When we setup our retirement plan, we rarely pay enough attention to the complications we can leave behind and how to optimise our death proceeds.
One of the most forgotten facts about superannuation is that it does not form part of our Will, unless we specifically request it. Rather, it acts as its own entity and requires specific instructions via the “beneficiary nomination form”. This occurs regardless of the type of super fund you hold – a self-managed, wrap or industry fund all need their own instructions, but they do offer different opportunities.
In Part 1 of this article, we will outline the most important tips and traps, which will be followed in Part 2 by understanding the tax friendly strategies depending on whom you want as the beneficiaries.
Self-Managed Super Funds – The Most Flexibility, The Most Complexity
The most common problem we see across self-managed super funds is that the structure is usually setup under a husband and wife arrangement such as “John and Mary Smith ATF The Smith Super Fund”. This appears perfectly normal on face value (it is known as the “individual trustee” structure), but it can produce an enormous mess upon death.
The reason it creates havoc is because it is not possible to have a one-member, one-trustee super fund under this arrangement. Therefore the following three options are available:
- Upon death – find a new member who is willing to join. For example, a child or friend. More often than not, this is not an ideal arrangement because they will have different investment timeframes, pension requirements and/or risk tolerances.
- Upon death – wind up the fund. This will mean that the surviving partner will need to sell all the holdings and cash these out (which is not ideal for tax purposes) or rollover to a standard super fund.
- Now – setup a corporate trustee. This usually only costs around $1,000-$2,000 and is the only way that a one-person super fund can exist. Most importantly, if one member passes away, the remaining member can continue to operate and benefit from the fund.
How to check if you have an ideal setup?
The easiest way is to check your bank statement or your latest SMSF tax returns. If your fund is listed as “John and Mary Smith ATF The Smith Super Fund” then it is likely to be sub-optimal, whereas if it is setup as “Smith Super Pty Ltd ATF The Smith Super Fund” then it is likely to be optimal for estate planning.
The Choice of Beneficiary
At the time of death, your super balance will be paid out depending on your “beneficiary nomination”. This nomination will either be binding, non-binding or not in place at all.
Without a binding beneficiary nomination form completed, it falls to the trustee/s of the super fund to decide and work out who gets your money (re-iterate that it doesn’t consider your Will). For those with a complicated family this can be a major area of concern.
A non-binding nomination will be “considered” but not guaranteed by the trustee/s, whereas no nomination at all leave the balance subject to trustee discretion. With an SMSF, the trustee is usually a beneficiary (eg. husband and wife), so you are taking a leap of faith that they will make the right choice. Note that this can be an advantage in comparison to an industry or retail fund, where the trustee will be an external body and can mean the funds end up in unintended hands.
One way to remove the risk of challenges or unintended beneficiaries is to put in place a “binding beneficiary nomination form” that is binding to the trustee. Bear in mind that many of these binding nominations are usually only valid for 3 years, after which they become non-binding and open to the same problems above.
Using a Testamentary Trust
Many wealthy individuals are engaging in complex estate planning tools these days, and one of the most common setups is the use of a testamentary trust. This is very useful for wealthy families with young children, complex circumstances or family business interests, but superannuation will not necessarily form part of this testamentary trust.
If your wish is to funnel all of your assets (including superannuation) into a testamentary trust, this will only be possible by having a valid “binding beneficiary nomination” to your legal personal representative.
Therefore, those considering such circumstances should check your current status to ensure it reflects this.
Reversionary Pensions
Another option available under many Trust Deeds is the ability to incorporate a reversionary pension. This means that a husband and wife that are in pension mode can have their deceased partner’s pension “revert” to them. Under this circumstance, there are no asset sales required and the surviving partner can continue the pension unchanged upon death. This is sensible for a straight forward circumstance.
Now that the structural side is out of the way, we can talk about strategies to optimally position your estate.
Tax to Non-Dependants
Most Australians are led to believe that death taxes and duties were abolished in the late 1970’s. However, superannuation is one of the last remaining areas that still attract significant death tax.
The rules relate to whether the beneficiary is a “dependant” or “non-dependant” according to the SIS Act. Note that the definitions differ from standard tax laws.
The major difference is typically the treatment of adult children, specifically those over 18 year of age. These children are commonly desired beneficiaries; however the tax implications on the payout can be enormous.
The typical death tax to adult children will be 16.5% or 31.5% depending on the underlying components of the fund. Therefore, a sensible strategy can be to allow for these “non-dependants” via your personal assets, which is done via an estate equalisation plan.
Insurance in Super – Can Be a Danger
Following on from the non-dependant issues above, life insurance payouts within super can attract 31.5% tax if paid to a non-dependant (0% if dependants). Therefore, if you have $1 million in insurance, this could equate to as much as $315,000 in tax if paid to non-dependants.
Therefore, it is vital that you consider the intended beneficiary. If it is intended to go to your spouse or young children, life insurance inside superannuation will unlikely pose you a problem. However, if you do have non-dependants as intended beneficiaries then a sensible strategy to avoid such issues is to allow for non-dependants via an external insurance policy. One such strategy can be to split your life insurance so that part of it is inside super (allowing for dependants) and the remainder outside super.
Death and Capital Gains
Another little known ruling affects everyone in pension mode and can have dire consequences. This rule relates to when a pension ceases to exist. The current stance is that the death of a member will cause a pension to revert back to accumulation mode. This is an enormous problem for many in pension mode.
The problem is capital gains tax (CGT). Using an example, let’s take an 80 year old that has $2 million in an SMSF in pension mode. Many people in this position will have underlying investments that have large capital gains (eg. Commonwealth Bank at inception). While the 80 year old is alive, he/she could sell the investments with no capital gains tax. However, think about what happens once the investments get sold upon death… In accumulation mode, CGT will be payable at 10% (or 15% if the asset/s are held for less than 12 months). Therefore, assuming the fund has unrealised gains of say $500,000, the unintended tax liability could be $50,000 or more.
The sensible solution for SMSF members in pension mode is to refresh their cost base when a large capital gain exists. The basis for this decision can’t be tax avoidance (don’t sell and buy the same shares on the same day), but if there are merits on other reasonable grounds it makes a lot of sense.
Getting Smart – Pre-Retirees with SMSF’s
- Strongly consider a corporate trustee arrangement.
- Work out which beneficiaries are SIS Act dependants and non-dependants. For dependants, create a binding nomination form. For non-dependants, consider providing for them via non-super assets instead. If in doubt or have a testamentary trust, consider a binding beneficiary nomination to your “legal personal representative”.
- Insurance – consider a split policy between super and non-super depending on your beneficiaries. Remember that insurance intended for adult children will attract 31.5% tax as they are not SIS Act dependants.
Getting Smart – Retirees with SMSF’s
- Strongly consider a corporate trustee arrangement.
- Work out which beneficiaries are SIS Act dependants and non-dependants. For dependants, create a binding nomination form. For non-dependants, consider providing for them via non-super assets instead. If in doubt or have a testamentary trust, consider a binding beneficiary nomination to your “legal personal representative”.
- If you are in pension mode, consider selling any investments with large capital gains. This will refresh the cost base which can remove tax implications if/when you must revert back to accumulation mode (ie. at death).
- If you have no SIS Act dependents, consider removing your investments from the super environment if/when you are facing mortality risk (eg. terminally ill).
