The $3m cap impact on death

The proposed additional tax on total super balances above $3 million will have far-ranging ramifications, including affecting situations when a fund member dies. Cooper Partners director and head of SMSF and succession Jemma Sanderson outlines its potential impact on the treatment of pensions upon death.

A long time ago, in a galaxy far, far away, some Australian pensioners had reversionary pensions in place to ensure their accounts continued to be paid to their spouses (or children when that was allowed a long time ago) when they died. They did so at a cost, whereby the annual taxation treatment of the pension was based on the life expectancy of the youngest of the pensioner or the reversion.

When the rules were changed in 2007, such that the reversion of a pension had no impact on the personal taxation of a pension payment because if you were over 60 it was all tax-free, there was contentiousness regarding the operation of the exempt current pension income (ECPI) provisions when a member died without reversion, resulting in more and more taxpayers making their pensions reversionary purely for tax reasons.

The other substantial change to super in 2017 then turned that decision on its head, with additional considerations when a member dies depending on whether the pension is reversionary or not.

This author’s view is not to make a pension reversionary due to the administrative and compliance requirements, and the consideration that a preferential outcome can be achieved with less ‘faffing around’.

The introduction of the $3 million soft cap may also tip the scales in favour of the non-reversionary option, given the expected operation of the net earnings calculation.

Now let’s overlay a reversionary example with a side of $3 million soft cap with the following example.

Han is 72 and in retirement phase at 30 June 2017 and has used $1.6 million of his transfer balance cap (TBC), and Leia is 68, has been in retirement phase since 1 July 2023 and has used $1.9 million of her TBC. The benefits they have in superannuation at 30 June 2025 are contained in Table 2.

If Han were to pass away on 1 September 2025, his total pension benefits are approximately worth $2,143,290 (based on 30 June 2025).

With automatic reversions to Leia, the following would occur:

• Both Han’s pensions and Leia’s pension would continue to be exempt on the earnings within the fund throughout 2025/26,

• The value of Han’s pension accounts on 1 September 2025 needs to be reported to the ATO by 28 October 2025, even though the transfer balance account (TBA) credit won’t arise until 1 September 2026,

• This requires either interim financial statements to be prepared or very accurate calculations of the two accounts at that time,

• The value of Han’s accumulation account needs to be paid out of superannuation as soon as practicably under Superannuation Industry Supervision (SIS) Regulation 6.21,

• Leia’s total super balance (TSB) would include the $2,143,290 immediately upon Han’s death, which would be relevant for the purposes of the $3 million threshold,

• Leia would have to take the minimum pension with respect to her own benefits, $95,000, plus Han’s benefits, $107,170, during 2025/26 if not already taken out prior to Han’s passing, and

• In the lead-up to September 2026, Leia needs to restructure. Let’s assume 30 June 2026 looks as in Table 3, incorporating a 7 per cent return.

- The value of Han’s two pensions at his date of death ($2,143,290 –assuming the same value as at 30 June 2025, for this purpose) will become a credit on 1 September 2026 to Leia’s TBA.

- Leia already has $1.9 millon assessed towards her TBC, so she would then have an excess.

- She is able to commute her own pension back to accumulation, but will still be in excess by $110,290.

- Leia will then have to commute $110,290 from Han’s pension accounts as a lump sum from superannuation in order to remain within her TBC.

- Her TBA would be as in Table 4.

• Therefore, it is Leia’s TBC that is relevant, not Han’s. Accordingly, the value of Leia’s benefit at the date that is 12 months after Han’s death is important also.

• If, for example, over the period Leia’s benefits increased to $2,100,000, then she would only have to commute $43,290 from Han’s pension accounts as a lump sum. Even if Han’s benefits have increased similarly, with the reversionary pensions it is the value at his date of death that is recorded as a TBA credit, so his pensions benefits could be worth $2,350,000 (where Leia’s were $2,100,000 in the lead-up to 31 August 2026), but only $43,290 needs to be paid out as a lump-sum benefit.

• Conversely, if Leia’s benefits reduced down to $1,750,000 over the period, and Han’s likewise to $1,900,000, then a higher amount would need to be paid out of Han’s pension benefits ($393,290, being $2,143,290 less $1,750,000) to fall within Leia’s TBC.

• Any amount that needs to be withdrawn from Han’s account and paid out as a lump sum to accord with the TBC requirements would then be a lump sum payment added back to the earnings calculation for the $3 million tax purposes.

• Leia’s position for the $3 million cap purposes is estimated as in Table 5, as per the government’s consultation paper and based on the 7 per cent return:

• Therefore, the reversion itself could be treated as ‘earnings’ and subject to tax.

