Tip – The trust deed should include if an effective reversionary pension beneficiary nomination or an effective BDBN prevails over the other. The trust deed must also include rules binding the trustee to payout death benefits in accordance with a members BDBN or revert a pension to a reversionary beneficiary.
Binding Death Benefit Nominations (BDBN)
A BDBN allows a member to nominate who their death benefit superannuation will be paid to. It is crucial to ensure it is well drafted and is updated regularly, particularly when there is a change in family relationships, or the family dynamic is complex with extended family members. Generally, a SMSF deed will include a clause that the BDBN is non-lapsing and dictates what form the nomination takes. However, some trust deeds merely adopt the provisions of regulation 6.17A of the SIS Regs which means that the BDBN must, amongst other rules, be updated every three years (lapsing) and signed by two witnesses who cannot be a beneficiary.
Example – BDBN Documentation gone wrong
In a 2009 Queensland Supreme Court (QSC) Donovan v Donovan case the wording in a BDBN included “wish to be paid to estate”. Unfortunately, the QSC found it did not follow the regulations in 6.17A as it was expressed as a wish. The trust deed incorporated regulation 6.17A which meant the BDBN made by the deceased member was invalid as it did not meet the very strict criteria under the SIS regulations.
Another QSC case Munro v Munro (2015) the BDBN nominated “trustee of my estate” instead of the legal personal representative. The court found the BDBN was invalid as the trustee of my estate is distinct from the legal personal representative (LPR). The LPR is defined under the SIS Act and SIS Regulations to mean the executor of the will.
Refer to our resources page “Set up Process – Binding Death Nominations” for further details.
Non-binding Death Benefit Nominations (NBDBN)
A NBDBN is merely noting the member’s wishes. The SMSF trustee decides who will receive the death benefit. The trustee has a fiduciary obligation to distribute the death benefit in accordance with the member’s wishes and has to determine all possible beneficiaries who may be entitled to receive the benefit. Reviewing the member’s will, death benefit nominations, binding nominations or non-binding, made by the member assists in determining the member’s wishes.
Ultimately it is the trustee who has a discretion to pay the benefit to a beneficiary of the deceased member which in some cases can include themselves. The trustee has to be careful to avoid a conflict of interest when the death benefit payment decision is made. This may be an issue when the surviving spouse, who is also a trustee, is the executor of the deceased member’s estate. A conflict of interest arises between the two roles as the surviving trustee may want to pay the death benefit directly to themselves but as executor of the member’s estate their role is to have the benefits paid to the estate.
Tip – to avoid a possible future conflict obtain specialist SMSF and legal advice which should be part of the role in estate planning.
Reversionary Pension
A reversionary pension nomination allows a deceased member’s pension to continue directly on to the nominated beneficiary. A death benefit pension is quarantined and is limited to a spouse, a person who was financially dependent on the deceased, a person with whom the deceased was in an interdependency relationship or a child of the deceased if the child is disabled or under 18 or between 18 and 25 and financially dependent on the deceased. An adult child of the deceased is excluded from being a pension beneficiary.
The pension minimum does not change and must be met for the year in which the member died. The pension paid will be the sum of the pension payments made to the deceased and to the reversionary pension beneficiary.
The reversionary pension counts immediately in relation to the members total super balance (TSB). This is an important consideration in relation to a member’s eligibility to utilise the following:
- the non-concessional cap
- the remainder amount of the non-concessional bring forward amount
- carried forward unused concessional contributions
Refer to our resources tab “Contributions -Contribution Caps”
A death benefit pension cannot be rolled back into accumulation mode. It can be partially or fully commuted as a death benefit lump sum payment.
A death benefit pension is required to be reported in relation to the member’s transfer balance cap (TBC) which is a cap imposed on the lifetime amount a person can have in pension mode (retirement phase pensions). A reversionary pension is added to the pension beneficiary’s transfer balance account (TBA) 12 months after the death of the original pensioner. However, the capital of the reversionary pension is valued on the date of death which is the amount reported and measured in relation to the TBC. The 12-month grace period can allow time to review options to ensure the reversionary pensioner does not exceed their TBC.
The discussion on reversionary pension beneficiary is based on account-based retirement phase pensions. If you have another type of pension, please discuss this with your SMSF Specialist. It is important to seek financial advice when you are the recipient of a reversionary pension to ensure you do not exceed your TBC or if your updated TSB potentially stops you from using strategies relating to non-concessional contributions in the following financial year.
