At the end of each holiday season, we come home to begin another year, some don’t. Early in this year, I got a call from a very old good friend, who lost both his clients in an overseas car accident. Joint deaths can create a very difficult situation specially when there are only two individual trustees of a self managed super fund.
In sudden death situations, the trustees do not get time to plan their affairs and the family of the deceased could be liable for avoidable tax (depending on what was left in the member account) and the dependants are restricted to do certain things due to legislative time limits and create un-necessary hassles especially when the family is grieving. So the golden two words for advisors and trustees is “estate planning” and to implement strategies which will limit or avoid taxes the next generation will pay.
My friend’s client’s children are now facing a tax bill of close to $300,000 which could have easily been avoided, had they put some simple strategies in place.
For some advisors, some of the information below will be recap to their prior knowledge, but for some, interesting reading, but nothing in these article will be “run of the mill”, I will not blame you to switch your printer on now.
Who gets your Super when you die?
Superannuation Death Benefits
When a member of a SMSF passes away, there are several issues the advisor needs to be aware and determine, such as
1. Was the member in accumulation phase or pension phase;
2. Is the death benefit of the member is being paid out to a death benefits dependant;
3. If the death benefit is being paid out to a death benefit dependant, is it being paid as a lump sum or as an income stream;
4. Is there a binding death nomination is in place;
5. If the death benefit is not being paid out to a death benefit dependant, what are the taxation components of the death benefit and how is insurance claim to be treated in the fund and whilst making a payment to the non death benefit dependant;
6. If assets of the fund are being sold to pay death benefit, what is the tax implication of the capital gain to the fund and payment to non death benefits dependant?
The above issues are to be resolved by the remaining members and in case of joint death, the LPR of the deceased. If your trust deed is pre 1st July 2007, you may have to update your SMSF trust deed.
Who are Death Benefits dependants?
If a member dies in pension phase, from 1st July 2007 only death benefits dependants will be able to receive a reversionary income stream from the superannuation interest. Which means that upon death the income payments form the pension can continue to be made to the specified death benefit beneficiary (provided they are able to be reversionary beneficiary as per Section 302-195 of ITAA 97) in the pension documents.
A death benefit dependant is:
a. A spouse or former spouse
b. A child, aged less than 18 years (or a financially dependant child over 18 but under 25 years)
c. Any person where an interdependency relationship existed just before death (Sec 302 – 200)
d. Any person who was a dependant of the deceased just prior to death
What constitutes an interdependency relationship is further defined (sec 302-200)
(1) Two persons have interdependency relationship if
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
(2) Two persons also have interdependency relationship if;
a. They have a close personal relationship; and
b. They do not satisfy one or more of the requirements of an interdependency relationship mentioned in (1) (b), (c) and (d); and
c. The reason they don’t satisfy those requirements is that either or both of them suffer from a physical, intellectual or psychiatric disability.
Tax on payments to death benefit dependants
If the member is in accumulation phase
From 1st July 2007 any lump sum death benefit payment to a death benefit dependant are not assessable or exempt income (Sec 302 – 60) and are therefore tax free;
If the member is in pension phase
If the pensioner or reversionary beneficiary is over age 60 when the pensioner dies, the income stream payments to the reversionary beneficiary are not assessable or exempt income (Sec 302 – 65)
If the pensioner or reversionary beneficiary is under age 60 when the pensioner dies (Sec 302 – 70), the income stream is assessable to reversionary beneficiary (eligible for a 15% rebate on the “taxable portion” of the pension) until the age of 60, after which it is not assessable or exempt income.
Reversionary Pensions paid to children
SISR 6.21(2B) states that if a pension is being paid to a child, that pension must cease once the child reaches the age of 25 (unless the child has a disability), at that point of time, a lump sum payment is made to the beneficiary. Since the lump sum is as a result of a commutation of a death benefit pension, it will be tax free to the child.
