Superannuation income stream following death of member

The Income Tax Assessment Amendment (Superannuation Measures No. 1) Regulation 2013 has been registered to give effect to the government’s 2012–2013 mid-year economic and fiscal outlook (MYEFO) announcement that it would provide tax certainty for superannuation trustees and deceased estates where a person has died while in receipt of a superannuation income stream. The Regulation effectively allows superannuation fund trustees to dispose of pension assets on a tax-free basis to fund the payment of death benefits from 1 July 2012.

Background

Investment earnings derived by complying superannuation funds from assets supporting current pensions are generally exempt from tax under ss 295-385 and 295-390 of the Income Tax Assessment Act 1997 (ITAA 1997). This is commonly referred to as exempt current pension income (ECPI). However, the exemption only applies in respect of a “superannuation income stream benefit” (defined in reg 995-1.01 of the Income Tax Assessment Regulations 1997 (ITA Regs)) that is “payable” by the fund at the relevant time.

A draft ruling issued by the Commissioner in 2011 caused some uncertainty over the eligibility for this tax exemption following the death of a member to whom a pension was being paid. In Draft Taxation Ruling TR 2011/D3, the Commissioner took the view that a superannuation income stream ceases (ie is no longer “payable”) upon the death of the pensioner, unless a dependent beneficiary of the deceased is automatically entitled to receive an income stream (eg under a valid binding death benefit nomination).

To provide certainty for deceased estates and superannuation trustees, the government announced in the 2012–2013 MYEFO that it would amend the law, with effect from 1 July 2012, to allow the pension earnings tax exemption to continue following the death of a pension recipient until the deceased member’s benefits have been paid out of the fund.

Superannuation income stream benefit – definition expanded

To give effect to the measure, the Regulation expands the meaning of “superannuation income stream benefit” in reg 995-1.01 of the ITA Regs for the purposes of the ECPI provisions.

The expanded meaning of “superannuation income stream benefit” is designed to ensure that, where a fund member was receiving a superannuation income stream immediately before their death, the superannuation fund will continue to be entitled to the pension earnings tax exemption in the period from the member’s death until their benefits are cashed by paying them out as a lump sum and/or by commencing a new superannuation income stream (subject to the benefits being paid as soon as practicable).

Specifically, for the purposes of the ECPI provisions, reg 995-1.01(3) provides that if:

• a superannuation death benefit that is a superannuation lump sum is paid after the death of a person (the “deceased”) using only an amount from a superannuation interest;

• immediately before the deceased’s death, the superannuation interest was supporting a superannuation income stream payable to the deceased; and

• the superannuation income stream did not automatically revert to another person on the death of the deceased;

• the amount paid as the superannuation lump sum, to the extent it is not attributable to any amount (other than investment earnings) added to the superannuation interest on or after the deceased’s death, is taken to be the amount of a payment from a superannuation income stream of a superannuation income stream benefit that was payable from the day of the deceased’s death until as soon as it was practicable to pay the superannuation lump sum.

If a new superannuation income stream is commenced using an amount applied from the superannuation interest after the death of the deceased, the amount so applied, to the extent it is not attributable to any amount (other than investments earnings) added to the superannuation interest on or after the deceased’s death, is taken to be the amount of a superannuation income stream benefit that was payable from the day of the deceased’s death until as soon as it was practicable to commence the new superannuation income stream: reg 995-1.01(4). For these purposes, “investment earnings” do not include an amount paid under a life insurance policy or an amount arising from self-insurance.

“As soon as practicable”

Taxpayers should note that the continuation of the ECPI provisions beyond the death of a member is still subject to the existing requirement for the benefits of a deceased member to be paid out of the fund “as soon as practicable” following the member’s death. (Note: The examples in the Explanatory Statement accompanying the Regulation acknowledge that there may be a delay in paying a death benefit “as soon as practicable”, eg due to the claims-staking process to determine the appropriate beneficiaries. Other reasons for a delay could include a legal dispute, beneficiaries being overseas, or further advice being required in the case of a minor. However, it will be critical to substantiate any delay to explain why it is reasonable in the particular circumstances. The longest delay in the examples in the Explanatory Statement is only 101 days in the specific circumstances considered: see below.)

Example

Doris was a member of a complying superannuation fund and was receiving a superannuation income stream immediately before her death on 25 January 2013. The income stream did not automatically revert to another person on Doris’s death and no amounts (other than investment earnings) were added on or after her death to the superannuation interest that was supporting the income stream.