SMSF Estate planning in conjunction with a member’s will
The SMSF trustee may be directed to pay superannuation death benefits to an estate. Alternatively, the SMSF trustee may exercise their discretion to pay the benefit from your SMSF on your death directly to your estate. When passed on to the estate there is no restriction on who can receive the super benefit. The following considerations should form part of your estate planning:
- the Will should consider distributions paid to beneficiaries from all assets, not just superannuation assets
- understand the effect of tax outcomes on the beneficiary of the superannuation benefits to minimise personal tax for the beneficiary
- to avoid conflict of interest it may be possible to include clauses to allow an executor of a will to pay and also receive superannuation benefits (refer to NBDBN above)
Death Benefit Agreement (DBA)
A DBA forms part of the fund’s trust deed and is generally considered to be non-lapsing unless it is revoked or terminated by the member and replaced with a new DBA. It is an agreement between the member and the trustee which identifies how the member wants their death benefit to be paid. It is more costly than a BDBN and it must be carefully drafted and reviewed regularly.
The Role of the Self-Managed Super Fund (SMSF)Trustee
It is critical to know who will be making decisions about the member’s death benefits to ensure SMSF benefits are paid out as per the member’s wishes.
The trustee of a SMSF has an unfettered discretion to determine who receives death benefits. This means the trustee has a very wide and absolute power which is otherwise offset by their fiduciary responsibility to act in good faith and in fairness to all of the members of the SMSF. However, the courts have demonstrated that they are reluctant to intervene in the trustee’s administration of an SMSF.
The superannuation law allows the trustee’s discretion to be removed but it must be formalised in the fund’s trust deed. Therefore, a member can nominate who the trustee must pay death benefits to.
Change of trustee of the SMSF
When a member dies generally a change to the trustee is required. The fund’s trust deed dictates how the trustee can be changed and when a member who has died ceases to be a member. Most trust deeds allow a deceased member to continue as a member until the death benefits are cashed out. Appropriate paperwork is required to acknowledge the member’s death and to detail the decisions made to change the trustee. The ATO should be advised of any changes to the trustee.
The super law allows a legal personal representative (LPR) to step into the shoes of a trustee at the date of the member’s death until the benefits start to be paid out. The LPR has to be appointed as a trustee as per the fund’s trust deed and the superannuation laws. A SMSF has 6 months to restructure the SMSF trustee. Therefore, the timeframe to restructure the trustee can be extended from the date of death when the LPR can step in to when the benefits commence to be paid plus 6 months which can be beneficial during this sensitive time.
A sole member with individual trustees of an SMSF may want to change the trustee from individuals to a sole director corporate trustee or add in another individual trustee who is eligible to act. Of course, the change of trustee will also be affected by decisions about winding up the fund which may mean a change of trustee is not required, especially if it can be done within the 6-month timeframe.
When a LPR steps into the shoes of the deceased member and the trustee is a company, they have to be appointed as a director and the deceased member has to be resigned as a director. Typically, a mum and dad fund are the two members of the SMSF and the two directors of the company trustee. Many constitutions dictate that a person ceases to be a director upon death. Often the majority of shareholders who are typically, mum and dad, can appoint and resign a director of the company. This becomes problematic when there is no majority.
The company’s constitution needs to be considered when there is no successor director which should be amended as part of estate planning for your SMSF with a corporate trustee.
How Important is an Enduring Power of Attorney (EPOA) for SMSF Estate Planning
An EPOA is an important element of estate planning. An EPOA allows a member who has lost mental capacity or is ill to have their properly appointed attorney make decisions for them in relation to their super. It is critical the attorney is a trusted person who will make decisions based on the best interest of the member. A member who wants their attorney to have the power to make, update or revoke a BDBN on their behalf should ensure the fund’s trust deed allows for it, and it is expressly provided for in the power of attorney agreement. This is critical if a member loses mental capacity and is unable to revoke a nomination which is no longer relevant to their family circumstances. The EPOA must be entered into before the member becomes incapacitated.
The attorney steps into the shoes of the incapacitated member and has to be appointed as a trustee or a director of the company trustee. This is not automatic (refer to Change of trustee of the SMSF above).
Tip – An enduring power of attorney (EPOA) ceases on death and therefore cannot step into the deceased member’s shoes as trustee or director of the trustee of the SMSF.
Who can SMSFs Pay Death Benefits to?
