The common theme in death: part two

Superannuation often plays a significant role when a person dies. In the final instalment of this two-part series, Jemma Sanderson, director at Cooper Partners, highlights certain actions that can be taken to ensure death benefits are passed on to the right people.

The ageing Australian population means superannuation is becoming a significant asset for many people and the introduction of the transfer balance cap (TBC) provisions, effective from 1 July 2017, has increased the volume of considerations when an SMSF member dies. Importantly, things may not always be as they seem within a fund and it is useful where possible to put all the pieces of the puzzle together before death.

Withdrawals before death

Since Simpler Super was introduced in July 2007, there have been issues regarding planning with respect to the payment of superannuation death benefits, particularly where both members of a couple have died, and the benefits are to be paid to adult children (either directly or via the estate). This is due to the death benefits tax payable on the taxable component within the benefits of a deceased member. Tax is generally applied at 15 per cent (if paid to the estate) to 17 per cent (if paid directly to beneficiaries). The tax may be up to 32 per cent, however, that is uncommon.

To reduce the taxable component within a benefit, and therefore the death benefits tax, withdrawal and recontribution strategies are often employed. However, given the contribution limits, this is unlikely to resolve a substantial level of taxable component within a benefit.

Another option is for the balance of the member’s benefits to be paid out of superannuation prior to them passing away. This means it would be considered a member benefit and not subject to tax on the taxable component (on the basis that the member is over 60 and eligible to take out lump sum benefits). This has its own challenges, the main one being the timing. If done too early, there could be years of losing the benefits of having assets held within the tax-advantaged superannuation environment, and if done too late, the death benefits tax is not mitigated.

The ideal scenario would see sufficient time for not only the paperwork to be signed that requests the lump sum payment, but also the beneficial ownership of the assets transferred. Where the assets have not been transferred in time, there are several private rulings on the ATO database that might be of assistance, and it could be appropriate to apply for your own ruling if the intention is to have certainty that the transfer is a member payment (with no tax on the taxable component) and not a death benefit payment. As with any situation, it is very fact driven and advice is worthwhile obtaining.

One area for consideration in executing a ‘death-bed withdrawal’ is ensuring the flow-on impact is addressed. This includes the fact the assets would no longer be held within the superannuation fund, but rather in the deceased’s own name at death, and therefore would form part of the estate. This is an important factor that can be missed, particularly if the will has particular clauses about the recipient of benefits, and the intended recipients of the superannuation benefits is different. By saving some death benefits tax, certain beneficiaries may then receive nothing from the estate if this scenario was not contemplated in the will.

Therefore, we once again refer to the member’s intentions. It is worthwhile to consider the tax saving achieved by a death-bed withdrawal, but if the monies in that situation are not distributed to whom the deceased member wanted, that is important. Munro v Munro demonstrated a will outlining the distribution of assets between beneficiaries is irrelevant if the benefits don’t ultimately form part of the estate. The flipside is also relevant – a will that doesn’t deal with the overall distribution of benefits is deficient.

It again brings to the fore the importance of reviewing all estate planning holistically and not only considering just superannuation, or just tax, or just the will, or just the reversionary status of a pension. All of these elements need to be considered together and the small details matter, and can matter substantially, being the difference between individuals inheriting or not.

Ultimately the preference is that an intended beneficiary actually receives the money. If that is 15 per cent less than what it could have been with a tax saving, then ultimately they may not be concerned as they at least received 85 pre cent of an inherited amount, rather than 100 per cent of nothing.

Practically dealing with death in an SMSF

As an enormous advocate of SMSFs, it is often painful to reflect on the fact that extracting members from them is a practical challenge. Whether that is death, divorce, dispute or departure of children, ensuring the exiting member is 100 per cent transferred out is difficult. Regulation 6.21(1) of the Superannuation Industry (Supervision) (SIS) Regulations requires death benefits to be paid out as soon as practicably possible. However, this can be challenging as the following example shows:

Bert, 78, and Mary, 76, are the members of the Chim Chim Cher-ee Super Fund, with benefits as at 30 June 2020 per Table 1. Bert dies in January 2021, and his pension is not reversionary. Bert and Mary have been married for 55 years, have no children, but have much-loved nieces and nephews. It is intended Mary is to receive all of Bert’s benefits. The SMSF has individual trustees.