This means that if a pensioner dies and has no spouse dependants and has only adult children (over the age of 25 years), only lumps sum can be paid to them upon death, as the child has become a Non-death benefits dependant (SISR 6.21 (2A).
The member at the time of setting up the account based pension decides the pension terms and conditions with the trustee of the SMSF. These pension conditions or “contract” between the pensioner and the trustee of the fund is where the name of the reversionary beneficiary is recorded; hence pensioner should take care whilst nominating reversionary beneficiary(s). These pension conditions should also meet the SISA and SISR pension conditions.
One major benefit of nominating reversionary beneficiary in pension documents is that the deceased death benefit dependants (like spouse) can start withdrawing after sudden death of the member, without any formal documentation or notices to the ATO. Also note that the new simple pension conditions allow 100% withdrawals. However, at the time of withdrawal, the age of the pensioner and reversionary pensioner is important, if any of them is below 60, the income stream will be assessable to the beneficiary (eligible for a 15% rebate on the “taxable” component of the pension).
What is “Tax Free” and “Taxable” Component of a death benefit?
Each superannuation interest within a fund has different taxation components. The amounts that form part of these components are as follows:
Tax Free Component (Sec 307-210 of ITAA 97) is the value of the crystallised component of the interest plus new non-concessional contributions after 1st July 2007.
Crystallised segment – the amount of the following components as at 1st July 2007:
o Concessional component (old definition)
o Post 1984 invalidity component
o Undeducted contributions
o CGT Exempt component
o Pre – July 1983 component
The taxable component of a superannuation interest is equal to the value of the total interest less the tax free component (Sec 305 -215 of ITAA 97)
Timing of Calculation of components
When a death benefit is paid as a lump sum to a non-death benefit beneficiary, the trustee must determine the value of the superannuation interest of the member and the amount of each those components of the interest.
The trustee must also determine components of a superannuation interest at the time of commencement of an income stream like an account based pension.
In accumulation phase, the tax free component is a fixed amount, increased only by additional non-concessional contributions and all growth or earnings increase only the taxable component. But in pension phase, it is the proportions at the time to commencement of the pension for the life of the pension. This means that any growth or earnings is proportionately allocated between the tax-free and taxable components based upon the value of pension at commencement.
For Example
John is in Accumulation phase:-
On 1st July 2009 the balance of the fund is
Taxable Component $300,000
Tax Free Component $200,000
Total superannuation interest $500,000
There are no new contributions and on the 30th June 2010 the balance of the fund is $585,000 due to earnings and growth of $100,000 less tax of $15,000. The two components on 1st July 2010 will be
Taxable Component $385,000
Tax Free Component $200,000
Total Superannuation interest $585,000
John is in Pension Phase
On 1st July 2009 the balance of the fund is
Taxable Component $300,000 60%
Tax Free Component $200,000 40%
Total superannuation interest $500,000
There are no new contributions (new contributions are a separate superannuation interest if the member is on pension phase) and on the 30th June 2010 the balance of the fund is $600,000 due to earnings and growth of $100,000 (pension paying assets do not pay tax). The two components on 1st July 2010 will be
Taxable Component $360,000
Tax Free Component $240,000
Total Superannuation interest $600,000
Since John is on pension phase, he must withdraw a minimum amount to meet the SISR pension conditions, say he withdraws 10% or $50,000 before 30th June 2010, the two components will be
Component 1st July 2009 Growth Pension Balance
Taxable 300,000 60,000 30,000 330,000
Tax Free 200,000 40,000 20,000 220,000
Total 500,000 100,000 50,000 550,000
This means that once the pension commences, the percentage of components get locked in and grow in the same percentage and any withdrawals are in the same percentage. Hence, it is very important for the trustee and advisor to track the two components till death of the member.
Tax on payment to Non-Death benefit dependant
As there is no option to pay an income stream to a non-death benefit dependant, a lump sum has to be paid. The tax free component of a death benefit would be tax free in the hands of beneficiary, however 15% (plus medicare levy) tax is paid for taxable component. Most of the strategies in estate planning concentrate on converting taxable component to tax-free component if the member only has non-death benefit dependants (spouse has already died and all the children are over 25 years old).
