benefit pensions to be superannuation income streams in the retirement phase.
- The fund’s ECPI exemption can continue to be claimed in respect of the assets supporting the death benefit TRIS as the pension did not cease (refer to TR 2013/5).
ECPI exemption
As noted above, a superannuation income stream (ie, the tax term for a ‘pension’) that is a TRIS must be in retirement phase in respect of the recipient for the ECPI exemption to apply at the fund-level.
Where a deceased TRIS member and a reversionary recipient of that TRIS are both in the retirement phase, ECPI can readily continue if the SMSF and pension documentation provides for an automatically reversionary pension consistent with TR 2013/5.
However, a unique problem arises in the context of reversionary TRISs where the deceased TRIS member was in retirement phase but the reversionary recipient of the TRIS is not.
Under the tax regulations that have been in place since FY2013, a fund paying a pension that ceased on a member’s death due to it not being automatically reversionary would ordinarily receive an extension to the ECPI exemption in respect of assets supporting that pension provided that the deceased member’s benefits are cashed ‘as soon as practicable’. However, this concession requires that ‘the superannuation income stream did not automatically revert to another person on the death of the deceased’. Accordingly, no extension of the pension exemption is available for TRISs that have reverted for tax purposes even where the TRIS is subsequently commuted due to the reversionary beneficiary not satisfying the requirements in s 307-80 of the ITAA 1997.
Accordingly, unless the death benefit TRIS is commuted on the day of the deceased’s death and a new account-based pension is commenced on the same day, there will be a period of time where no exempt income is available in respect of the assets that supported the TRIS.
Conclusions
We are aware of a number of professional bodies making submissions to the ATO and Treasury with a view of obtaining a more satisfactory solution and potentially a legislative fix may be needed. Accordingly, advisers and SMSF trustees should watch this space as developments unfold.
Naturally, some of the issues discussed above would not arise if the TRIS was an account-based pension, however, at this stage Treasury and the ATO appear to be unwilling to acknowledge the possibility of a TRIS ever being able to convert to an account-based pension without the TRIS being commuted and commenced as a new pension, notwithstanding the long-standing industry practice in this area.
Accordingly, at this stage, the only sure-fire way to overcome the above issues is for the retirement phase TRIS member to commute their TRIS during their lifetime so that a new account-based pension can be commenced that can be reverted to any eligible dependant. If, for example, a surviving spouse receives a reversionary account-based pension on the death of a member, there is no need for them to satisfy any condition of release because death by itself is a condition of release with a ‘nil’ cashing restriction. Naturally, this involves some upfront administration and costs that need to be weighed up against likelihood hurdles in the future.
If a retirement phase TRIS member does not commute their TRIS and commence an account-based pension instead, and the intended beneficiary of their death benefits is not likely to be in the retirement phase at the time of the member’s death, the TRIS member should strongly consider making the TRIS non-reversionary so that the extension of the ECPI exemption is available on their death.
For more information please speak with Leenane Templeton’s Self-Managed Super Specialists. Visit our main website at www.leenanetempleton.com.au
Published by permission and written by William Fettes, Senior Associate & Daniel Butler, Director, DBA Lawyers. 5 October 2017
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2000 (Cth).