The following needs to occur within the fund:

1. The fund requires either a second individual trustee or a corporate trustee be put in place (a new corporate trustee is preferred). In any event, the registration of all assets will need to be updated to the new trustee.

2. If Bert’s benefits are not going to be dealt with within six months from the date of his death, it is worthwhile considering the inclusion of the executor of Bert’s estate in the company – as Bert and Mary’s niece, Jane, and nephew, Michael, are the executors, Michael is added as an additional director. This will ensure SIS Act section 17A is addressed.

3. SIS regulation 6.21(1) requires the benefits to be paid out as soon as practicably possible, whether in the form of a lump sum payment out of the fund (a maximum of two is permitted, being an interim and a final lump sum), or the commencement of a pension for Mary.

4. At the time of Bert’s passing, the 30 June 2019 financials have only recently been finalised, given some of the detail of the investments was only recently available.

5. As Mary is currently in pension phase, the TBC implications of any strategy need to be considered.

6. It is resolved to pay all of Bert’s benefits to Mary as the only SIS Act dependant.

7. Until Bert’s benefits are dealt with, the pension exemption still applies to his pension benefit and Mary’s pension benefit, even though a minimum pension is not required to be paid from his pension.

8. In the lead-up to 30 June 2021 the decision is made to: a. commute Mary’s own pension, effective 30 June 2021, b. commence a pension for Mary with Bert’s pension account, effective 1 July 2021, up to her TBC, and c. if Mary has any remaining TBC available, she will commence a new pension from Bert’s accumulation account up to her remaining TBC.

9. The associated transfer balance account reporting (TBAR) will be as follows: a. 28 July 2021, b. 28 October 2021, and c. 28 October 2021.

10. At the time the paperwork is put in place, all values are unknown, and formulas are included for calculation when the value of the fund at 30 June 2021 is known.

11. Until that time, the level of Bert’s benefits that are ‘left over’ and can’t be retained in superannuation for Mary, and must be paid out as a lump sum withdrawal, is unknown.

12. Even once the 30 June 2021 financials are prepared, given the timing of the availability of the documents from the relevant investments, it may be nine months after year end that the numbers at 30 June 2021 are known.

13. Subsequently, the 30 June 2021 numbers will be out of date and the current value at that time of the amount to be paid out will be unknown with certainty.

14. In March 2022 the 30 June 2021 financial statements are finalised, which are outlined in Table 2,

15. Ignoring indexation, Mary: a. has an available TBC of $1.835 million when she commutes her pension account (refer to Table 3), b. can commence a new pension with 100 per cent of Bert’s existing pension, c. can commence a pension with $35,000 from Bert’s accumulation account, and d. would then have to receive a lump-sum payment of $2.815 million as of 30 June 2021, being Bert’s leftover benefits.

16. As it is now March 2022:

a. the reporting of the above amounts for TBAR would be late – a decision could be made to lodge TBAR earlier (and on time) and then lodge an amendment when the final numbers are available,

b. the value of the lump sum amount to be paid would be different as it is now nine months later since the 30 June 2021 number,

c. therefore, revised current calculations are required to be made of the potential current value of the lump sum,

d. it is not desirable to pay out too much as that would translate into funds outside superannuation in Mary’s own name, especially when a substantial level of benefits are already being transferred,

e. however, SIS regulation 6.21(2)(a) requires there is a maximum of two lump-sum payments, which can be a challenge if there are always leftovers given the timing of when balances are known,

f. it may be worthwhile paying out an additional amount as an extra buffer, which could then be treated as a lump sum from Mary’s own accumulation account if it is more than the lump sum required from Bert’s account,

g. until Bert’s benefits are completely paid out, he still has a death benefit in the fund and therefore his representative needs to be in the fund as a trustee to satisfy SIS Act section 17A,

h. Mary’s nephew Michael could remain in the fund longer term in any event as the second director, as well as representing Bert, and

i. the assets to be transferred out also need to be considered as there will be capital gains tax implications, which can then have a flow-on effect to the underlying values.

As is evident from the numerous items above, the practical side of dealing with benefits on death can be complicated and can make it difficult to achieve a quick outcome. It is beneficial to be aware of the implications, to educate our clients, and where possible do the best to mitigate any issues. The TBC regime has made estate planning more complex and also more important than ever to understand the practicalities of paying out benefits, but before that, consideration as to who is getting the money and how it is to be managed also needs to be reviewed and addressed. Who gets the money and whether that is as intended should remain paramount.