Estate Planning and SMSFs

Where a member dies without a binding nomination, the distribution of the death benefits is at the discretion of the remaining trustees. This can result in some planning after the death of a member in order to achieve the optimal tax outcome. For example, one child may still be a minor and be entitled to receive the death benefits tax-free. In this situation, the trustee could allocate a greater amount to that child and rely on an estate equalisation clause in the Will to ensure that the other children receive a greater share of the estate assets.

However, there are a number of traps when using an SMSF for estate planning, particularly where there are blended families. It is possible that the individual controlling the trust does not agree with the wishes of the deceased. As they have control of the fund, they can frustrate the attempts of other beneficiaries, such as children from a previous marriage, to receive their inheritance — even where the trustee has agreed there is a valid binding nomination in their favour.

Nominations

SMSF members have more options when making a nomination than what is available via a public offer fund. As well as having access to non-binding, binding, non-lapsing binding and reversionary nominations, members also have the option of establishing an SMSF Will.

An SMSF Will is a collection of rules written into the governing rules of the fund’s trust deed, which broadly have a similar format to a Will. These rules place an obligation on the trustee, and they can be as complex as the member wishes — specifying who is to benefit, any contingent beneficiaries, and in what form.

It may also be possible to provide for a ‘life interest’ death benefit pension, whereby one beneficiary (such as a spouse) has an entitlement to the pension payments during their lifetime, but on their death, the capital would be distributed to the beneficiaries of the first deceased (such as any children from a previous marriage).

Superannuation Dependants

There are three types of dependants for the purposes of death benefits being paid from a superannuation fund:

• SIS dependants, who can be paid directly from a super fund

• Income stream dependants, who are entitled to take their benefit as an income stream

• Death benefit dependants, who can receive lump sum death benefits tax-free

Summary Table:

If a member wants some or all of their superannuation benefits to be paid to someone not in the list above, the benefit must be paid to their legal personal representative and included in their Will.

All eligible beneficiaries may choose to take the benefit as a lump sum. However, only certain dependants can take it as an income stream. Adult children can only do so if:

• They are financially dependent

• And under age 25 (unless they are disabled)

If eligible children take an income stream, it must be commuted and withdrawn as a tax-free lump sum before their 25th birthday (unless they are disabled).

Note: Superannuation legislation defines what is allowable, but SMSF trust deeds may have more restrictive rules.

Taxation of Benefits Paid to Non-Dependants

If the beneficiary is not a death benefit dependant, then:

• Benefits must be taken as a lump sum

• The taxable component will be taxed as follows:

  • 15% + Medicare Levy on the taxed element

  • 30% + Medicare Levy on the untaxed element

Although SIS Act and Tax Act definitions are largely aligned, there is a key difference:

• Adult children are SIS dependants, so they can be paid directly

• But they are not death benefit dependants, so tax applies on the benefit

For tax purposes, the ultimate beneficiary is what matters.

If a benefit is paid to the estate and then passed to a death benefit dependant, it will be tax-free. However, if the benefit passes through a testamentary trust that includes non-dependant beneficiaries (even as potential beneficiaries), the entire benefit may be taxed.

A possible solution:

Include a superannuation benefits testamentary trust in the Will that limits beneficiaries to death benefit dependants only.

Source: BT