Newsletter:

Super News - Estate Planning

23 January 2014

Shirley Schaefer , Partner, Superannuation |

Since the introduction of the Simpler Super reforms in 2007, which saw the abolition of compulsory cashing rules and tax on benefits paid to members over 60, superannuation has become one of the most effective wealth generation vehicles for Australians.

However, it is important to remember that superannuation is not an estate asset. This means that upon death, it does not automatically form part of your estate. Therefore, a member must ensure that they clearly document how they wish their superannuation entitlements dealt with on death.

WHO CAN RECEIVE SUPERANNUATION BENEFITS ON THE DEATH OF A MEMBER?

Upon the death of a member, superannuation death benefits must be paid to either a dependant of the deceased or the deceased’s estate.

The Superannuation Industry (Supervision) Act 1993 (SIS Act) definition of a dependant, often referred to as a ‘SIS dependant’, is the relevant definition when determining who a superannuation death benefit can be paid to upon the death of a member. A SIS dependant includes:

  • Spouse of the person
  • Any child of the person
  • Any person with whom the person had an interdependency relationship.

Where the beneficiary does not come under the definition of a SIS dependant, the benefit must be passed to the member’s estate and then allocated according to the member’s Will.

HOW CAN A SUPERANNUATION DEATH BENEFIT BE PAID?

Subject to the trust deed of the Self Managed Superannuation Fund (SMSF), a superannuation death benefit can be paid as a lump sum, a pension or as a combination of both.

From 1 July 2007, if a superannuation death benefit is paid to a beneficiary who is not a dependant for tax purposes, the benefit must be paid as a lump sum.

A dependant for tax purposes, often referred to as a tax dependant, includes:

  • Spouse of the person
  • Any child of the person who was under 18 years at the date of the deceased’s death
  • Any person with whom the person had an interdependency relationship.

It is important to note that the Income Tax Assessment Act 1997 (ITAA) definition of a dependant and the SIS Act definition of a dependant are different and not all beneficiaries are considered both tax dependants and SIS dependants.

A superannuation death benefit may only be paid in the form of a pension where the beneficiary meets the definition of a SIS dependant and a tax dependant.

TAXATION OF SUPERANNUATION DEATH BENEFITS

The way in which a superannuation death benefit will be taxed will generally depend on:

  • Who the superannuation death benefit is being paid to
  • The taxable and tax-free component of the payment
  • The type of benefit being paid.

The taxable and tax-free component of the payment

Each superannuation death benefit is comprised of a tax-free component and a taxable component. The tax-free component is paid tax-free regardless of who the beneficiary is. The taxable component will be taxable if the benefit is paid to a non-tax dependant.

The type of benefit being paid

Lump Sum

Where a superannuation death benefit is paid to a beneficiary by way of a lump sum, the following tax rates will apply:

  Tax Free Component Taxable Component
   

Taxed Element

Untaxed Element

Tax Dependant

Tax free

Tax free

Tax free

Non-Tax Dependant

Tax free

15% plus Medicare Levy

30% plus Medicare Levy

As can be seen in the table above, the tax-free component of a lump sum superannuation death benefit will be tax-free irrespective of whether or not the beneficiary is a tax dependant.

Therefore, only the taxable component is subject to tax unless the beneficiary is a tax dependant. In which case, the taxable component is also tax free.

Where a superannuation death benefit is paid as a lump sum to the deceased’s estate, the taxation treatment will depend on who the ultimate beneficiary is.

Pension

Where a superannuation death benefit is paid to a beneficiary by way of a pension, the following tax rates will apply:

Age of Beneficiary Deceased Under 60 Deceased Over 60
Aged 60 or over Tax free Tax free

Aged under 60

Tax free component: Tax free
Taxable component: Taxed at marginal rates, less 15% rebate

Tax free

It should be noted that special circumstances exist for children who receive a superannuation death benefit in the form of a pension. A child of the deceased will be required to commute the benefit to a lump sum once they reach age 25. The resulting lump sum will be tax free providing the pension is commuted before attaining age 25. The requirement to cash the benefit as a lump sum by the time the child attains age 25 does not apply if the child is a dependant child with a permanent disability.

