As superannuation does not automatically form part of your estate, it is important to ensure that you have considered what will happen to both your fund and your superannuation when you die.
Structure of your SMSF
Generally, your Legal Personal Representative (LPR) may act as a trustee of the fund or a director of the corporate trustee from the date of death until the benefits commence to be paid. At this time, the LPR must cease to be a trustee/director and the fund must meet the definition of a SMSF in order to continue.
If the fund has individual trustees and one dies the fund can continue as a single member fund if either a new, related, individual trustee is appointed or if a corporate trustee is appointed. Both of these changes of trustee require the transfer of all investments and bank accounts, owned by the fund, to the new trustees’ name. This may be a considerable burden at a distressing time.
If the fund has a corporate trustee and one of the two directors has died, the fund can continue with a single director and member. One other director may be appointed without the need to become a member of the fund. If more than one additional director is appointed, they must both also become a member. Where a corporate trustee was already in place there is no change required for the investments of the fund.
It is important to consider who you want to control the fund after you have died as in the absence of a Binding Death Benefit Nomination it is the trustees of the fund who have discretion to decide how to pay the death benefits. Generally, problems will not arise but where former spouses and blended families are involved, there could be complications and potential conflicts.
Planning now can reduce the possibility of issues arising later.
Also consider whether or not the fund should be wound up. This may be the preferred option where the member who has died was carrying out the majority of the day to day activities of the fund and the surviving member does not have the inclination or skills to maintain a SMSF.
There are a number of ways of making your wishes known:
- Binding death benefit nomination (BDBN)
- Reversionary pension nomination
- Non-binding nomination
A BDBN must be followed by the trustee and gives complete certainty as to how the death benefit will be paid. A disadvantage is that it removes any flexibility for the trustees to pay a benefit in the most tax effective way.
A reversionary pension can only be paid to a death benefit dependant (DBD). A DBD is your spouse (including former, de facto and same sex), your children (including ex-nuptial and adopted but not independent adults), any person who is financially dependent on you and any person who is deemed to be in an ‘interdependency relationship’ with you at the time of death.
A non-binding nomination provides the trustee with guidance as to how you would like your superannuation distributed but is not binding on the trustee. This often provides greater flexibility for families.
Tax issues to be considered
There are two levels of tax issues to be considered when a member dies.
Tax implications for the fund
The death of a member is a compulsory cashing event. If a benefit is paid to a non-dependant, the benefit must be paid as a lump sum. It can be paid as either a lump sum or a pension to a DBD.
If a lump sum is chosen, the deceased member’s balance must be paid out of the superannuation fund as soon as practicable after death.
In most instances this will result in the need to sell down SMSF assets in order to pay out the benefit. This may result in Capital Gains Tax being incurred by the fund.
Where the deceased member’s balance was in pension phase at the time of their death, it is important to note that their pension ceases on the date of death (unless it was auto-reversionary) and the tax exemption applying to assets supporting a pension also ceases at that date.
If the pension was established as a reversionary pension both the pension and the tax exemption continues.
Where the DBD requests that the death benefit be paid as a pension there is no need to sell down the investments but there may be some delay in commencing the pension account. An actuarial certificate will be required in that year to determine what proportion of the fund’s income will be tax exempt.
In light of the above it is important to monitor large unrealised gains in your fund and take steps to reduce these over time if possible.
Tax implications for the beneficiaries
The tax free component of a member balance is tax exempt no matter how it is paid or who it is paid to. A lump sum paid to a DBD is tax free to the beneficiary. Pensions are also paid tax free except where both the deceased and the beneficiary are under age 60.
It is when a superannuation death benefit is paid to a non-dependant (eg. an independent adult child) that there is tax to pay on the taxed component. Maximum rates payable are 16.5% on the taxed element and 31.5% on the untaxed element.
Where substantial superannuation benefits are concerned and these will pass to non-dependants, it is definitely advantageous to reduce the taxable component as much as possible.
This can be done by using the withdrawal and re-contribution strategy and also if you are over 60 by withdrawing your benefits prior to death.
Mark who is 62 and retired is a member of a SMSF. He has $1million in superannuation and it is 100% taxable. His only beneficiary is his adult daughter Jenny. If Mark dies today Jenny will pay $165,000 tax. If however, Mark withdraws and re-contributes the maximum amount he can prior to reaching 65 of $750,000 in total ($150,000 + $150,000 + $450,000) the tax payable will reduce to $41,250 providing a tax saving of $123,750. Also Mark could withdraw a further $250,000 and hold this outside of superannuation or provide a pre-inheritance gift to his daughter. This would potentially reduce the tax payable completely.