Payment to estate of the member
If the death benefit is paid to the estate of the member, any payment to a beneficiary will be taxed in accordance with how the executor (Legal personal representative – LPR) deals with it. This means that if the death benefit payment will not be taxed if it is paid to a death benefit dependant and only taxable component will be taxed if it is paid to a non-dependant of the deceased.
Commutation of Death Benefit pension
When a pension member dies and if the pension is a reversionary pension, it is possible that the beneficiary may want to commute this pension and draw a lump sum of the superannuation interest. If the reversionary beneficiary wants the death benefit lump sum to be treated as a death benefit and be tax free to the death benefits dependant, the commutation must occur before the latter of
Six months from the date of the death or
Three months from the grant of probate or letter of administration
If the commutation does not happen within this time frame, the lump sum will not be classified as a death benefit payment and taxed depending on the age of the beneficiary and if the beneficiary is less than 60 years old can result in additional tax. Further, any death benefit cannot be rolled over to a superannuation fund.
Strategies to reduce tax – estate planning
There are many strategies trustees and advisors should be aware, if the superannuation interest of the member has any “taxable” component and if the aim is to reduce tax payable by the next generation.
These strategies relate to
reducing taxable component and increasing tax free component if there are only adult non-death benefit dependants;
creating reserves to pay anti-detriment payments on death, if there is likely hood of new members joining the fund and making concessional contributions;
creation of a testamentary trusts upon death to distribute income to interdependent beneficiaries (ruling from the grave);
Which strategy to use depends on many factors, such as, the amount of taxable component in the superannuation interest, the age of the pensioner, possibility of new members joining the fund and making concessional contributions etc and depend on personal circumstances of the pensioner.
Usually the trustee has this last string to tie and visits estate planning issues after all assets are ready to be contributed to super and just before age 60.
Manoj Abichandani
SMSF Specialist Advisor
SMSF Specialist Auditor
In sudden death situations, the trustees do not get time to plan their affairs and the family of the deceased could be liable for avoidable tax (depending on what was left in the member account) and the dependants are restricted to do certain things due to legislative time limits and create un-necessary hassles especially when the family is grieving. So the golden two words for advisors and trustees is “estate planning” and to implement strategies which will limit or avoid taxes the next generation will pay.
My friend’s client’s children are now facing a tax bill of close to $300,000 which could have easily been avoided, had they put some simple strategies in place.
For some advisors, some of the information below will be recap to their prior knowledge, but for some, interesting reading, but nothing in these article will be “run of the mill”, I will not blame you to switch your printer on now.
Who gets your Super when you die?
Superannuation Death Benefits
When a member of a SMSF passes away, there are several issues the advisor needs to be aware and determine, such as
1. Was the member in accumulation phase or pension phase;
2. Is the death benefit of the member is being paid out to a death benefits dependant;
3. If the death benefit is being paid out to a death benefit dependant, is it being paid as a lump sum or as an income stream;
4. Is there a binding death nomination is in place;
5. If the death benefit is not being paid out to a death benefit dependant, what are the taxation components of the death benefit and how is insurance claim to be treated in the fund and whilst making a payment to the non death benefit dependant;
6. If assets of the fund are being sold to pay death benefit, what is the tax implication of the capital gain to the fund and payment to non death benefits dependant?
The above issues are to be resolved by the remaining members and in case of joint death, the LPR of the deceased. If your trust deed is pre 1st July 2007, you may have to update your SMSF trust deed.
Who are Death Benefits dependants?
If a member dies in pension phase, from 1st July 2007 only death benefits dependants will be able to receive a reversionary income stream from the superannuation interest. Which means that upon death the income payments form the pension can continue to be made to the specified death benefit beneficiary (provided they are able to be reversionary beneficiary as per Section 302-195 of ITAA 97) in the pension documents.
