The finer details of death benefits

Formulating an estate plan for an SMSF member is a complicated process. Lightyear Docs founder, Grant Abbott lays out the critical items advisers need to determine when providing death benefit-related advice.

It is projected that more than $300 billion in SMSF monies will be transferred from current SMSF members by way of death benefit transfers over the next 20 years. The sad part is much of it will be litigated and this brings costs, family squabbles and no access to much-needed income for the grieving family.

Moreover, it is now in our face as a large percentage of SMSF members reach their twilight years. The continuous dire warnings from legal experts that binding death benefit nominations (BDBN) are easily attacked, plus the less than optimal advice of estate planning lawyers directing a deceased member’s superannuation to their estate, only to be potentially attacked by a family provisions challenge, means there is no certainty when it comes to SMSF estate planning. However, a solution might be at hand.

The new skill: SMSF specialist estate planners

You may already have the skills to advise in the field of superannuation estate planning. The key issue is whether you are technically competent to provide advice on superannuation estate planning.

In that regard I had a big hand in drafting the SMSF industry competency standards for the Financial Services Training Package in the early 2000s and they are still relevant today. These standards are objective and all practitioners must adhere and show their competency in dealing with SMSF members and trustees. They are over 50 pages long and identify the following competency requirements when it comes to advising on death benefits and SMSF estate planning. These are mandatory requirements:

• the client is informed of the treatment of death benefits,

• the client is aware of the impact of the trust deed on death benefit payments (lump sum and pension),

• the adviser shows an ability to identify relevant Superannuation Industry (Supervision) (SIS) Act and Income Tax Assessment Act (ITAA) legislation and regulations relevant to each client,

• the adviser shows an ability to use a range of interpersonal and communication skills to relate to a range of clients, and

• the adviser is able to identify and show knowledge of the tax treatment of death benefits (lump sum and pension issues).

Some 15 years on, in my opinion, a good SMSF specialist adviser and certainly one with estate planning knowledge must be able to answer the following death benefit issues:

i. Should a BDBN be used? And what type and what cases show their deficiencies?

ii. What is an SMSF will and how is it different to a BDBN?

iii. Will current BDBN cases impact current SMSF estate planning?

iv. How is the trustee or board of directors of a corporate trustee of an SMSF convened in the event of the death of a member?

v. Does the member’s entitlements cease on death or carry on post death in the name of the legal personal representative?

vi. Is it possible for an SMSF trustee to create a testamentary trust on the death of a member – one that flows from the SMSF and sits outside the estate?

vii. Who can be paid directly from a superannuation fund?

viii. What is tax dependency?

ix. Can a reversionary pension go beyond two people to multi-generations such as grandchildren?

x. What tax rates are applicable to life insurance death benefit pensions?

xi. How do the family provisions laws in each state impact direct death benefit payments versus super passed to a deceased member’s estate?

xii. How can you protect super from a family provisions claim if a member wants to pay all of their super to an adult child from the first marriage and not children from their second?

These are just some of the questions a competent SMSF specialist adviser and lawyer are required to know and, more importantly, communicate with a client on top of advising the trustee on administering a deceased member’s superannuation estate.

Building an effective SMSF estate plan

Creating an effective SMSF estate plan can be a long and demanding task, requiring great skill from a specialist adviser in order to achieve coverage of all contingencies. Advanced skill, care and time are required in developing and documenting an SMSF estate plan. My experience shows the key elements of an estate plan are to:

a. determine what is important to the SMSF member in relation to looking after their family and dependants in the event of their death,

b. determine who is going to control the distribution of the deceased member’s superannuation interests as super benefits upon the person’s death,

c. create a blueprint to deliver the desired SMSF estate planning goals using the right combination of vehicles and life insurance if need be,

d. make sure the plan is simple, certain and easy for all parties to understand before the person dies,

e. ensure the person or people left in charge of implementing the plan on behalf of the deceased know what they are doing or use experienced advisers to deliver the plan. For an SMSF this is the trustee of the fund,

f. ensure the SMSF estate plan is taxeffective, and

g. ensure it complies with the laws and any chance of legal disputation is minimised.

Table 1: The payment of death benefits to a member’s SMSF estate

Beneficiary Allowable superannuation benefit

Spouse Lump sum, income stream and/or both

Dependant child under the age of 18 Lump sum, income stream and/or both, however, any income stream must be commuted by age 25

Financially dependant child b/n 18 and 25 Lump sum, income stream and/or both, however, any income stream must be commuted by age 25

Disabled child Lump sum, income stream and/or both

Dependant grandchild Lump sum, income stream and/or both

Non-dependant grandchild Lump sum via the legal estate

Dependant brothers, sisters Lump sum, income stream and/or both and parents

Non-dependant brothers, sisters Lump sum via the legal estate and parents

Dependant child over the age of 25 Lump sum

Non-dependant (not a child Lump sum via the legal estate of the member)

Legal estate Lump sum

The SIS Act and death benefits

For the most part, SMSF estate planning can be carried out via the direct transfer of a deceased member’s super interests from their family SMSF to a dependant under section 62 of the SIS Act. This may be by way of a lump sum or pension, although there are legal limitations for the trustee of a fund paying an income stream or pension pursuant to SIS regulation 6.21. The strategic possibilities for a member of a fund in terms of their SMSF estate planning are shown in Table 1.

