What’s in a word?

Martin Breckon, Senior Manager – Technical Services

2017 will see some remarkable changes to super. Often with these changes we risk looking at the forest and missing the trees. This article looks at two small, but important, issues which will have a significant impact on super estate planning.

On 29 November 2016 royal assent was given to the Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016. As if to help make the laws easier to understand, the 135 pages of amendments were accompanied by 363 pages of explanatory memoranda.

So it is easy to get profoundly pre-occupied with the big ticket items such as the $1.6m transfer cap but overlook significant issues created by some minor modifications. Take for example the following two seemingly insignificant amendments contained in the Act:

  • 5 Paragraph 306-10(a): omit ‘member’
  • 6 Subsections 307-5(3): repeal of subsections (3A) and (3B)

At first glance these could be mistaken for some ‘housekeeping’, however a closer look reveals a substantial change to the treatment of super death benefits.

What is Paragraph 306-10?

It is the part of Income Tax Assessment Act 1997 (ITAA 1997) which defines what a rollover superannuation benefit is from a tax perspective. This currently states that a rollover is a superannuation benefit and it is also a superannuation member benefit.

From a practical perspective to be able to rollover a super benefit, the member has to be alive. Also, you cannot rollover a death benefit, which has meant death benefit income streams were ‘locked in’ to the provider the deceased had before death.

What the change means?

By omitting ‘member’ from the definition of a rollover, it will be possible to rollover death benefits without having them lose their nature. This provides flexibility particularly for spouses who wish to receive a death benefit income stream but do not wish to continue using the deceased’s fund. A common problem in this space was a spouse who had their partner pass away as a member of a SMSF. Previously, the surviving spouse would have to continue operating the SMSF to maintain the death benefit income stream, but this change means they will be able to roll this to a retail fund.

In addition, a huge estate planning problem has been resolved by making superannuation estate planning strategies under best interest obligations far less complex, particularly with respect to standalone super insurance policies.

The new rules will allow super death benefits from standalone insurance policies to be rolled over to a “traditional” super environment, whereby they can be immediately cashed in the form of a death benefit income stream. For insurance advisers, this removes one of the larger potential downsides for using standalone insurers who may offer better policy terms and/or pricing, at the cost of flexibility when it comes to paying death benefits.

On top of this, the changes finally align super and tax law with respect to rolling over death benefits. SIS regulations have long since held that trustees can rollover death benefits for immediate cashing (as part of SISR 6.21(3)), however tax law has stopped the practical implementation of this. As such, funds who do not have a pension division will be able to arrange for death benefits to be rolled over to an alternative provider for immediate cashing as a death benefit income stream.

What is Paragraph 307-5?

This section defines what a ‘superannuation benefit’ is, and creates the distinction between member benefits and death benefits. Subsections 307-5(3), (3A) and (3B) -the parts to be removed by the amendments noted - provide a mechanism for death benefits to be treated as member benefits after what is commonly referred to as the ‘prescribed period’. Generally the prescribed period is the longer of six months from date of death, or three months from grant of probate. This time period can be extended in certain circumstances, which is the focus of subsections 3A and 3B.

What the change means?

The modifications to s307.5 remove the ability for death benefits to be treated as member benefits after the prescribed period has passed. This results in two key outcomes:

  • A death benefit will always remain a death benefit. This means a lump sum commutation can be paid from a death benefit income stream at any time and be taxed as a death benefit. In most cases this will either be a positive or a neutral outcome as the death benefit will be tax-free regardless of age of the recipient.
  • Death benefits cannot be held in accumulation phase – they must be cashed as a lump sum or a pension. Previously it was possible to commence a death benefit income stream, wait out the prescribed period and then, using the fact the death benefit would ‘convert’ to a member benefit, rollover the income stream to accumulation. Whilst this would make the income stream lose its nature as a death benefit, it could then be combined with other super monies and maintained within the accumulation environment. When combined with the transfer balance cap, this change may severely reduce the amount of funds a surviving spouse may be able to keep in super altogether, let alone the tax-free pension phase.

The information contained in this newsletter is provided on behalf of the IOOF group of companies and is intended for financial adviser use only. It is given in good faith and has been prepared based on information that is believed to be accurate and reliable at the time of publication. Any examples are for illustration purposes only and are based on the continuance of present laws and our interpretation of them at the time.