A death benefit dependant is:
a. A spouse or former spouse
b. A child, aged less than 18 years (or a financially dependant child over 18 but under 25 years)
c. Any person where an interdependency relationship existed just before death (Sec 302 – 200)
d. Any person who was a dependant of the deceased just prior to death
What constitutes an interdependency relationship is further defined (sec 302-200)
(1) Two persons have interdependency relationship if
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
(2) Two persons also have interdependency relationship if;
a. They have a close personal relationship; and
b. They do not satisfy one or more of the requirements of an interdependency relationship mentioned in (1) (b), (c) and (d); and
c. The reason they don’t satisfy those requirements is that either or both of them suffer from a physical, intellectual or psychiatric disability.
Tax on payments to death benefit dependants
If the member is in accumulation phase
From 1st July 2007 any lump sum death benefit payment to a death benefit dependant are not assessable or exempt income (Sec 302 – 60) and are therefore tax free;
If the member is in pension phase
If the pensioner or reversionary beneficiary is over age 60 when the pensioner dies, the income stream payments to the reversionary beneficiary are not assessable or exempt income (Sec 302 – 65)
If the pensioner or reversionary beneficiary is under age 60 when the pensioner dies (Sec 302 – 70), the income stream is assessable to reversionary beneficiary (eligible for a 15% rebate on the “taxable portion” of the pension) until the age of 60, after which it is not assessable or exempt income.
Reversionary Pensions paid to children
SISR 6.21(2B) states that if a pension is being paid to a child, that pension must cease once the child reaches the age of 25 (unless the child has a disability), at that point of time, a lump sum payment is made to the beneficiary. Since the lump sum is as a result of a commutation of a death benefit pension, it will be tax free to the child.
This means that if a pensioner dies and has no spouse dependants and has only adult children (over the age of 25 years), only lumps sum can be paid to them upon death, as the child has become a Non-death benefits dependant (SISR 6.21 (2A).
The member at the time of setting up the account based pension decides the pension terms and conditions with the trustee of the SMSF. These pension conditions or “contract” between the pensioner and the trustee of the fund is where the name of the reversionary beneficiary is recorded; hence pensioner should take care whilst nominating reversionary beneficiary(s). These pension conditions should also meet the SISA and SISR pension conditions.
One major benefit of nominating reversionary beneficiary in pension documents is that the deceased death benefit dependants (like spouse) can start withdrawing after sudden death of the member, without any formal documentation or notices to the ATO. Also note that the new simple pension conditions allow 100% withdrawals. However, at the time of withdrawal, the age of the pensioner and reversionary pensioner is important, if any of them is below 60, the income stream will be assessable to the beneficiary (eligible for a 15% rebate on the “taxable” component of the pension).
What is “Tax Free” and “Taxable” Component of a death benefit?
Each superannuation interest within a fund has different taxation components. The amounts that form part of these components are as follows:
Tax Free Component (Sec 307-210 of ITAA 97) is the value of the crystallised component of the interest plus new non-concessional contributions after 1st July 2007.
Crystallised segment – the amount of the following components as at 1st July 2007:
o Concessional component (old definition)
o Post 1984 invalidity component
o Undeducted contributions
o CGT Exempt component
o Pre – July 1983 component
The taxable component of a superannuation interest is equal to the value of the total interest less the tax free component (Sec 305 -215 of ITAA 97)
Timing of Calculation of components
When a death benefit is paid as a lump sum to a non-death benefit beneficiary, the trustee must determine the value of the superannuation interest of the member and the amount of each those components of the interest.
The trustee must also determine components of a superannuation interest at the time of commencement of an income stream like an account based pension.
In accumulation phase, the tax free component is a fixed amount, increased only by additional non-concessional contributions and all growth or earnings increase only the taxable component. But in pension phase, it is the proportions at the time to commencement of the pension for the life of the pension. This means that any growth or earnings is proportionately allocated between the tax-free and taxable components based upon the value of pension at commencement.
