Q: It has been suggested, that a family self-managed super fund (SMSF) can become a multi-generational tax haven, which can go on into perpetuity, provided that you establish a special corporate trustee, as well as a SMSF Will. The money as I understand cannot remain in the fund indefinitely and the relevant tax has to be paid. Another limiting factor would be that you cannot have more than four members of a SMSF. Could you kindly clarify the situation?
A: Estate planning is probably one of the trickier areas in superannuation because you are trying to control what happens to your super benefits after you die. For many Australians, deciding what happens to super benefits when you’re alive can be challenging enough. If you’re seeking to cater for your family after you die, via a SMSF, then finding an adviser who understands the super rules and inheritance rules is essential.
Benefits paid from a super fund after the member dies are known as death benefits and can only be paid to certain individuals, or to your estate. Death benefits are subject to tax when paid to non-dependants, for example, independent adult children (see article Beware the dastardly death tax).
Your question is really two questions: first, how can a family use a SMSF as a ‘multi-generational tax haven’ if benefits have to be paid out when a member dies; and second, how can a SMSF be a family SMSF for generations if you can have only a maximum of four members in a SMSF?
Before I respond further to your question/s, I need to clarify the term ‘SMSF Will’ that you use in your question. This term is marketing speak coined by a particular industry professional who educates SMSF advisers, and advises SMSF trustees. The ‘SMSF Will’ is a term used by this professional to describe a strategy that includes a binding nomination and an updated watertight trust deed and that ensures your binding nomination is implemented in the specific way that you intended, taking into account the tax implications for each beneficiary. The creators of this product believe that such an approach eliminates the risk of having your regular will challenged if you otherwise arrange for your super benefits to be paid to your estate.
I personally don’t like the term ‘SMSF Will’, although I support the sentiment in trying to explain a complex area with a familiar word. I believe using the term ‘SMSF Will’, confuses SMSF trustees into believing that a SMSF Will is an actual will, that can automatically protect what happens to your super benefits. The term ‘SMSF Will’ is simply an easy-to-remember term for a particular provider’s approach when planning how your family can receive your super benefits in the most tax-effective way after you die, within your SMSF.
Where there’s a will there’s a super way
Making a regular will means your non-superannuation assets are likely to end up in the hands of those you expect, but a regular will doesn’t necessarily guarantee your super ends up where you want it to. A regular will can control where a person’s super ends up in two instances:
- A binding death benefit nomination is in place. For a nomination to be binding, the fund member must nominate that the death benefit is to be paid to one or more of your dependants (and the percentage allocation for each dependant), or is to be paid to the estate. If a fund member makes a binding nomination instructing the fund’s trustee to pay the death benefit to the member’s estate, the executor of the estate (the person appointed by the will to administer the estate) then pays out the super benefit according to the terms of the will. A fund member needs to be careful about the tax implications of this decision if he or she plans for non-dependants to receive the death benefit, because tax is generally payable when death benefits are paid to non-dependants (see article Dear Dad: Tax for everything)
- No dependants. If you have no dependants, the SMSF trustee (that is, the fund member’s legal personal representative) usually pays the death benefit to the member’s estate. The term ‘dependant’ and ‘non-dependant’ have special meanings (see article Beware the dastardly death tax). If a fund member doesn’t have a will in place, however, the fund trustee may decide to pay the benefit to the deceased member’s next of kin or another person with a close relationship to the member.
A will cannot determine how super benefits are to be distributed after a fund member dies, unless the fund member makes a binding nomination that directs the death benefits to the fund member’s estate.
Death benefits can mean tax, or sometimes a tax refund
The term ‘multi-generational tax haven’ is often used in promotional brochures by financial advising houses to entice individuals to seminars so that the presenters can talk about setting up a SMSF. In its simplest form the ‘tax haven’ relates to the tax-exempt treatment of pension earnings within a super fund, and tax-free benefits for over-60s. Accumulating wealth within a tax-free vehicle (if a fund member is taking an income stream) or a concessionally taxed vehicle (if a fund member has not yet started an income stream) is hard to beat particularly if the fund member is paying high levels of income tax on personal income.
In terms of estate planning, the term ‘tax haven’ can extend to minimising the tax payable on superannuation death benefits paid to non-dependants, and dividing up non-super and super assets in a way that minimises the effect of tax on a client’s children and grandchildren, and also protects the assets from wayward children or children’s spouses.
In terms of creating a SMSF to live on ‘forever’, such strategies can be as simple as adding children or grandchildren to a SMSF, or adding a new member when a member dies. (The four-member rule is an inconvenience for those Australians using a SMSF as a family vehicle, and there many working within the SMSF industry who are pushing for the definition to be relaxed to permit more than four members if the members are related. Unfortunately, this sensible suggestion hasn’t carried and the four-member limit remains in place.)
Alternatively, creating a SMSF to live ‘forever’ can be as complicated as creating reserves to enable the SMSF to claim the refund of contributions tax that may be available when a lump sum is paid to a dependant. The special payment, representing a refund of contributions tax payable, is known as an anti-detriment payment and can represent a handy sum of money for dependants, and an attractive tax deduction for the SMSF (assuming the fund has members in accumulation phase paying tax on fund earnings from which the fund can claim a deduction). Don’t try this at home unless you have an adviser who knows about this rule, and be aware that many advisers are not familiar with this special rule.
Note: When a SMSF member dies, the legal representative of the deceased member can act as trustee of the SMSF until the death benefits are paid or begin to be paid. If an income stream (that is, pension) is paid, only a ‘dependant’ can be a recipient of a death benefit pension. The recipient of that death benefit pension must be, or become, a member and trustee of the SMSF.
Any reader considering any of the issues contained in this article should ensure that they assess their individual needs and conduct thorough research on the options available. I strongly recommend chatting to an estate planning specialist, a superannuation specialist and an accountant.