After undertaking a claims-staking process to determine the appropriate beneficiaries, the trustee of the fund determined that the deceased member’s benefits in the fund of $200,000 would be paid equally between the deceased’s two children – Grace (age 14) and Max (age 22).

Using only an amount from the relevant superannuation interest, Max was paid a lump sum of $100,000 on 3 April 2013, which was, in the circumstances, “as soon as practicable” after Doris’s death. As Grace was a minor, advice was sought as to whether to pay her share of the deceased member’s benefits as an income stream or a lump sum. As a result, it was not until 6 May 2013 that a new superannuation income stream for Grace was commenced using $100,000 applied from the relevant superannuation interest, which was, in the circumstances, “as soon as practicable” after Doris’s death.

For the purposes of the pension earnings tax exemption, $100,000 will be taken to be the amount of a superannuation income stream benefit payable from 25 January 2013 until 3 April 2013 (when Max was paid), and $100,000 will be taken to be such an amount payable from 25 January 2013 until 6 May 2013 (when the new income stream for Grace was commenced).

Proportioning rule – alternative method

The Regulation also establishes an alternative method for the “proportioning rule” used to calculate the tax free and taxable components of superannuation benefits paid after the death of a person who was receiving a superannuation income stream immediately before their death. Broadly, the new method (reg 307-125.02 of the ITA Regs) allows the tax free proportion of that superannuation income stream to be used in calculating the tax components of those benefits.

Where the superannuation death benefit lump sum (or new income stream) is not to any extent attributable to an “anti-detriment increase” (as defined) or an insurance-related amount paid or arising on or after the deceased’s death, the death benefit lump sum (or new income stream) is taken to be paid in a way that has the same proportions of tax free and taxable components as the superannuation income stream benefits that were paid to the deceased before their death.

Where the superannuation death benefit lump sum (or new income stream) is to any extent attributable to an anti-detriment increase or an insurance-related amount paid or arising or on after the deceased’s death, the general proportioning approach above applies to the amount of the benefit as reduced by the extent to which it is so attributable.

Example

Harold was a member of a complying superannuation fund and was receiving a superannuation income stream immediately before his death on 1 February 2013. When the income stream commenced, the value of the superannuation interest from which it was paid (the relevant interest) was $100,000, of which the tax free component was $20,000 (20% of the value) and the taxable component was $80,000 (80% of the value). The income stream did not automatically revert to another person on Harold’s death and no amounts were added to the relevant interest on or after his death.

The trustee of the fund determined that the entire value of the deceased member’s benefits in the fund (being the value of the relevant interest) would be paid as a single lump sum to the deceased’s adult child, Emma. The lump sum death benefit, in the amount of $75,000, was paid on 20 July 2013 using only an amount from the relevant interest. The fund did not increase the lump sum death benefit by an anti-detriment increase amount and the benefit was not to any extent attributable to an insurance-related amount paid or arising on or after the deceased’s death. The lump sum death benefit of $75,000 consists of a tax free component of $15,000 (ie 20% of the amount of the benefit) and a taxable component of $60,000 (ie the remainder of the benefit).

If in the example above the trustee of the fund had added $10,000 to the relevant interest to fund an anti-detriment increase of that amount in the payment to Emma, the lump sum death benefit of $85,000 would consist of a tax free component of $15,000 (ie 20% of the amount of the benefit as reduced by the $10,000 anti-detriment increase) and a taxable component of $70,000 (the remainder of the benefit).

Date of effect

The Regulation commenced on 4 June 2013 (ie the day after it was registered) and applies in relation to the 2012–2013 and later income years. The alternative method for the proportioning rule applies to a superannuation benefit paid on or after 4 June 2013: reg 910-1.01 of the ITA Regs.

Previous announcement

The measure was originally announced as part of the 2012–2013 MYEFO on 22 October 2012. The final regulation has been revised from the draft regulation released on 29 January 2013.

Note

The Commissioner has also previously indicated that he will exercise his powers of general administration to allow a superannuation income stream to continue in certain circumstances, even though it has not met the minimum pension standards: ATO document, Self-managed super funds – starting and stopping a superannuation income stream (pension) (available on the ATO website at www.ato.gov.au/superfunds/content.aspx?doc=/content/00343757.htm).

Source: Income Tax Assessment Amendment (Superannuation Measures No. 1) Regulation 2013, registered on 3 June 2013, www.comlaw.gov.au/Details/F2013L00894.