Capital gains tax comes back from the dead
Here's a retirement planning tip: don't die until you've spent all your super.
Here's a retirement planning tip: don't die until you've spent all your super.I'm serious. Superannuation death benefits can be a super headache unless you have the convenience of a surviving spouse to leave your money to. The treatment of death benefits is always arcane and often arbitrary, as evidenced by the latest issue to have advisers and industry groups spitting into their morning weeties.Last week, the Tax Office issued a draft ruling stating, in very simple terms, that when you die, you're no longer eligible to receive a pension.On the face of it, that's a sublime case of stating the obvious. But it has got sections of the industry screaming blue murder, while others are scratching their heads wondering what all the fuss is about.The thing is that, as any retiree knows, taking a super pension is a good thing. If you're over 60, income from a super pension is tax-free. Even better, your pension fund (or the portion of a super fund that is used to provide your pension) is not taxed on its earnings, unlike ordinary super money, which is taxed at up to 15 per cent.That is particularly attractive if you have your own self-managed super fund as any capital gains you incurred while you were saving for retirement become effectively tax-free once you convert to a pension.The gains are still there but, as the pension fund is exempt from tax, you don't have to worry about what, potentially, could have been a sizeable tax liability.So far, so good. But what happens if you die before selling those assets? If the pension reverts to your spouse or child under 18, it's no problem as an eligible pension is still being paid from the fund.But if you don't have a handy spouse or minor to leave the benefit to, that lovely tax-free pension you were encouraged to set up no longer exists. If your super is to be paid to someone else - an adult child, for instance - it becomes a lump sum and that capital gains tax liability you thought you'd abolished comes back to life.When the fund sells the assets to pay out your beneficiaries, it could be facing a substantial tax bill.The Self-Managed Super Fund Professionals Association (SPAA) reckons this will hit self-managed funds particularly hard.If you're in a big public fund, it may not have to sell assets to pay out your death benefit.But many self-managed funds hold assets such as shares and property, often owned for decades, and if they haven't made provision for tax, SPAA says the capital gains tax bill could be a substantial part of the account balance.SPAA says it has always worked on the assumption that the pension does not cease until the death benefit is paid, which would allow the assets to be sold without incurring tax. It will be making a submission to the Tax Office that this should be in the final ruling.But others in the industry say the Tax Office's position has long been clear and its latest ruling changes nothing.The head of technical at Super IQ, Kate Anderson, points to a 2004 interpretive decision by the Tax Office, ATO ID 2004/688, which concluded that the tax exemption for pension assets ceased when the pensioner died unless arrangements were in place for someone else to receive the pension. She says she has always worked on this interpretation - though, clearly, many accountants and advisers were unaware of it or disagreed with the Tax Office's view.Part of the problem may be that most pensions still revert to the surviving spouse and it is not until that spouse dies that tax will become an issue.Anderson says strategies can be used to minimise the potential tax bite. These include selling assets in retirement and replacing them with new ones, effectively refreshing the cost base of the fund's assets for tax purposes and recontribution strategies, whereby assets are sold to fund lump-sum withdrawals and the member then uses the money to make a new contribution to fund new asset purchases.However, recontributions can be tricky as the member will still need to be eligible to contribute and will be limited in how much they can put in by contribution caps.The tax treatment of death benefits is also complicated by the fact that "non-dependants", such as adult children, are taxed on receipt of the benefit, whereas dependants are not.So, again, if you don't have that handy spouse or minor to pass your super on to, tax could apply both within the fund and when the money is paid out to your beneficiaries.The super industry has long argued that all super death benefits should be taxed in the same manner. It seems unfair and arbitrary that some beneficiaries pay tax while others do not.The latest draft ruling merely provides further meat for the grill.From a retiree's viewpoint, it all adds up to a complicated headache. Even if you intend for your spouse to continue your pension, what happens when he or she dies and your benefits go to someone else?There are basically three options unless the rules are simplified and changed to treat all beneficiaries equally.Get advice and plan well aheadLet your beneficiaries worry about any tax billConsult a fortune teller for your use-by date and make sure you spend the last dollar of your super the day before. If only we could.