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. I thought that the super money could not remain in the fund indefinitely because eventually the fund member dies, 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, the related tax rules, and inheritance rules is essential.
Background: Benefits paid from a super fund, after the member dies, are known as superannuation death benefits and can only be paid to certain individuals, or to your estate. Individuals that can receive death benefits directly from a super fund are known as ‘dependants under the superannuation laws’, and this category of recipient can include:
- Your spouse, children under the age of 18, financially dependent adult children or other financially independent individuals, and also individuals who had an interdependency relationship with you. This category is known as death benefit dependants (‘dependants under the tax laws’). Death benefits paid to dependants under the tax laws are tax-free in the hands of the dependant.
- Your financially independent adult children. Your adult children are considered dependants under the super laws (so they receive your death benefits from a super fund), but they are considered non-dependants under the tax laws, which means benefits tax is payable on the taxable component of the benefit.
- Other individuals who do not fall within the two categories above. Death benefits paid to non-dependants under both the superannuation laws and tax laws are generally first directed to the estate of the deceased fund members, after tax has been deducted (for more information on the tax treatment of death benefits, see SuperGuide article Superannuation after-life: Beware the dastardly death tax).
Your question is really two questions:
- How can a family use a SMSF as a ‘multi-generational tax haven’ if benefits have to be paid out when a member dies?
- 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 (and it seems to increasingly be used by others in the SMSF sector) to describe a strategy that includes a binding nomination and an updated watertight trust deed, which 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 under the tax laws’ (see SuperGuide article Superannuation after-life: Dear Dad, Tax for everything).
- If there are NO dependants. If a fund member does not have 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 text earlier in article, and also SuperGuide article Superannuation after-life: Beware the dastardly death tax, and the cap). 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.
Note: 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. Some large superannuation funds automatically pay superannuation death benefits to a deceased fund member’s estate, rather than rely on nominations from the fund member.
Death benefits can mean tax, and before July 2017, sometimes resulted in 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 SMSFs. In its simplest form, the ‘tax haven’ relates to the tax-exempt treatment of 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 a super pension) or a concessionally taxed vehicle (if a fund member has not yet started a super pension) 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 are many working within the SMSF industry who have pushed 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.)
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, a super pension) is paid, only a certain type of ‘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.
Anti-detriment payments: Until 30 June 2017, creating a SMSF to live ‘forever’ could be as complicated as creating reserves to enable the SMSF to claim the refund of contributions tax that may have been available when a lump sum was paid to a dependant. The special payment, representing a refund of contributions tax payable, is known as an anti-detriment payment and could represent a handy sum of money for dependants, and an attractive tax deduction for the SMSF (assuming the fund had members in accumulation phase paying tax on fund earnings from which the fund can claim a deduction). This strategy was abolished from 1 July 2017 (for more information, see SuperGuide article Anti-detriment payments banned since July 2017).
New transfer balance cap for pension may cause problems for superannuation death benefits
Since 1 July 2017, the government has imposed a cap on the amount of super that can be transferred into pension phase (see SuperGuide articles Retirement phase: A super guide to the $1.6 million transfer balance cap and Superannuation death benefits and the $1.6 million transfer balance cap). The government has also abolished the anti-detriment payment rules (see SuperGuide article Anti-detriment payments banned since July 2017).
Important: If you are part of a couple, and the combined super benefits of your spouse and yourself are likely to exceed $1.6 million when one of you pass away, then note that any benefits either of you receive a death benefit, will count towards the surviving spouse’s individual transfer balance cap, and a death benefit lump sum may not be able to be retained in the super system due to the transfer balance cap rules.. Note that this scenario could also arise with any dependant eligible to receive a superannuation death benefit. For more information, see SuperGuide article Superannuation death benefits and the $1.6 million transfer balance cap.
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.
For more information on superannuation death benefits, see the following SuperGuide articles:
- Superannuation death benefits and the $1.6 million transfer balance cap
- Superannuation after-life: Beware the dastardly death tax, and the cap
- Superannuation after-life: Dear Dad, Tax for everything
- Death benefits: Is a binding DBN different from a reversionary pension?
- Anti-detriment payments banned since July 2017
- SMSF pension earnings remain tax-free after death