As part of the above process of Han’s death, the following is also of relevance:

• Reporting required by 28 October 2025 – difficult to ascertain the balance in Han’s accounts at his date of death without interim financials. Although the ATO is taking a practical approach regarding the timeframes for TBA reporting at present, once this system has been in place for a number of years, that approach is likely to become stronger with respect to late lodgments.

• Minimum pension payments are required to be made to get the pension exemption on Han’s pension accounts.

• Two additional sets of financials may be needed over the period, adding a substantial cost:

- Han’s date of death, and

- 12 months after Han’s date of death (to value Leia’s pension account).

• If there is time, strategically it is worthwhile paying out Han’s minimum pension before he dies, both reducing his benefit value at his date of death, and means Leia doesn’t have to pay out the minimum after his death to receive the exemption. Further, that withdrawal will be before the reversion, so won’t be added back to Leia’s ‘earnings’ for the $3 million soft cap purposes.

Reversionary pension alternative

Taking the above example, if Han’s pensions were not reversionary, and Leia was the sole beneficiary, then the following would occur:

• Both Han’s pensions and Leia’s pension would continue to be exempt on the earnings within the fund throughout 2025/26,

• Han’s pensions can receive the exemption provided they are dealt with as soon as practicably (ASAP). But what does that mean?

- Leia needs to either take out a lump sum with respect to Han’s pension accounts ASAP or commence a new pension for herself ASAP (on the basis she is the nominated beneficiary, or after consideration by the trustee she is the most appropriate beneficiary to receive the benefits).

- Rule of thumb is between six and 12 months.

- Would 1 July 2026 suffice? Likely yes as it is a very practical time to look to resolve Han’s pensions, as 30 June 2026 is the one time during a financial year that the benefits are known.

- The value of Han’s accumulation account needs to be paid out of superannuation ASAP also, so all of this timing lines up if Leia deals with Han’s pensions at 30 June 2026, as well as the accumulation account.

• Over 2025/26 Leia only needs to take out her minimum pension payment. If she takes our more than her minimum, the amounts would need to be either lump-sum payments from her own accumulation or partial commutations from her pension account. She should not have any lump sums paid from Han’s accounts as SIS Regulation 6.21 only technically allows a maximum of two lump sums, interim and final, so it would be preferable to not touch his account.

• In the lead-up to 1 July 2026, Leia needs to consider the options available to restructure her account. Again, let’s assume the accounts are as in Table 6 at 30 June 2026:

- Leia can commute her $2,033,000 pension,

- She is then able to commence new pensions with Han’s benefits up to the $2,033,000 amount:

1. Pension #1 of $701,920,

2. Pension #2 of $1,331,080,

- These would be TBA credits at 1 July 2026,

- Reporting required by 28 October 2026.

• Although the above amounts won’t be known with certainty at 30 June 2026, the relevant paperwork can be drafted to reflect the intention, with the balance withdrawn once the 2025/26 accounts have been completed.

• Leia’s TBA would be as as in Table 7.

• Where Han’s accounts are per the previous table, then with the new pensions there would be $1,597,820 remaining in Han’s accumulation and pension that would need to be paid out as soon as practicably as a lump sum.

The above can be a more practical approach and saves some additional requirements, such as interim financials, minimum payment requirements and reporting just after the date of death.

In light of the above, it may therefore be appropriate to consider whether clients’ pensions should be non-reversionary.

The only downside of a non-reversionary pension from a TBC perspective is it is the value of the benefits at the date they are dealt with that form the TBA credit, as opposed to the situation where the pension is reversionary, where it is the value at the date of death. Where assets have substantially appreciated in value, there would be a negative impact. However, the loss of some pension exemption on the assets could be offset by the cost of the two sets of interim financials and additional administration and advice costs.

Further to the above, the interaction of a non-reversionary pension with the $3 million provisions is also of relevance for Leia:

• At 30 June 2026 the accounts that would form part of Leia’s TSB are only her own pension account and accumulation account – a total of $2,942,500. Therefore, there would be no $3 million soft cap consideration in 2025/26.

• In 2026/27, the commencement of the new pensions, valued at $2,033,000, would add to her TSB, but likely then would be a net contribution for the ‘earnings’ purposes, and therefore it would be the pension withdrawal for the two new pensions that would be considered, plus the actual rate of return on the assets (see Table 8).

• The lump sum payment of Han’s #2 pension to Leia would not be included in any of the above, nor would Han’s accumulation account needing to be paid out.

• When compared to the reversionary option, there is less tax payable, although less that is able to be retained in pension phase in this scenario (see Table 9.)

Conclusion

The $3 million soft cap may be another catalyst for pensions being nonreversionary and should be a conversation beforepensions commence regarding the impact of being reversionary or not.