*Note this article has been reviewed (and the writing assisted) by Daniel Butler and Annette Esposito, DBA Lawyers.
Most of what is written about self managed superannuation fund (‘SMSF’) estate planning tends to revolve around passing your assets onto beneficiaries who are known as ‘dependants’ as defined under the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SIS Act’) (referred to as ‘death benefit dependants’ in the Income Tax Assessment Act 1997 (Cth) (‘Tax Act’) with regard to the taxation consequences for persons who receive superannuation benefits). However, not so much is written of the situation where upon the death of both you and your spouse and you leave no dependants (i.e. no children).
You may wish to support for instance, other extended family members such as grand-nephews who do not qualify as “dependants”. What happens then, and what are your choices?
Now just to refresh your memory, a ‘dependant’ is defined in the SIS Act and includes your spouse (includes de facto), any of your children, and any person with whom you had an ‘interdependency relationship’.
An interdependency relationship between two people is where:
(a) they have a close personal relationship; and
(b) they live together; and
(c) one or each of them provides the other with financial support; and
(d) one or each of them provides the other with domestic support and personal care.
Note that if two persons satisfy the requirement of (a); but they do not satisfy the other requirements because either or both of them suffer from a physical, intellectual or psychiatric disability, then they are still classed as having an interdependency relationship. Further, two persons will not have an interdependency relationship if one of them provides domestic support and personal care to the other under an employment contract or a contract for services or on behalf of another organisation such as a government body.
Note also that the SIS definition is inclusive, but not exhaustive and as such a commonly accepted inclusion in the definition of dependant for SIS purposes is also any other person who was a financial dependant of you (i.e. relied on you for financial maintenance) just before you died.
What if there are no dependants ?
To illustrate what choices are available where there are no dependants left upon death, we will outline a case study. Here we have John and Jane, a married couple. They are the only members of their SMSF, and are directors of the corporate trustee of the SMSF. They have no children, and no one else who can be classed as a dependant but they do have extended family and they wish to assist their favorite grand-nephews once they have both passed away.
John has the following questions:
(a) upon his death, he wants all his SMSF assets to remain within the SMSF for the benefit of Jane. How does he accomplish this? And
(b) upon Jane’s death, he wants to know his options and how can he pass assets to his grand nephews?
Firstly, let’s deal with scenario (a) where John dies.
When a member of a SMSF dies, SIS Reg 6.21(1) states that the member’s benefits must be ‘cashed’ as soon as practicable. This can be satisfied by either a lump sum payout to dependants or to the estate, or an income stream commenced to a dependant (note that a child must be less than 18, or be between 18 and 25 and be financially dependent, or have a severe disability at the time of death for the benefit to be paid in pension form).
So for John, if his superannuation benefits are applied towards an income stream, that enables the assets to remain in the SMSF for the continued benefit of Jane. John can accomplish this via inserting these wishes into a binding death benefit nomination (‘BDBN’) (some trust deeds have what is called a death benefit agreement, or SMSF will) to ensure it happens. The other option is where John does not make a BDBN, and the remaining director of the corporate trustee Jane uses her discretion at the time of John’s death in terms of how much she wants to receive as a lump sum and how much she would like to stay within the SMSF to pay a pension. If John is about to commence an income stream, then he could have it created as a ‘reversionary income stream’, which means that it just continues to operate past his death for the benefit of Jane.
Secondly, let’s deal with scenario (b) where Jane dies, and there are no remaining dependant beneficiaries.
In this case where there are no remaining dependants then there is very little choice. Where the member has prepared a will, the executor of the will (also known as the legal personal representative (‘LPR’) will generally step in as the trustee of the SMSF (subject to prior arrangements), assets will be realised and paid out to the estate and then paid out according to the will (say to the grand-nephews). The member may have also prepared a will which includes a testamentary trust, where benefits are paid into the trust and then flow through as either income or capital to the beneficiaries of the trust (e.g. grand-nephews).
You might ask at this point, why doesn’t the SMSF simply pay out directly to say the grand-nephews? Well, a superannuation fund cannot pay money out directly to a non-dependant unless after reasonable inquiry they cannot find a LPR or any dependants. But let’s just assume here that Jane has a valid will.
What are the taxation consequences?
Lets keep going with our case study, and assume that once Jane has passed away, and with no SIS dependants, the assets flow through to the estate and are now distributed according to Jane’s Will with the grand-nephews in line for a lump sum payout. The next thing to consider is the taxation consequences of any payout, and its here that things can get interesting.
You see, even though there are no dependants as defined by the SIS Act, (that is, no one who can receive a payout directly from the SMSF), there is no limit on the range of people who receive a payout from the estate as there is no need for them qualify as what are called ‘death benefits dependants’ which is not exactly the same as a dependant as defined in the SIS Act. For instance, you could leave your superannuation via your will to a distant cousin, an old friend or a charity.
The significance of this is that anyone who receives death benefits from the SMSF or via the estate who is classed under the Tax Act as a death benefits dependant, will receive the payout tax free.
A death benefits dependant for the Tax Act purposes includes:
• your spouse or former spouse
• a child aged less than 18
• any other person with whom you had an interdependency relationship with just prior to death or
• any other person who was a dependant of you (i.e. relied on you for financial maintenance) just before you died.
Note there is also a provision that says anyone who receives a superannuation lump sum payout due to the death of a member who was killed in the line of duty (e.g. Defence Force, Police, Protective Services Officer) will also be classed as a death benefits dependant.
So as you can see, your adult children will generally only satisfy the requirements of a death benefit dependant where they are financially dependant on you. Where there is no financial dependency even your adult children don’t qualify as a death benefits dependant for tax purposes meaning that the taxable component will generally be taxed at 15% (+ medicare levy if paid from the SMSF).
So what’s the tax position for non-dependants?
The bottom line is that non-dependants pay no tax on the ‘tax free’ component of the superannuation lump sum payout, but do pay 15% tax on the taxable component of the payout. If the taxable component has what is called an ‘untaxed element’ (usually this is where insurance proceeds form part of the death benefit) then this portion is subject to a 30% tax rate (note that a specific formulae applies to this). Note also that the medicare levy is also applied if paid out directly from the SMSF, but not if paid via the estate.
To try and get all or as much of this as possible to be tax free is where strategies such as the re-contribution strategy might come in depending on how much a member has and the components of their account. The idea is to increase the ‘tax free’ component as much as possible so that no matter who receives it, it will be tax free in their hands. Note this is something you have to do while you are still alive.
An interesting twist that some people promote is that if grand-nephews or others who are normally classed as non-dependants were in some way financially dependent on the deceased member, then they could receive tax free lump sums via the estate as they would now be classed as death benefits dependants. The Commissioner’s view is that a dependant includes any person who relied on the deceased for financial maintenance at the time of their death. Note this would need to show financial reliance upon the deceased, so things like merely paying a few school fees etc are unlikely to satisfy the requirements.
What should you do?
As you can see, SMSF estate planning is not a walk in the park. There are many twists and turns, many variables to consider, and it involves interaction between multiple legal Acts (SIS Act, Tax Act etc) and also interaction between your SMSF deed, your will, and your BDBN.
A good estate planning lawyer with SMSF expertise and experience will be able to take you through all your options and get you to where you want to be. This is not the area to be DIY’ing it where you have even a small amount of complexity.