The two-pension strategy: splitting super into tax-free and taxable streams for estate planning

For Australian retirees — particularly SMSF members with substantial superannuation and adult children as intended beneficiaries — the two-pension strategy is one of the most consequential estate-planning techniques available within super. It rests on a foundational rule: every super interest is made up of a tax-free component (built from non-concessional contributions, government co-contributions, and any pre-July-1983 amount) and a taxable component (concessional and employer contributions, plus earnings). Under the proportioning rule in section 307-125 of the Income Tax Assessment Act 1997, any withdrawal, rollover or pension started from a single interest must draw on both components in the same proportion — you cannot selectively pull out only the tax-free part. The two-pension strategy works around that by first separating the components into two distinct interests (usually via a recontribution strategy), then commencing two separate pensions — one made up entirely of the tax-free component, the other entirely of the taxable component — so that each can be directed to a different beneficiary on death.

The death-benefit tax differential is what makes the strategy worth the effort. A super death benefit paid to a death benefits dependant — a spouse or former spouse, a child under 18, a person in an interdependency relationship, or someone financially dependent — is entirely tax-free, regardless of components. But paid to a non-dependant — most commonly an adult, financially independent child — the tax-free component passes tax-free while the taxable component is assessable, with a tax offset capping the rate on the taxed element at 15% (about 17% with the 2% Medicare levy) and on any untaxed element at 30% (about 32%). On a $1.5M balance that is 67% taxable, paying the lot to adult children costs roughly $170,000 of tax on the taxable component. If instead a $500,000 tax-free pension went to the children and a $1M taxable pension reverted to a surviving spouse, the tax would be nil. The two-pension structure is what enables that directed split.

The recontribution mechanism is the usual route to separating the components, and it carries hard age limits that make timing everything. While still able to access super (a condition of release met) and still eligible to contribute, the member withdraws an amount from accumulation — proportionally, taking both components — and immediately recontributes it as a non-concessional contribution (NCC), which by definition is 100% tax-free component. That creates a second interest that is wholly tax-free, while the original interest shrinks. The NCC cap is $120,000 a year, or up to $360,000 under the three-year bring-forward where the member's total super balance allows. Crucially, NCCs can only be made up to age 75 — strictly, on or before the 28th day of the month after the member turns 75 — and, since 1 July 2022, no work test applies to non-concessional contributions. The practical upshot: the recontribution work has to be done before that age-75 window closes — leave it too late and the strategy is simply unavailable.

Once the components are separated, the pension structure creates the planning options. The accumulation balance is split into Interest A (100% tax-free) and Interest B (100% taxable), and a separate account-based pension is started from each — Pension A the tax-free pension, Pension B the taxable one. Each has its own minimum drawdown that must be paid annually to keep its pension status, its own transfer balance account reporting, and its own death-benefit nominations. A common design pairs a binding death benefit nomination on the tax-free pension directing it as a lump sum to the adult children (payable tax-free), with a reversionary nomination on the taxable pension to the surviving spouse, so that pension simply continues to the spouse — tax-free in their hands as a dependant — on the member's death. That combination keeps income flowing to the spouse immediately while delivering the tax-free pension to the children without a tax cost. One important consequence to manage: a reverted pension counts against the spouse's transfer balance cap, but the credit arises 12 months after the date of death, valued at the date of death, giving the survivor time to arrange their affairs.

The transfer balance cap is the binding constraint, and the strategy does not loosen it. Both pensions count toward the member's cap of $2.0M for FY25-26; splitting one pension into two creates no extra capacity, so if the combined commencement values would exceed the cap the excess must stay in accumulation. There is also real administrative weight: two pensions mean two sets of reporting, two minimum drawdown calculations a year, and separate accounting for each — and some older SMSF deeds may need updating to support component-pure pensions before the strategy can even be implemented. For self-administered funds that load is meaningful; for those using a professional administrator it is a modest cost against the tax saving.

