Investment Strategy

What does the compulsory cashing rule mean for your succession planning?

By AMP Capital

As part of the recent super changes, the compulsory cashing rule changed how death benefits should be paid - a rule that trustees need to be aware of when succession planning.

Succession planning and your SMSF is a hot topic following the many changes introduced into the super system this year.

In fact, this issue is the focus of a series of master classes being run by the Self Managed Super Fund Association of Australia (SMSFA).Peter Hogan, head of education and technical, SMSF Association explains why this is an important issue for trustees to consider.

“The rules and system have changed, consequently, the arrangements you have for your fund may need to be reconsidered. Trustees may think that just because the value of their assets is well below the new $1.6 million transfer balance cap they are not affected, but that’s not always the case,” he says.

Under the $1.6 million transfer balance cap rules, retirees can only hold assets to the value of $1.6 million in the tax-free super environment with which to support their retirement income stream.

One change of which trustees need to be aware is the compulsory cashing rule. When a fund member dies, the regulations require a death benefit be paid as soon as possible. A death benefit is either a death benefit pension or a death benefit lump sum. 

Previously, tax legislation set out that a death benefit was a benefit paid as a lump sum within six months of death or three months of probate. But that definition no longer applies.

“The ATO's view is any benefit paid as a consequence of someone else's death is a death benefit and stays a death benefit indefinitely,” says Hogan.

“The upside is trustees don't have to wait for three or six months. They can simply roll over an account balance members have inherited to another fund, provided a new death benefit pension is started right away,” he adds.

The downside is that it’s no longer possible once a death benefit has been paid out to commute the pension entitlement back into accumulation phase. 

“The ATO’s view is that because that definition of six months after death or three months after probate no longer applies, the only option is for members to receive a pension. If you commute the pension, then you can't leave it in accumulation phase. You must pay it out as a death benefit lump sum,” Hogan adds. 

In the past SMSF members may have rolled their money back into accumulation phase as a strategy to generate cash flow, but they can no longer do that. 

This is particularly important for couples with two funds. While both funds may be well below $1.6 million individually, these new rules mean SMSF trustees need to think about how to plan for the future in the event one member dies. 

If a reversionary death benefit nomination is in place, or if there is a binding death benefit nomination to pay an income stream on a member’s death to their spouse, the new pension is assessed against the recipient's transfer balance cap.

“In the event the couple each has $1 million in their own fund, suddenly the surviving spouse has $2 million in their pension account, which produces an excess benefit they need to address.”

“One option is to simply commute the excess from the reversionary pension or death benefit pension, which must be paid out as a death benefit lump sum. That won’t be a problem for some clients who may be able to pay off debt, for instance a mortgage. Or they may have a family trust or into which they can invest the funds,” Hogan explains.

Alternatively, he says, if the surviving fund member needs to keep money in superannuation, they could commute their own pension back into accumulation phase. This would be to make as much room as possible so that when they receive their reversionary pension or their death benefit pension, the value of their funds is below the $1.6 million transfer balance cap.

Members can, however, choose which pension to commute. They can commute their own pension to remain under the cap, which can remain in accumulation phase. If the member chooses to commute the reversionary pension it must be paid out as a death benefit lump sum.

If the fund is in excess it accrues tax on a daily basis at 7% above the 90-day bank bill rate, annualised, which can add up.

This is a very complex area, and SMSF members in this situation may consider taking advice to ensure they remain within the rules.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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