Under superannuation laws SMSFs can only pay death benefits to:
- the deceased member’s legal personal representative (paid out in accordance with the member’s will)
- the member’s dependants
- any other person (not a company or other entity) but only if no estate is in place or the trustee is unable to find any dependants of the member
The fund’s trust deed can limit the above beneficiaries and so it is crucial to understand what your deed says.
Whilst the super laws and the fund’s trust deed determine who the benefits can be paid to the taxation laws determine how the beneficiary will be taxed.
Who is a Dependant for Tax Purposes vs Superannuation Dependant?
| Deceased Beneficiary |
SIS Dependant |
Death Benefit Dependant (Tax Dependant) |
| Spouse |
Yes |
Yes |
| Ex Spouse |
No |
Yes |
| Brother/Sister |
No |
No |
| Parent |
No |
No |
| Child |
Yes – any age |
Yes but limited to under age 18 before the deceased’s death. |
| A beneficiary who had an interdependency relationship with the deceased |
Yes |
Yes |
| A beneficiary who was financially dependant on the deceased |
Yes |
Yes |
Please seek advice from your SMSF Specialist or Financial Adviser in relation to the definitions of the above as it can get complicated.
What tax do Beneficiaries Pay on Death Benefits?
When planning what superannuation benefits you want to pass on to your death benefit nominees it is important to understand the effect of receiving superannuation death benefits has on the beneficiary’s tax situation. The tax treatment of lump sum payments depends on if the death benefits are paid directly to death benefit dependants (dependants for tax purposes), directly to non-dependants or to the trustee of the deceased’s estate.
| Type of Dependant |
Type of Payment |
Tax Payable |
Tax Offset |
| Tax Dependant |
Lump Sum |
Tax free |
|
| Non-Tax Dependant |
Lump Sum |
Generally taxed at 15% plus medicare. If the beneficiary’s marginal tax rate (MTR) is less, than the lump sum is taxed at the beneficiary’s MTR.
Underlying tax-free component remains tax free; taxable component is taxed at 15% plus medicare; untaxed component is taxed at 30% plus medicare (not common) |
Tax offset reducing tax to a maximum of 15% on taxed components or 30% on untaxed components. |
| Deceased Estate |
Lump Sum |
Tax is paid in the hands of the deceased estate based on the tax situation of the beneficiaries expected to receive the super benefits- the estate is not subject to Medicare levy. Underlying tax free components remain tax free to the beneficiary. |
Possibly depending on who it is paid to. |
Death benefit pensions are tax free if the deceased member was 60 at the date of death. If the deceased member was under 60 but the beneficiary is over 60 the pension is tax free. However, if the deceased member was under 60 at the date of death and the beneficiary is under 60 (such as an eligible child of the member) tax is paid at the beneficiary’s marginal tax rate plus medicare. No tax applies to the underlying tax-free component and there is a 15% tax offset on the underlying taxable component. A child in receipt of a death benefit pension will be taxed at adult tax rates and not at the child penalty rates.
Tip – Consider paying an amount above the death benefit pension minimum as a partial commutation. A commutation from a death benefit pension is taxed as a lump sum payment which is tax free. This is useful when both the deceased member at the time of death and the pension beneficiary are under 60 and there are no or little underlying tax-free components.
Common Mistakes to Avoid in SMSF Estate Planning
- Failing to update estate planning documents
- Overlooking the importance of a binding death benefit nomination
- Ignoring the impact of superannuation laws on estate plans
- Neglecting tax considerations for death benefits
- Lack of coordination between SMSF and personal estate plans
- Conflict of interest between BDBN and reversionary pension
- Knowing who is a dependant v non-dependant for tax purposes and SIS purposes
Key Takeaways – Estate Planning within your SMSF
- Estate planning is the process of controlling how your super can be directed to a beneficiary of your choice
- Consider if a BDBN or and a Reversionary Pension Beneficiary is appropriate as part of your superannuation estate planning to payout your death benefits when you die
- Upon your death it is important a death benefit nomination is binding and cannot be litigated due to bad drafting
- If a binding death benefit nomination has lapsed as the trust deed required it to be updated every 3 years then consider updating the fund’s trust deed if you want a non-lapsing BDBN
- Ensure your SMSF trust deed does not have any conflicts about how and in what order death benefits can be paid
- Review the constitution of a corporate trustee to ensure there is a successor director especially if there are only 2 members of the fund and 2 directors of the corporate trustee who also hold equal shares
Do you need help with understanding SMSF Estate Planning?
Give us a call on 1300 392 544 or get in touch online
