Australia: Under the microscope: ATO scrutinises the paying of death benefits in light of superannuation reforms

Last Updated: 8 March 2018
Article by Rebecca James

The ATO is now considering aspects of recent superannuation legislation reform and has the payment of death benefits in its direct line of sight.

In brief

Following recent reforms, in this post transfer balance cap world, advisers must consider the practical implications and revise their strategies around the payment of superannuation death benefits.

What you need to know

  • It is important that the Fund's trust deed expressly allows the member to direct the trustee to pay the member's death benefit as a reversionary pension.
  • There should be a clear and specific member direction under the pension documents (without any discretion on the part of the trustee) to pay the pension to the nominated reversionary beneficiary on the member's death.
  • Pension documents should expressly permit the terms of the pension to be amended with the written consent of the trustee and the member.

Requirement to 'cash' death benefits

On a member's death, the Fund trustee is required to cash a deceased member's superannuation death benefits to the deceased member's eligible beneficiaries or legal personal representative (LPR) as soon as practicable. The death benefit cannot go back into 'accumulation phase'.

According to the compliance approach adopted by the ATO in PCG 2017/6, if a death benefit is paid as a complying pension to an eligible beneficiary and that pension is then commuted, the commuted amount must be paid pursuant to regulation 6.21 of the SIS Regulations, either as a lump sum, a complying income stream or a combination of both. The effect is that the commuted amount is essentially retested against the compulsory cashing requirements under superannuation law.

Thus, death benefits cannot be retained within the accumulation phase. This interpretation adopted by the ATO has significant implications for structuring death benefit payments in light of the transfer balance cap.

Reversionary pensions

A key benefit of ensuring that a pension is reversionary on the member's death is the availability of a 12 month period, usually commencing from the date the pension reverts, to restructure both the deceased member's and the reversionary beneficiary's superannuation benefits to address potential excess transfer balance tax issues.

Thus, a critical consideration is what is required to ensure a pension is in fact reversionary? Given the trustee's discretion under superannuation law to determine who receives the death benefit, a key issue is whether paying a reversionary pension constitutes an improper fetter of the trustee's discretion regarding the payment of benefits. This is addressed by ensuring a specific power in the trust deed is included.

This then gives rise to the further question of when is the proper time for the trustee to exercise its discretion when paying member benefits. For example, is the correct time for the trustee to exercise its discretion:

  • when the trustee agrees to pay the pension to the member, pursuant to agreed terms, including paying the pension to the reversionary beneficiary on the member's death; or
  • on the member's death?

The difficulty in this scenario is that there is no case law that has specifically considered this point of law, but only general trust law cases that consider what constitutes an improper fetter on the decision-making powers of a trustee.

The uncertainty in this context highlights the importance of ensuring the Fund's trust deed contains a specific power to allow the member to direct the trustee to pay the member's death benefit as a reversionary pension. Further, there should be a clear and specific direction under the pension documents (without any discretion on the part of the trustee) to pay the pension to the nominated reversionary beneficiary on the member's death.

Can an existing pension be converted to a reversionary pension?

There is also a question as to whether an existing pension can be amended prior to the member's death to vary the terms to ensure the pension becomes payable to a reversionary beneficiary on the member's death.

The ATO appear to accept that an existing pension can be varied to nominate a reversionary beneficiary before the member's death (refer to LCG 2017/3 at paragraph 13). As a matter of law, however, a variation to the terms of an existing pension would be on a much sounder footing if the pension documents contained a provision permitting the terms of the pension document to be amended with the written consent of the trustee and the member, and the variation is made in accordance with that amendment power.

Can a pension be made reversionary under a BDBN?

Finally, is it possible to make a pension reversionary under a valid and effective BDBN?

A BDBN generally directs the trustee as to whom to pay the deceased member's benefits, and may direct the form of the payment, such as a lump sum or pension (subject to complying with superannuation law and there being the requisite power under the trust deed). A BDBN would typically not be sufficient to vary an existing pension agreement with a nominated reversionary beneficiary, subject to the terms of the Fund deed.

It is generally best practice for the trustee and the member to enter into a pension deed setting out the terms on which the pension is payable to the member, and to include a clause permitting the pension to be varied, such that a reversionary beneficiary can be nominated under the relevant pension documents.

This approach also appears to be consistent with the Commissioner of Taxation's view in LCG 2017/3 at paragraph 15, which states that:

A BDBN, by itself, does not make a pension reversionary. If the governing rules or the agreement/standards under which the pension is provided does not expressly provide for reversion then a BDBN cannot alter this. The BDBN may have the effect of directing the trustee as to whom the death benefit is to be paid and the form, but it cannot turn a non-reversionary pension into a reversionary pension.

While the above excerpt is not a binding statement of law, the ATO's view in LCG 2017/3 is a timely reminder to review the Fund's trust deed and relevant pension documents where it is intended that a pension is to be reversionary on the member's death.

Conclusion

There is a number of technical and uncertain legal issues regarding the payment of superannuation death benefits, and the exercise of the trustee's discretion. An important factor in addressing these issues is to ensure the Fund's trust deed and pension documents contain the relevant provisions to avoid some of these issues and the uncertainties associated with the payment of superannuation death benefits.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Madgwicks is a member of Meritas, one of the world's largest law firm alliances.

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