Superannuation and estate planning

David O’Connell says advisers need to tread carefully when dealing with retirement savings and implementing clients’ wishes effectively.

For many Australians, superannuation forms a significant proportion of their wealth when they die and may even be the primary source of assets (outside of the family home) to be passed to dependants. Superannuation benefits often do not form part of the deceased’s estate and are subject to superannuation rules in relation to distribution and taxation. As such, when reviewing estate planning, it is important to ensure that clients’ superannuation will be distributed efficiently, according to their wishes.

An advantage of superannuation benefits over estate assets is that they can be paid to beneficiaries directly from the superannuation fund. This can mean greater certainty over who receives an inheritance, and such inheritances may be received more quickly. However, there are limitations on who can be paid directly from a superannuation fund.

Superannuation dependants

The trustee of a superannuation fund may generally only pay death benefits to a dependant or the deceased’s legal personal representative. A dependant is defined in the Superannuation Industry (Supervision) Act 1993 (the SIS Act) as:

• a spouse of the deceased, including members of de facto couples;

• a child of the deceased; or

• someone with whom the deceased was in an interdependency relationship.

‘It is important to ensure that clients’ superannuation be distributed efficiently’

If members would prefer some or all of their superannuation benefits to be paid to someone other than those in the above list, they would need to have that portion paid to their legal personal representative and make a provision for that person in their Will.

All beneficiaries who are entitled to receive death benefits directly from a superannuation trustee are allowed, under superannuation legislation, to take that benefit as a lump sum. However, there are restrictions on who can receive death benefits as an income stream. While most of the aforementioned dependants can receive the benefits as an income stream, children of the deceased who are aged over 18 can only receive an income stream if they are:

• financially dependent and under 25; or

• disabled. Where children of the deceased receive death benefits as an income stream, the income stream must be commuted and the benefits withdrawn as a tax-free lump sum no later than their 25th birthday, unless they are disabled.

As with a lot of aspects concerning superannuation, the legislation specifies what is allowable; however, individual funds may have further restrictions in place through their trust deeds.

Nominations

Superannuation fund members can advise the trustee of their wishes in relation to the distribution of their benefits by making a death benefits nomination, which can be either binding or non-binding.

Binding

With a binding nomination, as long as the nomination is valid, the trustee is obligated to pay the death benefits to the beneficiaries nominated and in the specified proportions.

Non-Binding

In contrast, a non-binding nomination leaves the payment of the death benefits to the discretion of the trustee. The nomination will be taken into account but the trustee will make its decision based on a variety of information and may call for submissions from other potential beneficiaries.

Death benefits dependants

How death benefits are taxed depends on the recipients, the payment method and the tax components. Where the beneficiary is a death benefits dependant, as defined in the Income Tax Assessment Act 1997 (the Tax Act), and the benefits are paid as a lump sum, the benefits are tax-free. A death benefits dependant includes the following persons:

• a spouse of the deceased, including members of de facto couples;

• a former spouse;

• a child under 18;

• someone with whom the deceased was in an interdependency relationship at time of death; and

• someone who was dependent on the deceased at the time of death. For lump sums only, where the deceased was a member of the Defence Force, Police or Protective Services and died in the line of duty, the beneficiary is always a death benefits dependant.

Where the benefits are taken as a pension, the taxation treatment depends on the age of the deceased and the beneficiary and the Taxable Components (TCs) of the pension payments, as shown in Table 1.

Taxation of benefits to non-dependants

Where the beneficiary is not a death benefits dependant, the benefits must be taken as a lump sum and the TC of the benefit will be subject to:

• tax of up to 15 per cent plus Medicare Levy on the taxed element; and

• up to 30 per cent plus Medicare Levy on the untaxed element. While the definitions of dependant in the SIS Act and death benefits dependant in the Tax Act are substantially the same, there is a notable difference. Adult children are SIS Act dependants and, therefore, can be paid directly by the trustees of the superannuation fund. However, as they are not death benefits dependants as defined in the Tax Act, the benefits will be subject to tax.

For tax purposes, the beneficiary to be considered is the ultimate beneficiary. Therefore, a benefit that passes through the estate but is paid to a death benefits dependant will be tax-free. There can be an issue where the benefits are paid to the beneficiaries via a testamentary trust. While it may be envisaged that the only persons to benefit from the fund are death benefits dependants, the trust may have potential beneficiaries who are not death benefits dependants, in which case all benefits appropriated to the trust will be subject to tax.