Working out what should happen to your super after you die can be tricky. Should you opt for a Reversionary Pension, or a Binding Death Benefit Nomination (BDBN) – or both?
I explained BDBNs in last week’s report in How do I arrange my death benefits, so click on that now if you need a refresher. Today, let’s look at reversionary pensions and then compare the two.
What’s a reversionary pension?
A pension will be a reversionary if its documentation specifically states that upon the death of the primary pensioner, the pension will continue to be paid to specific individuals. These individuals must be either the primary pensioner’s spouse or other eligible dependants, such as the primary pensioner’s minor child. In the vast majority of cases, the primary pensioner’s nominated reversionary will be their spouse.
You’ll know if a pension is reversionary by reviewing the specific documentation governing the pension, such as the pension agreement between your super fund and the pensioner, the Product Disclosure Statement issued to the primary pensioner, relevant trustee minutes or the governing rules of the super fund.
The principal advantage of reversionary pensions is their set-and-forget nature. This means that when the primary pensioner dies, the survivor’s financial affairs don’t change.
Centrelink test
Last week, I used a case study involving 65-year-old Tom and his 62-year-old spouse. His pension’s purchase price was $500,000, which meant that for Centrelink’s income test, a non-reversionary pension would use his life expectancy when working out how much income to ignore. In this example, $26,968.72 in income would be ignored each year.
Centrelink’s income test is different for reversionary pensions. The longer of the two life expectancies between the primary and the nominated reversionary is used for these pensions.
In our example, the 62-year-old spouse has a life expectancy of 24.23, which is longer than Tom’s 18.54 years. The purchase price of $500,000 divided by 24.23 means that $20,635.58 will be ignored for Centrelink’s income test not $26,968.72 when we use Tom’s life expectancy. Potentially, a lot more income will be counted under this important test, which may reduce a person’s aged pension.
Advantages
However, the main advantage with reversionary pensions is their certainty.
Another advantage with reversionary pensions involves the minimum income payment in the year of death. Because the reversionary pension continues, the minimum income amount worked out on July 1 remains unchanged for the financial year in which the primary pensioner dies.
Just for the record – a Transition to Retirement pension (TTR pension) which has a nominated reversionary, will cease to be a TTR pension upon the death of the primary pensioner.
Disadvantages
Some disadvantages with reversionary pensions are:
• They’re often inflexible. Because of the way many pension rules are drafted, it’s often not possible to alter the nominated reversionary (this is technically possible, but your documents have to be drafted in the right way).
• What ownership rights does the reversionary beneficiary have? This will depend upon the pension’s specific rules. Will the reversionary have an ability to decide how much income should be paid each year? Will the reversionary have the ability to partially or fully commute the pension and take a lump sum benefit. For tax purposes, the pension will cease to be a death benefit pension once the longer of six months after death or three months after probate has been granted or letters of administration have been issued and any lump sum payments taxed accordingly.
• The reversionary pension structure fails if the nominated reversionary pre-deceases the primary pensioner or they otherwise become ineligible. For example, they ceased to be the primary pensioner’s spouse.
Binding nominations
So that’s a look at reversionary pensions. But before we complete our discussion on this topic, it’s important to detail the advantages and disadvantages of your other option: Binding Death Benefit Nominations. The advantages of BDBNs can be summarised as follows:
• They can be changed prior to death without too much hassle.
• If the BDBN has been drafted appropriately and the dependants are allowed to take a pension benefit, then the dependants can choose what type of benefit best suits their needs.
• More than one dependant can be nominated (with reversionary pensions, only one reversionary pensioner can be nominated).
• The anti-detriment death benefit tax concessions are only available for lump sum benefits.
• BDBNs overcome restrictions on reverting pensions to children (this is often not a problem for SMSFs, but some retail super funds don’t allow this option).
The disadvantages of BDBNs are as follows:
• If you want your dependants to receive a pension, then this must be clearly stated on your BDBN and many pro-forma BDBN documents don’t provide this option.
• If you’re receiving a pension, then upon death it’s commuted and its assets are moved back to the accumulation phase. This money is then merged with any other interests you have in your super fund – this may have tax implications.
• Any new pension or pensions paid will have their own minimum pension calculations that have to be paid in the normal way.
Which one’s best?
Now that we’ve discussed the differences between BDBNs and reversionary pensions, you’ll want to know what’s the best approach.
Overall, I think for couples with a stable relationship reversionary pensions ‘beat’ BDBNs. But as the Duke of Wellington said after the Battle of Waterloo – It’s “the nearest run thing you ever saw”. In these cases, I think reversionary pensions should be used with BDBNs. The BDBN will become useful if the reversionary pre-deceases the primary pensioner. They can also be used for the payment of any other interests that the deceased might have in their super fund.
For all other people, BDBNs will probably come out on top, but the option you chose will often depend on what you want to happen with your super assets on death.
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.
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