TOOLS FOR ENSURING YOUR SUPERANNUATION IS PAID TO YOUR DESIRED BENEFICIARY

As a general rule, the Trustee of your SMSF has absolute discretion to decide who receives your superannuation benefits upon your death. In order to ensure that the Trustee directs your superannuation benefits to your desired beneficiaries, various estate planning tools may be utilised. Some of the main estate planning tools are outlined below:

Binding Death Benefit Nomination

A Binding Death Benefit Nomination (BDBN) allows a member to specify who their superannuation death benefits are to be paid to on death and removes Trustee discretion by binding the Trustee.
There are two main types of BDBNs:

  • BDBN which expires every three years
  • Non-lapsing or indefinite BDBN (that does not expire, however some may have conditions such as divorce or bankruptcy which will cause them to expire).

In order for a BDBN to be valid, it must meet a number of requirements, including:

  • Be in writing
  • Signed by the member
  • Witnessed by two independent parties who are over 18 and are not the nominated beneficiary
  • Beneficiary must meet the definition of a SIS dependant.

In addition, a BDBN will not be binding on the Trustee if the trust deed does not contain a clause permitting the Trustee to accept a BDBN. This can be overcome by varying the trust deed.

Discretionary Nomination / Non-Binding Death Benefit Nomination

A discretionary nomination or non-binding death benefit nomination allows a member to specify who they would like their superannuation death benefits to be paid to on death. However, it is not binding on the Trustee and as such the Trustee retains their discretion.
While a discretionary nomination or non-binding death benefit nomination does not provide the member with certainty as to who their superannuation benefits will be paid to upon death, it does allow the surviving Trustee to consider the circumstances of all potential beneficiaries and distribute benefits in a more tax effective manner than what could be achieved under a BDBN.

‘Hard Wired’ Clause

A ‘hard wired’ clause is a clause included in the trust deed of the SMSF which states who superannuation benefits are to be paid to on the death of a member. For example, it may state that a superannuation death benefit must be paid to a spouse where the spouse survives the deceased.

A ‘hard wired’ clause is not only binding on the Trustee but can also be tailored to suit specific requirements. For example, the clause may cover additional factors such as how the superannuation death benefit must be paid to the beneficiary, who is to succeed to the role of Trustee and what investments must be maintained within the SMSF.

Whilst a ‘hard wired’ clause has many advantages, it requires complex legal tailoring which can be expensive. Care is needed so that subsequent trust deed upgrades do not override these provisions.

When determining which estate planning tool(s) should be utilised in order to achieve your desired outcome, it is important to ensure that there are no discrepancies between each nomination.   

RISKS ASSOCIATED WITH PAYING A SUPERANNUATION DEATH BENEFIT TO YOUR ESTATE

Where a superannuation death benefit is paid directly to your estate, rather than as a payment directly from the SMSF to a dependant, there is an increased level of risk. Upon receipt by your estate, the superannuation death benefit automatically forms part of your estate. The funds will be used to cover estate costs and settle any taxes. It also means that should a person make a claim against your estate under the Family Law Act 1982, they will have the opportunity to make a claim for your accumulated benefit.

If however, your superannuation benefits were distributed directly from the SMSF to a dependant, your superannuation benefit would be protected to a much greater extent.

When planning for your family’s future, superannuation should not be forgotten as part of the estate planning process, neither should superannuation planning be done in isolation. Planning for the future can be a relatively simple process. However, planning for a tax effective future for yourself and your family can be much more complex. We recommend you seek specialist advice in this area and the BDO Superannuation Team are happy to assist you.

For further information, please contact your BDO adviser or a member of the BDO Superannuation Team.