Your SMSF is paying a pension or you’re thinking of commencing a pension from your fund and you realise there’s one issue that’s troubling you and you can’t really find enough information to make a firm decision.
This one issue involves a choice between a Binding Death Benefit Nomination (BDBN) or having a nominated reversionary beneficiary named for your pension. But what’s the difference, and which should you choose?
Over the next couple of articles I’m going to describe what these options are and when you might use either or both of them for your pension.
Binding nominations
This week I’ll look at BDBNs and pensions. At its simplest level, a BDBN is a firm nomination for your super fund benefit to be paid, on your death, to your chosen dependants or to your deceased estate. I wrote about BDBNs in March and you can read that article here [1].
Firstly as a matter of course, as with everything in your SMSF, in order for a BDBN to be effective, your trust deed must allow for them to be used and you and your fund’s trustee must follow the trust deed’s requirements to put one in place.
For example, our SMSF trust deed provides that when I give a BDBN to my trustee, he or she must formally accept that document.
Also look at the rules your trust deed provides. Does it allow you to nominate what type of benefit your chosen survivors will receive? Plenty of trust deeds, especially for large super funds, make no allowance for this.
Here are some common questions I’m asked:
What happens if you use a BDBN with your non-reversionary pension?
Your pension will cease immediately upon your death. If your BDBN specifies that one or more pensions are to be paid to specific survivors, then these will be new pensions.
Your pension beneficiary will have to become a trustee and member of your super fund if they’re not already. The taxable and tax-free component split for the pension will be calculated at this point.
Additionally, the Centrelink income test assessment will be re-calculated. The importance of this point is best explained by an example:
Example
Suppose at the age of 65, Tom begins a non-reversionary pension with a purchase price of $500,000. His spouse is 62.
Under Centrelink’s income test, $26,968.72 in income paid from the pension won’t be counted under that test each year for the life of the pension. This is worked out by dividing the pension’s purchase price by Tom’s actuarial life expectancy.
$500,000 ÷ 18.54 = $26,968.72
Suppose Tom dies at the age of 80 and the account balance of the pension is now $600,000. On death, the super fund begins to pay his spouse a new pension when she is 78 years old. At that point in time, she will have a life expectancy of 11.35 years, which means each year Centrelink’s income test won’t count $52,863.44 in income paid from the pension.
(The life expectancy of 11.35 is based on current life expectancy tables. In 15 years’ time we could expect a 78-year-old female to have a life expectancy of about 13.50 years. Regardless the lower life expectancy means she’s in a good position.)
Technically, you can commence to pay a death benefit pension to minor children (that is, children under 18). These pensions must cease when they reach 25 years of age. Please be aware however that some retail super funds don’t allow pensions to be paid to minor children.
What happens if you want lump sums paid from your pension?
At this point how your super fund assets are treated is a matter of conjecture. Based on a Tax Office draft tax ruling issued last year, your assets are sent back to accumulation phase and any assets sold to pay the benefit will be subject to capital gains tax (CGT). However, in minutes of the National Tax Liaison Group Super Technical Committee Minutes it would appear that this initial ATO view will be modified in the final version of this ruling when it’s released.
Until this document is released (at the time of writing the publication date of the final ruling is unknown) no one is sure how these lump sums are meant to be treated.
In the next article, I’ll provide some details on how reversionary pensions work.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.
Also in the Switzer Super Report
- Peter Switzer: Why I’m anxious this week [2]
- Paul Rickard: Our high-income portfolio is up! Time to rebalance [3]
- Lance Lai: Chart of the week: will gold climb higher? [4]
- Rudi Filapek-Vandyck: The broker wrap: QAN, NCM, TOL, SVW [5]