SMSFs and estate planning: Issues to consider after the death of a SMSF member

Keep in mind that insurance policies held within a super fund are owned by the fund trustees and not the fund members. The fund member would be the ‘life insured’ on the insurance policy, but the SMSF (trustee) itself would be the owner of these policies.

When a claim is made, the insurance policy proceeds are paid to the SMSF; then the trustees would usually allocate these amounts to the account from which the policy premiums were paid.

For example, if the premium for a member’s life insurance policy is paid from that member’s own member account within the fund, then you would expect any proceeds or payout from that policy to be allocated to that member’s account.

It is also worth noting that some older insurance arrangements resulted in the insurance policy premiums being treated as a general fund expense and not direct from any one member’s account. In these circumstances, you would then expect any proceeds or payout from that policy to be allocated to the SMSF balance for all members.

On the death of a member, the remaining trustees should review how any relevant policy had been treated and allocate any policy proceeds accordingly.

Taxation considerations

SMSF trustees should also consider the relevant tax outcomes that may arise at the fund level.

For instance, where a member’s death benefit needs to be paid from the fund, the trustees may have to sell fund assets to cover these payments. If a capital gain results, it would certainly be worth seeking fund specific tax advice on this.

There may also be pay as you go withholding (PAYG) requirements to consider where a superannuation death benefit is paid from the fund.

This would usually apply where the death benefit is paid directly to a non-dependent beneficiary, for example an adult child of the deceased member. It could also apply where a death benefit is paid as a pension and both the deceased member and the death benefit recipient are under 60.

These requirements often mean the fund must register with the ATO as a PAYG withholder. The fund then withholds the relevant tax from these benefit payments and remits these amounts to the ATO. The trustees would then need to complete the relevant PAYG withholding forms and provide a copy of the form to both the ATO and the death benefit recipient.

The ATO has some very good information for SMSF trustees around the PAYG requirements.

Tax deduction for insurance premiums in the year of death

Another important issue for SMSF trustees to consider relates to the claiming of a tax deduction for insurance premiums that are paid for life insurance and TPD policies held for the fund members.

Most trustees would claim the annual cost of these insurance policies each and every year, including any premium paid in the year of the members death or disablement.

There is, however, another option to consider.

Instead of claiming the cost of the annual insurance premium in the year of death or disablement of the member, the trustee can actually claim what is referred to as a ‘future service period’ deduction.

Essentially this means that the trustees forego claiming the annual cost of the relevant insurance premium in that year AND each year moving forward! So foregoing all tax deductions for relevant insurance premiums forever.

Instead, the trustees claim a future service period deduction when the member’s benefit is paid out from the fund. This requires the payout to be split into two parts:

1. The period from when the member joined the fund up until the date of the insurance payout.
2. The period from the date of the insurance payout until the members ordinary retirement date (age 65).

It is this second amount that can then be claimed as a tax deduction and would usually be considerably more than any annual premium deduction that may be allowed. Any unused amount of the deduction can be carried forward into future years.

Where the deceased or disabled member is relatively young and would therefore have many years until reaching age 65, the relevant tax deduction can be so large that the fund may never again have to pay earnings tax!

As this area of taxation law can be confusing and also dependent on the individual circumstances of each member, it would certainly be worth seeking fund specific tax advice on this.

The future of the fund

Where a fund member passes away, it’s up to the remaining SMSF trustees to ensure their fund continues to meet the legislative requirements around trusteeship; that is, someone has to fulfill the trustee role for the now deceased member.

If this is not addressed appropriately, and within the required time frame, the SMSF may fail to meet the ongoing compliance requirements.

It may be that the legal personal representative of the deceased steps in and takes on this role. They can act in this position until the deceased member’s benefits start to be paid from the fund. At this stage, a more permanent restructure may be required.

In some cases, the deceased member may have already put in place appropriate paperwork that allows a nominated person to automatically step in and act as Trustee or Director, by using replacement director nominations.

Where the remaining trustee(s) has had little to do with the ongoing management of the SMSF, or lost the drive to do so, they may decide that it’s a good time for changes to occur. This could include:

• Winding up the SMSF and rolling over remaining balances to another non SMSF superfund; or
• Converting their SMSF to a small APRA fund, whereby an approved APRA trustee is appointed to take over the trusteeship of the SMSF. This may allow the fund to maintain its existing assets without the need to sell, but have a professional trustee take over management of the fund.

The bottom line

The death of an SMSF member will require action by the remaining trustees in a relatively timely matter. Many of these required steps and actions can be simplified where you have plans in place.

Taking a few hours out of your busy schedules now to sit down with an estate planning professional will often assist when a significant event occurs. It can also save you a lot of time and frustration when these events ultimately occur.

The information contained in this article is general in nature.