Estate planning is often overlooked or neglected by superannuation investors. A broad and complex topic, it can be made easier by breaking down the key elements.
This article won’t address all financial and legal issues in depth, especially for non-super assets. Instead, in the context of SMSFs, we will highlight some tricky areas, reinforce the need for proper planning and updating, and suggest strategies to manage certain situations.
Past learnings loom large
Superannuation is not automatically part of your personal estate, so from the outset decisions will need to be made as to what happens to it when you die.
It’s important to note that the provisions of the trust deed of the SMSF take precedence over any instructions given in a will. In other words, creating a will and automatically expecting it to be a binding authorisation of where super benefits are to be paid won’t work.
There are real-life examples of where SMSF trustees have ignored the deceased’s wishes in a will and re-directed the payment of super death benefits, such as the well-known Katz vs Grossman case in 2005. Such situations can leave children or spouses out in the cold, denied hundreds of thousands or even millions of dollars.
A will is still a critical part of any estate plan, but let’s first explore how to structure a SMSF in this context.
Control, update, be ready
Who controls the SMSF on death is the bedrock for decisions on what happens to assets. Taking a step back, how is the control organised and structured to avoid emotional stress or disastrous court battles?
It starts with having an updated SMSF trust deed. Quality and currency matters with your trust deed, not just to meet legislative requirements but to benefit from innovations in the industry. New changes came in from 2017 and the number of trustees is also due to be increased from four to six from July 1, 2019. Careful selection of trustees is not taken lightly, from a trust and responsibility viewpoint.
The trust deed should reflect what you want to achieve – do you want to pay a lump sum of assets, or provide for an income stream? With many SMSF operators ageing, industry players suspect a critical point is nearing. One scenario involves two SMSF trustees, a husband and wife. If the more “active” trustee dies or becomes seriously ill with dementia, for example, the less active trustee may not be adequately prepared to make key decisions. An enduring power of attorney may be useful here.
Having a corporate trustee rather than an individual trustee arrangement can be favourable for estate planning – SMSFs with a corporate trustee can continue with a single corporate trustee if a trustee director of the two-person fund dies. Also, a sole purpose corporate trustee does remove the need to change ownership of every investment and account when a trustee dies.
Similarly, bespoke SMSF trust deeds can have clauses that limit death benefit distribution, control and beneficiaries. Again, if the trust deed is updated you will need to ensure these clauses remain or are still relevant. Decide what asset ownership structure works for you, and weigh up the time/costs involved under each arrangement.
Further to this, properly prepared change of trustee documentation is important in disputes that arise from divorce, or the death of a trustee/member. It helps avoid having the validity of the appointment of new trustees challenged. Similarly, your succession planning documentation which sets out any death benefit nominations or reversionary pension distributions needs to be complete, thorough and signed.
Assets and death benefits: getting it right
There are several ways to ensure the desired distribution of your super assets. Read our articles on Binding death benefit nominations (BDBNs) and reversionary pensions, which cover the major tax and financial implications.
It is critical that BDBNs remain consistent with the deceased’s intentions, as changing life, tax and relationship circumstances play a major role here. BDBNs are not always seen as entirely optimal for SMSFs, given the lack of flexibility for trustees to assess the current situation at time of death. One strategy may be to ensure a favoured beneficiary is left in control of the SMSF, and thus how the proceeds are managed.
Reversionary pensions can be suitable in an estate planning context – multiple pensions can be set up for different beneficiaries, protecting those who may be vulnerable. They automatically pass to a dependent upon the member’s death, providing certainty and minimising potential legal challenges. Having an existing pension continuing to be paid to your spouse upon your death is a simple and tax effective way of managing SMSF death benefits. Your spouse can commute (stop) the pension partially or in full if they want a lump sum.
A will is important where SMSF benefits are paid to the legal personal representative (LPR). Note that the LPR doesn’t automatically take the place of the deceased individual trustee – the trust deed must allow this. The LPR has major control over how death benefits are to be paid, but they still must abide by any binding death benefit nomination still in place.
In a worst-case scenario of being diagnosed with a terminal illness, you can access your super as a lump sum at any age and distribute to any persons of your choosing.