Who is a dependant?

As noted above, the sole purpose test in section 62 of the SIS Act provides that the trustee of an SMSF can pay death benefits to a dependant upon the death of a member. There are different definitions of dependant in the SIS Act and the ITAA. Table 1 looks at the SIS Act, which includes a child as a dependant, even though they may not be financially dependent. For tax purposes a dependant receives favourable taxation treatment – no death benefits tax on the payment of taxable components – which leads us to the next point.

Section 302-195 of the ITAA: meaning of death benefits dependant

1. A death benefits dependant, of a person who has died, is:

a. the deceased person’s spouse or former spouse, or

b. the deceased person’s child, aged less than 18, or

c. any other person with whom the deceased person had an interdependence relationship under section 302-200 just before he or she died, or

d. any other person who was a dependant of the deceased.

It also includes someone receiving a superannuation lump sum if the deceased died in the line of duty as a member of:

a. the defence force,

b. the Australian Federal Police,

c. the police force of a state or territory,

d. a protective service officer, or

e. the deceased member’s former spouse or de facto spouse.

The meaning of ‘interdependent relationship’ has been described by the courts and taxation commissioner as “one of continuing mutual commitment to financial and emotional support between two people who reside together. The definition will also include a person with a disability who may live in an institution but is nevertheless interdependent with the deceased. For example, two elderly sisters who reside together and are interdependent will be able to receive each other’s superannuation benefits tax-free. Similarly, an adult child who resides with and cares for an elderly parent will be eligible for tax-free superannuation benefits upon the death of the parent.”

Who is a financial dependant?

A financial dependant at law falls within section 302-195(1)(d) of the ITAA. In that regard, the issue of who is a financial dependant has occupied the courts’ mind for more than a century in relation to workers’ compensation, taxation and superannuation matters. There is substantial High Court precedent on who is a financial dependant in Aafjes v Kearney (1976) 180 CLR 1999 and Kauri Timber Co (Tas) Pty Ltd v Reeman (1973) 128 CLR 177. Specific to superannuation, there have been two significant cases concerning the meaning of financial dependant for the purposes of super law: Malek v FC of T [1999] ATC 2294 and Faull v Superannuation Complaints Tribunal [1999] NSWSC 1137.

In Malek’s case, Antoine Malek was aged 25 when he died. He was single, had no children and, prior to his death, he and his widowed mother lived together. Mrs Malek received a disability support pension of about $153 a week, but her accountant estimated Antoine contributed around $258 a week to Mrs Malek’s living expenses for food, mortgage payments, taxi fares, medical expenses and other bills. The issue at hand was whether Antoine’s mother was a financial dependant. The taxation commissioner argued she was not and to this end stated the person had to be wholly or substantially reliant on the ongoing support provided under the arrangement. The tribunal reviewed the cases on financial dependence and in its decision cited the following authoritative statement from Justice Gibbs of the High Court:

Gibbs said in Aafjes v Kearney (1976) 180 CLR 1999 at page 207: “In Kauri Timber Co (Tas) Pty Ltd v Reeman (1973) 128 CLR 177 at pp 188–189, I accepted that one person is dependent on another for support if the former in fact depends on the latter for support even though he does not need to do so and could have provided some or all of his necessities from another source. I adhere to that view.”

The decision of the Administrative Appeals Tribunal was that Mrs Malek was a financial dependant because the financial support she received from her son maintained her normal standard of living. Moreover, she was reliant on the regular continuous contribution of the other person to maintain that standard.

In Faull’s case, the court held the mother of 19-year-old Llewellyn Faull was a financial dependant of his at the time of his death and determined his death benefit in its entirety should be paid to her without any tax deduction. At the time of her son’s death, Mrs Faull had regular employment that earned her an annual income of $30,000. Her wages were supplemented by an amount of $30 a week paid by her son as board and lodging. Although the sum paid to Mrs Faull every week by her son was small, the court stated: “The payment of that amount augmented her other income and, to that extent, she was dependent upon the deceased for the receipt of some of her income. Accordingly, she was partially dependent upon the payments made by the deceased.”

Both of these cases, which have been cited in numerous ATO private binding rulings, concluded that partial dependence and reliance is enough to establish financial dependence for the purposes of the SIS Act and the ITAA provided the payment is ongoing and recurring.

Regulator guideline

The Australian Prudential Regulation Authority (APRA) has also considered the issue of financial dependence and in its payments standard guideline, APRA Guideline No.I.C.2, it stated the following: “There is no need for one person to be wholly dependent upon another for that person to be a ‘dependant’ for the purposes of the payment standards. Financial dependency can be established where a person relies wholly or in part on another for his or her means of subsistence. Nor must the recipient show a need for the money received from the deceased member in order to qualify as a dependant. Moreover, since partial financial dependency can generally be sufficient to establish a relationship of dependence, it is possible for two persons to be dependent on each other for the purposes of the payment standards.”