For Example
John is in Accumulation phase:-
On 1st July 2009 the balance of the fund is
Taxable Component $300,000
Tax Free Component $200,000
Total superannuation interest $500,000
There are no new contributions and on the 30th June 2010 the balance of the fund is $585,000 due to earnings and growth of $100,000 less tax of $15,000. The two components on 1st July 2010 will be
Taxable Component $385,000
Tax Free Component $200,000
Total Superannuation interest $585,000
John is in Pension Phase
On 1st July 2009 the balance of the fund is
Taxable Component $300,000 60%
Tax Free Component $200,000 40%
Total superannuation interest $500,000
There are no new contributions (new contributions are a separate superannuation interest if the member is on pension phase) and on the 30th June 2010 the balance of the fund is $600,000 due to earnings and growth of $100,000 (pension paying assets do not pay tax). The two components on 1st July 2010 will be
Taxable Component $360,000
Tax Free Component $240,000
Total Superannuation interest $600,000
Since John is on pension phase, he must withdraw a minimum amount to meet the SISR pension conditions, say he withdraws 10% or $50,000 before 30th June 2010, the two components will be
Component 1st July 2009 Growth Pension Balance
Taxable 300,000 60,000 30,000 330,000
Tax Free 200,000 40,000 20,000 220,000
Total 500,000 100,000 50,000 550,000
This means that once the pension commences, the percentage of components get locked in and grow in the same percentage and any withdrawals are in the same percentage. Hence, it is very important for the trustee and advisor to track the two components till death of the member.
Tax on payment to Non-Death benefit dependant
As there is no option to pay an income stream to a non-death benefit dependant, a lump sum has to be paid. The tax free component of a death benefit would be tax free in the hands of beneficiary, however 15% (plus medicare levy) tax is paid for taxable component. Most of the strategies in estate planning concentrate on converting taxable component to tax-free component if the member only has non-death benefit dependants (spouse has already died and all the children are over 25 years old).
Payment to estate of the member
If the death benefit is paid to the estate of the member, any payment to a beneficiary will be taxed in accordance with how the executor (Legal personal representative – LPR) deals with it. This means that if the death benefit payment will not be taxed if it is paid to a death benefit dependant and only taxable component will be taxed if it is paid to a non-dependant of the deceased.
Commutation of Death Benefit pension
When a pension member dies and if the pension is a reversionary pension, it is possible that the beneficiary may want to commute this pension and draw a lump sum of the superannuation interest. If the reversionary beneficiary wants the death benefit lump sum to be treated as a death benefit and be tax free to the death benefits dependant, the commutation must occur before the latter of
Six months from the date of the death or
Three months from the grant of probate or letter of administration
If the commutation does not happen within this time frame, the lump sum will not be classified as a death benefit payment and taxed depending on the age of the beneficiary and if the beneficiary is less than 60 years old can result in additional tax. Further, any death benefit cannot be rolled over to a superannuation fund.
Strategies to reduce tax – estate planning
There are many strategies trustees and advisors should be aware, if the superannuation interest of the member has any “taxable” component and if the aim is to reduce tax payable by the next generation.
These strategies relate to
reducing taxable component and increasing tax free component if there are only adult non-death benefit dependants;
creating reserves to pay anti-detriment payments on death, if there is likely hood of new members joining the fund and making concessional contributions;
creation of a testamentary trusts upon death to distribute income to interdependent beneficiaries (ruling from the grave);
Which strategy to use depends on many factors, such as, the amount of taxable component in the superannuation interest, the age of the pensioner, possibility of new members joining the fund and making concessional contributions etc and depend on personal circumstances of the pensioner.
Usually the trustee has this last string to tie and visits estate planning issues after all assets are ready to be contributed to super and just before age 60.
Manoj Abichandani
SMSF Specialist Advisor
SMSF Specialist Auditor
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