Reversionary pensions: What are they and how do they work?

What is a reversionary pension?

A reversionary pension is a type of income stream you set up with your super fund or Self Managed Super Fund (SMSF) that automatically transfers to your chosen dependant beneficiary (such as your spouse or child) when you pass away. When a beneficiary receives the reversionary pension, it will continue to operate as an income stream under its original terms and conditions.

Before creating a reversionary pension, it’s recommended to obtain professional financial advice. You may be able to get this kind of advice from your super fund or from a financial adviser, both usually for a fee.

Who can you nominate as a reversionary beneficiary?

An eligible reversionary pension beneficiary can be:

• A spouse at the time of death (de-facto or married)

• A child (under the age of 18)

• A child aged between 18–25 who’s classified as a financial dependant

• A child of any age who has a disability, as defined in the Disability Services Act 1986

• A person in an interdependency relationship with you (e.g. someone who lives and shares a close personal relationship with you where one or both of you provide for the financial and domestic support and personal care of the other).

It’s a good idea to speak with your super fund to learn more about its rules around reversionary pensions. There may be restrictions on the payment of pensions to people who are not your spouse, and some super funds may only allow you to nominate your spouse as the beneficiary.

What if you don’t have someone to nominate as a reversionary beneficiary?

In this situation, you may need to consider nominating a legal personal representative to receive it using a binding death benefit nomination (BDBN)—if this option is available under your super fund.

If you nominate your legal personal representative under a BDBN, then your super benefit will become part of your assets distributed by your will. If you don’t have a will, your super benefit will be distributed according to the laws that concern people who pass away without a will.

How can you make a reversionary beneficiary nomination?

Before making a decision, it might be worth discussing with relevant people, such as your legal adviser, about who you want to benefit from your pension after you pass away and consider your decision in terms of your overall estate planning.

If you’re a member of a retail or industry super fund, you’ll need to check the options available to you on their pension application forms. Some funds may allow you to nominate a reversionary beneficiary when setting up your pension or during the life of the pension.

When it comes to a SMSF, always read the trust deed (legal document) and see what it says about the options for payment of death benefits and whether or not a reversionary pension nomination has priority over a BDBN.

Consider sourcing the SMSF pension documentation from a quality supplier who has relevant experience and qualifications to ensure the documents are valid, effective and work with your specific deed.

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Can you change or cancel your reversionary beneficiary nomination?

If your circumstances change then you generally should be able to cancel or change a reversionary nomination through an industry or retail super fund.

Most SMSFs won’t allow you to change the nomination, and you must instead commute the current pension (withdraw a lump sum payment) and commence a new pension with a new reversionary nomination or with a binding death benefit nomination. Some newer SMSF deeds may be more flexible.

Commuting a pension may mean you lose Centrelink grandfathering (meaning the rules around receiving Centrelink payments may no longer apply) and the new pension may be deemed under the income test (this test helps determine the level of benefit payments you receive), so it’s important to seek financial advice before doing this.

How does a reversionary pension differ from a binding death benefit nomination?

With a reversionary pension, the income stream from your super will automatically continue to your beneficiary. As such, there’s no decision to be made by the trustees of the super fund or SMSF other than confirming the nomination.

With a BDBN, the current pension must cease and the trustees of that super fund or SMSF must decide whether to start a new pension for the nominated beneficiaries (if they qualify) or to pay out the death benefit as a lump sum.

So, there’s no way under a BDBN to ensure your remaining super funds automatically continue to a beneficiary. But a BDBN does provide some flexibility for the executors/replacement trustees dealing with complex estates to work out solutions that may not have even been available or considered when a nomination was drafted. Under a reversionary pension, this is generally not possible.

It’s also important to note that while superannuation death benefits usually don’t form part of a deceased’s estate, the Supreme Court in New South Wales has the power to bring back into the estate of a deceased person any superannuation paid out from a BDBN and designate these funds as ‘notional estate’ (assets that can be retrieved by court order).

In recent years there’ve been many successful challenges to BDBNs, so it’s vital these nominations are completed correctly and the instructions in the deed and the trustee’s fiduciary duties are followed in their implementation. A BDBN must also be in writing and signed and dated in the presence of two witnesses for it to be valid.

Some super and SMSF trust deeds may allow a BDBN to override a reversionary pension nomination, but this is usually not the case.

What are the benefits of a reversionary pension?

• Estate security: There’s generally more certainty that the chosen beneficiary will receive the pension if it’s noted the decision was made at the outset, when the pension member was more likely to have had the capacity to make their own decision.

• Less pressure to act: By using a reversionary pension there may be more time for your family to grieve and take their time to deal with other complex financial matters, as the income stream from your pension will automatically continue to your beneficiary.

• Retain the funds within the superannuation system: If a super pension is paid out as a lump sum death benefit then the beneficiary of that lump sum may be too old to recontribute to their own super or face some contribution cap restrictions, meaning they would incur tax on the payment. With a reversionary pension this would not occur.

• Extra time for coordinating financial affairs: There’s a 12-month delay before the receipt of a reversionary pension affects the receiving beneficiary’s own transfer balance account report. This gives the beneficiary more time to get their own affairs in order, and may be helpful if they have a pre-existing pension (and the sum of the two exceeds the reversionary’s transfer balance cap set by the government). During this 12-month delay the income stream from the reversionary pension will continue. For a pension that’s not reversionary, the credit arises immediately once the decision is made to pay the death benefit as a pension.

• More seamless legal transfer: In the event that the original owner of the pension passes away, a reversionary pension will generally transfer seamlessly to the beneficiary and does not form part of the deceased’s estate (especially important in NSW as discussed above). Reversionary pensions are rarely challenged as they’re fixed in place usually at the start of the pension when the member has capacity to nominate a beneficiary.

• Centrelink advantage: In some circumstances a reversionary pension may retain Centrelink grandfathering for treatment under the income test (meaning the rules around receiving these payments stay the same and aren’t affected by legislative changes). This happens where both the deceased and the reversionary beneficiary were receiving and the reversionary beneficiary continues to receive an Age Pension or holds and continues to hold a Commonwealth Seniors Healthcare card.

• Tax benefits for retaining funds in a pension: When receiving an account-based pension income stream (such as a reversionary pension), this pension may be tax-free or taxed at a concessional rate, depending on your age and the age of the deceased.

What are the drawbacks of a reversionary pension?

• Limited beneficiaries: A reversionary pension can have only one beneficiary. So, if you want to split the proceeds, you may want to consider multiple pensions, such as having one that will revert to your spouse and one that will revert to a child or that’s covered by a BDBN.

• Limited beneficiary choices: There are limitations to who can be a reversionary beneficiary.

• Tax implications: The value of a reversionary pension will count towards a beneficiary’s transfer balance cap—the limit which restricts how much money a person can have in tax-free pensions—based on the value of the pension at the date of death. So, if they’ve already used much of their own transfer balance cap then they may not be able to receive the reversionary pension without first commuting (withdrawing) some of their own pension to an accumulation account (earnings taxed at up to 15% maximum) or as a lump sum to their personal name (earnings taxed at your marginal tax rate).

• Less flexibility with estate management: There’s generally less flexibility for the trustee(s) and executors to manage superannuation as part of a person’s overall estate, which could make it challenging to distribute a person’s wealth evenly (if this is what’s preferred) among their beneficiaries.

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