When a member of a couple dies leaving a pension that automatically reverts to their spouse, they can be holding amounts well in excess of their own $1.6M Transfer Balance Cap (TBC) in the tax-free pension phase for up to 12 months.
A reversionary pension is a pension that continues with the entitlement to the pension passing from one person (the pensioner) to another (a dependant beneficiary) on the death of the pensioner. They can be desirable between couples as they can provide certainty as to whom the pension interest will go to on death – if the trust deed provides that the reversionary beneficiary nomination is binding on the trustee, there is little scope for other beneficiaries to make a claim on them.
However, there is another little quirk for couples with larger pension balances. As a reversionary pension is simply the continuation of the deceased’s pension, the tax exemption that applied to the fund’s investment income because of the deceased’s pension (Exempt Current Pension Income or ECPI) continues after their death.
When a member in receipt of a reversionary APB dies, and the pension reverts to the surviving spouse, it does not count towards the spouse’s TBC straight away - rather it will count towards their TBC on the 12-month anniversary of the death.
The reversionary pensioner (ie the surviving spouse) will often have retirement phase ABPs themselves. The 12-month hiatus from having the reversionary pension count for TBC purposes means that for 12 months following death, the surviving spouse may have amounts in retirement phase well in excess of their TBC, and yet the fund will continue to receive a tax exemption on the investment income supporting all their pensions.
Just before the 12 months is up, they will have to re-think their pensions to make sure they don’t have an excess over their TBC when the reversionary pension is counted. Often they will remove amounts out of retirement phase either by rolling some or all of their own balance back to accumulation or commuting out lump sums from the reversionary pension to bring their Transfer Balance Account back to within the $1.6m cap. The reversionary pension cannot be rolled back to accumulation, but the surviving spouses own pension(s) can.
To illustrate, a couple each have retirement phase ABPs currently valued at $2m each, incorporating the other as a reversionary beneficiary. They have both used up all of their TBC.
One of them passes away. As the deceased’s pension is reversionary, it simply continues after death to the surviving spouse and ECPI continues to apply to the investment earnings. Under the TBC rules, the value at date of death (ie $2m) will be credited to the surviving spouse, but not until the 12-month anniversary of the death of the member.
For 12 months the surviving spouse now has two retirement phase pensions totaling $4m with ECPI applying to the lot. Just prior to the 12-month anniversary, they will need to take action to remove the excess out of retirement phase by either rolling their own ABP(s) back to accumulation, or commuting a lump sum from the reversionary pension, or a combination of both.