It is just as important to know when not to bother. If every intended beneficiary is a tax-dependant (a spouse, dependent children), the death benefit is tax-free anyway and the structure adds nothing. If the balance is modest — broadly under a few hundred thousand dollars — the running cost of two pensions can outweigh the saving. If the super is almost entirely taxable component with no room to recontribute (the NCC cap is used up, or the total super balance is too high to contribute), there is nothing to separate without first doing the recontribution. And if the member is already past the age-75 NCC window, the recontribution route is closed and the strategy generally cannot be built now. In those cases a simpler structure — a single pension reverting to the spouse, with a binding nomination covering any residual lump sum to the children — is usually the better fit.

What do worked planning examples show?

These two cases show how the two-pension strategy applies in practice. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — David, 64 (retired, so able to access his super), and Helen, 62. David has $1.8M in SMSF super — $400,000 tax-free and $1.4M taxable. They have two adult children and no minor dependants, and David wants the super to reach the children, with Helen provided for first if he dies before her. On these facts the two-pension strategy fits well. Because David's total super balance is under $2.0M, he can make a $120,000-cap non-concessional contribution each year, so over several years he withdraws (say) $100,000 annually — proportionally about $22,000 tax-free and $78,000 taxable each time — and recontributes it as an NCC, building a new, wholly tax-free interest while his balance stays broadly stable and under the cap. After a few years he commences two pensions, for example Pension A of about $700,000 (100% tax-free) and Pension B of about $1.1M (100% taxable), and sets the nominations: a binding nomination on Pension A to the two children equally, and a reversionary nomination on Pension B to Helen. On his death, Pension B continues to Helen tax-free and Pension A pays to the children as a tax-free lump sum — saving on the order of $120,000 against a single proportional pension. On these facts the administrative overhead (two pensions, two reporting streams, a possible deed update) is well justified by the saving, and the work simply needs to start while David is comfortably under 75.

Case 2 — Margaret, 78, single since divorcing 12 years ago, with $750,000 in her SMSF ($250,000 tax-free, $500,000 taxable), two adult children as intended beneficiaries, and a single account-based pension running. Here the hard truth is that the recontribution route is closed: at 78 Margaret is well past the age-75 cutoff for non-concessional contributions, so she cannot build a new tax-free interest by recontribution, and commuting and re-starting her existing pension changes nothing — the proportioning rule means each interest keeps its existing component mix. The taxable component of $500,000 will, if it passes to her non-dependant children, attract roughly $85,000 of tax, and the two-pension strategy can no longer be used to avoid it. The instructive point is one of timing: had the recontribution been done in her late 60s or early 70s, the components could have been separated and that tax largely removed. On these facts the realistic remaining steps are to make sure her single pension and any accumulation carry current, valid nominations to the children, and to consider whether bringing some benefit forward as a tax-free withdrawal during her lifetime (she is over 60, so withdrawals are tax-free) makes sense for her circumstances — accepting that the elegant component split is no longer on the table.

For SMSF retirees with substantial balances and non-dependant beneficiaries, the two-pension strategy is among the most valuable estate-planning techniques in super — but it is fundamentally a timing strategy. The advice work is to analyse the component mix early, identify the beneficiaries and their dependency status, run the recontribution well before the age-75 NCC window closes, structure two pensions with the right reversionary and binding nominations, keep within the single transfer balance cap, and accept the extra administration as the price of the saving. Done in time, it can remove $50,000–$200,000 of death-benefit tax that a single proportional pension would have left payable; left too late, it simply cannot be done.

Sources

• Australian Taxation Office (ATO) — Superannuation death benefits
• Australian Taxation Office (ATO) — Super death benefits
• Australian Taxation Office (ATO) — Non concessional contributions cap
• Australian Taxation Office (ATO) — Restrictions on voluntary contributions
• Australian Taxation Office (ATO) — Transfer balance account