Death Benefit Pensions - what happens when too little is paid?

What’s the fuss all about?

What are the consequences if there is an underpayment of a death benefit pension?  A death benefit pension is an account based pension which has either transferred to the recipient (because it was originally a reversionary pension) or because it has been issued to the recipient from the death benefit of a deceased member.  These pensions are account based pensions and, so, are subject to the requirement that a certain minimum amount of pension payments are made each financial year.  An underpayment occurs when the minimum amount is not paid (or, in the extreme case, no pension payments have been made).

The ATO has recently highlighted the consequences of death benefit underpayments and what action must be taken by the trustee.

Typically, an underpayment will not be detected until after the close of the relevant financial year.  In the ideal world, the trustees of SMSFs could in April or May of each year undertake a “health check” of each pension to determine the minimum amount required to be paid and how much must be paid before financial year end to satisfy the requirement – and also to ensure any necessary payments are made before year end.

However, in the real world, the minimum payment requirement may not be satisfied due to forgetfulness, due to the assumption that someone is attending to it, pre-set payments not occurring or occurring late or miscalculation of the minimum payment amount.

What to do if an underpayment has occurred?

First, it is necessary to determine whether the circumstances of the underpayment fit within the ATO’s administrative concession.  If so, the underpayment can be ignored if corrective action is promptly taken.  However the concession only applies if the underpayment is 1/12^th of the correct payment; the fund has not previously used the concession and the underpayment is promptly paid when discovered.

If the administrative concession does not apply then for taxation purposes fund earnings supporting the pension will not be entitled to the earnings tax exemption for the entire financial year and also, as the pension is a death benefit pension, there will be a breach of the benefit access/cashing standards.  The first consequence involves no contravention: it is merely a loss of a tax concession.  The second consequence does not constitute a contravention of the mandatory operating standards.

The ATO has indicated that, as to the second consequence, so long as the contravention is promptly rectified on a forward looking basis, the contravention will not give rise to any compliance action.  The unstated premise is the contravention is a once only occurrence and action has been taken to ensure that it does not happen again.

Corrective action would be either a full commutation of the death benefit pension to a lump sum payment or restarting the death benefit pension (whether in the current fund or another fund).  Clearly restarting the death benefit pension would be the preferable solution, as once a death benefit is paid out as a lump sum it cannot be returned to the super system except as a new contribution.

In the April 2019 update of the SUPERCentral Governing Rules this issue was addressed by the inclusion of a new sub-rule 15.7A which automatically restarts a pension (unless the pension recipient determines otherwise) which has ceased due to failure to comply with the pension standards.  The restart occurs at the commencement of the immediately following financial year.

What should the trustees do if they wish to restart a pension?

The trustees should, by resolution or minute, note the failure of the pension to comply with the pension standards and that the pension has restarted with effect from the commencement of the current financial year on the same terms as applied previously.

Additionally, the trustees will have to notify the ATO of the cessation of the pension (by lodging a TBA Report to ensure a transfer balance debit is recorded for the cessation of the pension) and lodging a second TBA Report for the re-commencement of the pension (this will cause a credit to be recorded in the transfer balance account).  Given the different dates between the cessation of the pension (at the start of the financial year in which the breach occurred) and the re-commencement of the pension (at the start of the following financial year) the credit may be different to the debit.

Visit the SUPERCentral product range if you would like more information on SMSF death benefit planning or account based pensions.

For further information call our office on 02 8296 6266 or email info@supercentral.com.au .