Understanding SMSF | Death of a Member

Death, much like taxes, is inevitable and something your SMSF will eventually have to deal with.  It is important to understand how a death of a member is dealt with and the effect on the continuity of the SMSF. It is important to be aware of what is permitted under the superannuation laws and regulations (SIS). The SMSF trustee must review how the fund’s death benefits are paid in accordance with its trust deed, the deceased’s will, potential beneficiaries and any binding or non-binding death benefit nominations or a death benefit agreement.

Dealing with the death of a member in a timely manner

The death of a SMSF member requires a compulsory payment. The deceased member’s superannuation must be cashed “as soon as practicable“. The ATO generally considers this to be within six months. If the delay in handling the death benefit exceeds this time frame, the trustee should document the reasons why the payment of the death benefit was delayed.

Factors which may cause delays include:

• calculating the deceased member’s account balance
• obtaining valuation of fund assets especially complex property or unit trusts
• seeking advice determining who the death benefit should be paid to and the form in which they should be paid
• dealing with legal disputes and locating potential beneficiaries

Hint – A death benefit can be “cashed out” or withdrawn as cash or an in-specie payment or it can be retained in the fund and “cashed out” or paid as a new death benefit pension, or an existing pension can revert automatically to a reversionary pension beneficiary provided they were elected prior to the death of the member.

How can the death benefit be paid?

Death benefits can be paid out as lump sum payments or retirement phase pensions (account based pensions) or a combination. Death benefits can be rolled over to another fund for immediate cashing i.e. consolidate all of the deceased benefits into their SMSF and then establish a death benefit pension.

Death benefits cannot be retained in the accumulation phase.

Lump sum payments are limited under SIS to a maximum of two lump sums payable as an interim payment and a final payment. This is probably not so bad as it is per beneficiary and each super interest held by the deceased member.

There is no limit on the number of pensions that can be established.  There are, however, limits on who can receive a death benefit pension.

A death benefit pension is quarantined and cannot be rolled back into accumulation phase. Cashing out or commuting part or all of a death benefit pension is counted as a death benefit lump sum payment and tax free if paid to a spouse or other death tax dependant.

A reversionary pension, including a transition to retirement pension (TRIS) automatically transfers to the reversionary pensioner, who is usually the spouse, as a death benefit pension. On death a TRIS is no longer subject to restrictions and moves into retirement phase. The reversionary pension beneficiary must be a dependant who is able to receive a death benefit pension, or the pension may have to be cashed out as a lump sum.

Who can death benefits be paid to?

Death benefits can only be paid to:

• the deceased member’s legal personal representative (meaning the estate of the deceased member)
• one of more of the member’s dependants
• any other person (cannot be a company or a trust, it must be an individual) BUT only if no dependants can be found and the deceased member has no estate

Hint – The definition of a dependant for SISA differs from the tax definition. Death benefits are tax-free when paid to a tax dependant. The eligibility of a dependant to receive a death benefit is determined under SISA. The most common dependant is a spouse who is a dependant for SISA and tax purposes. A spouse includes a de facto partner or a same sex partner.

Death benefit pensions are limited to:

• a spouse
• a child under 18 years or a disabled child
• an individual who the deceased member shares an interdependency relationship (other than a child)
• an individual who was financially dependent on the deceased but not including the deceased’s children (except if they are between 18 and 25)

Generally, death benefit pensions cannot be paid to adult children. A death benefit pension paid to a child (except if the child is disabled) who was under 18 at the time of the member’s death must commute the pension when they reach 25 and any leftover pension is paid as a tax-free lump sum.

Other considerations

Consider the following:

• how the surviving spouse’s transfer balance account (TBA) is affected
• what is the spouse’s transfer balance cap (TBC) which is the maximum amount a member can have in pension phase and how will it be impacted by the receipt of the deceased’s death benefit?
• the death benefit cannot be rolled back into accumulation phase
• a reversionary death benefit pension is required to be reported near the time of the member’s death vs a non-reversionary pension which is reported near the time it is started
• when to value the pension which is on the death of the deceased in relation to a reversionary pension and when the pension is started for a non-reversionary pension.
• Importantly a reversionary death pension does not get added to the spouse’s TBA until 12 months after the member’s death allowing time to roll back the spouse’s pension, or part thereof, to make room for the death benefit pension
• a reversionary death pension is counted towards the spouse’s total superannuation balance on the death of the member, but a non-reversionary death pension does not count until the new death benefit pension is started which can impact on the eligibility of the spouse to make non concessional contributions, use the bring forward rule and make catch-up concessional contributions
• consider if tax is required to be withheld on the death benefit payment

How does the death of a member effect the SMSF Structure?

Is it time to wind up the SMSF or where the trustees are individuals should the trustee be changed to a sole purpose corporate trustee or appoint dear aunty Susie as the second trustee?

On the death of a member change is inevitable. A SMSF has six months to restructure the SMSF, but this can be extended if the deceased member’s legal personal representative (LPR) can step in as an individual trustee or as a director of the corporate trustee.

An LPR does not automatically step in but must be properly appointed. SIS allows that a LPR can be appointed but the appointment must follow the rules in the SMSF’s trust deed and governing rules.  Furthermore, if the trustee is a company the appointment of a new director is in accordance with the company’s constitution.

The LPR can act as a trustee/director until the death benefits start to be paid out.

Changes to the trustee/director of the SMSF trustee must be reported to the Australian Taxation Office (ATO) and Australian Securities and Investments Commission (ASIC) where there is a change to a director of the corporate trustee.

Death of a member is often a pivotal point to change individual trustees to a sole purpose corporate trustee. Typically, mum and dad have operated their SMSF with individual trustees. When one of them dies, the surviving spouse cannot continue to act as a sole individual trustee.  Resigning as a trustee and appointing a single director trustee company means the spouse can continue to operate the fund without having to appoint a relative or other eligible person to act as a second trustee.

It is crucial to ensure the title of the fund’s assets reflect the current trustee of the SMSF. Where a SMSF already has a corporate trustee there is no requirement to change the title of fund assets. However, if changing from individual trustees to a corporate trustee or removing the deceased and appointing a new individual trustee the title of all fund assets must be changed accordingly. A fund heavily invested into properties or other complex investments can find this process costly and time consuming.

Death is one of the many reasons why a sole purpose trustee company is the best option when setting up your SMSF.