While we don’t discuss life insurance outside of super here, if you have this in place and are the policy owner, ensure that you have nominated a beneficiary otherwise the proceeds will be paid to your estate. Life insurance within your SMSF has tax advantages, but all payouts must now satisfy a condition of release, otherwise they may be held in the fund.
Can trusts and SMSFs work together?
Testamentary trusts are another option, where super funds become part of the estate under a will and can be directed to beneficiaries. They can be quite tax-effective, especially for minors. This can protect assets inherited by your children if their own relationship or marriage should break down.
Family trusts may also be an option, mainly as an intergenerational wealth transfer mechanism. It is not necessarily a case of family trusts vs SMSFs – both can complement each other. In a family trust, assets are owned by the trust rather than the individual. If one spouse dies or the $1.6 million super transfer balance cap is reached, trusts can act as a secondary investment vehicle.
Personal use assets such as holiday homes, as well as businesses, can be placed in family trusts. Family trusts can be established at any life stage to assist with wealth creation and continue upon death, keeping investments in place. Family trust deeds are also relatively simple to establish, and often require little amendment.
Blended families – is yours one of them?
With a high divorce rate and blended families more common, that raises new questions as to estate planning.
A husband and wife in their second marriage may both have children from their first marriage. Will makers, when they die, want to ensure their spouse receives estate benefits, but also that their own children benefit if their surviving spouse dies. A surviving spouse could change their will and leave everything in their estate to their own children.
One way to manage this risk is to have mutual wills. A mutual will is when each spouse agrees not to change their will if their spouse dies, and both agree on the beneficiaries of any assets – usually children of each spouse, including those from previous relationships. Changing circumstances also play a role here in testing the effectiveness of the agreement, especially if the surviving spouse is unfairly disadvantaged or cannot liquidate assets for any reason under the terms of the will.
For super death benefits, they can be received tax-free by a surviving spouse of the deceased member, but tax is payable if it goes to adult non-dependent children of the deceased member. Be careful in drawing up an agreement whereby a spouse who receives tax-free death benefits is obliged under the deed to give some or all these benefits to a non-dependant, as the ATO may well consider this a tax-avoidance scheme.
While death benefits can be payable to your step-children, after your death your children no longer qualify as the step-children of your former spouse and cannot be the beneficiary of their superannuation death benefits, unless they qualify as financial dependants or interdependent relations.
If you think your family is likely to dispute something if you die, you may consider creating a second SMSF so that each spouse has one. That separates the interests of both families and can give greater certainty for death benefit distribution – not to mention less likelihood of ending up in court.
Small APRA funds
Moving from a SMSF to a small APRA fund is not necessarily common or a recent trend. However, they can have benefits from an estate planning perspective, for blended families and for the elderly with diminished capacities or willingness to put in the time to run a SMSF.
A small APRA fund (SAF) is basically a self-managed super fund with a professional trustee. You won’t have the trustee responsibilities or risk of compliance oversights, and you get to maintain control of your investments.
It comes at a cost, of course, but you can set up an income stream for an intellectually-disabled relative, among other things. It might also be useful if you are moving or living overseas and thus are ineligible to be a SMSF trustee.
Summary and moving forward
One reason why estate planning is not black and white is that it relates solely to people’s lives, their changing circumstances, and in some cases, their eligibility for death benefits or even to take on the role of a trustee.
As a checklist, note the following to ensure your estate planning is in the best shape possible.
- Check your trust deeds and have them updated when your circumstances, or those of family members, begin to change.
- Select trustees carefully and recognise the time and costs involved in various structures.
- Ensure your lawyer, accountant and other SMSF advisers prepare complete and signed documentation.
- Be clear on your wealth generation objectives after you die – what type of income streams, under what asset structures, do you want for living beneficiaries?
- Have a clear strategy for super and non-super assets.
- Have a current will and adjust if necessary for changing family or other situations so that it properly reflects your wishes.
- Ensure any death benefit nominations are properly structured and documented, taking tax and legal issues into account.
- Consider complementary vehicles alongside SMSFs that may help with estate planning, such as trusts or other specialist retirement products/advice.