SMSF wills versus testamentary trust wills – what’s the verdict?

Estate planning for clients with a significant balance in a self-managed superannuation fund (SMSF) has always posed special issues for the professional planner.

One view is that, to promote certainty for dealing with the client’s super on death, plus provide asset protection and potential tax savings on investment income, the client should make a binding death benefit nomination (BDBN) to their estate, and make a Will which incorporates a testamentary discretionary trust (TDT) of which the client’s spouse and children are beneficiaries.

This means that:
• if the super death benefit goes into the TDT, it may be protected from a claim against one of the beneficiaries;
• investment income can be tax effectively split – especially amongst minor children; and
• in a “blended family” situation the terms of the TDT can be tailored for the death benefit to provide income for the client’s current spouse for life, and on their death the capital will benefit the client’s children from a previous relationship.

Tax-free status

All good – but how do you preserve the tax-free status for a super death benefit paid to a “death benefits dependant” for tax purposes for your client? In a TDT Will, you can restrict the TDT beneficiaries to death benefits dependants, but this sacrifices the ability to distribute to other beneficiaries such as minor grandchildren. Plus, what if the only death benefits dependant is the surviving spouse? Last but not least, the assets are no longer in the superannuation environment, eliminating any possibility of setting up a tax free income stream for the surviving spouse.

An alternate view is for your client to only make a non-binding nomination to their estate, so that (where appropriate) you can instead set up a tax free pension for their surviving spouse. The downside (from your client’s perspective) is that a non-binding nomination is, well, non-binding and therefore provides less certainty.

Plus, once a pension is paid to the surviving spouse the client’s death benefit essentially becomes the spouse’s asset, so the client must trust that the surviving spouse on their death will use the balance (if any) to benefit the client’s children via the spouse’s own Will (which can be changed after the death of the client). There is therefore the risk that the client’s trust may ultimately be misplaced, especially in a “blended family” situation where the surviving spouse also has children of their own who are not children of the client.

A “mutual Wills” arrangement might be used, but that raises other issues such as enforceability, inflexibility if the surviving spouse’s circumstances change, and so forth.

Is there another strategy?

Enter the so-called “SMSF Will”, which is essentially a non-lapsing, conditional BDBN drafted in very specific terms that dictates how a death benefit is to be paid in particular circumstances. Importantly the trust deed for the SMSF must support the making of such a BDBN. This can provide:
• tax free income via pensions for the client’s spouse and (if the client was over 60 years old) the client’s children up to age 25 years (longer for a child with a qualifying disability);
• tax free investment earnings within the SMSF pension account;
• asset protection for the SMSF assets (excluding contributions made to defraud creditors);
• with appropriate wording, the ability to cater for a “blended family” situation by providing for a non-commutable pension to the client’s surviving spouse for life, and on death for any remaining balance to be paid to the client’s children or to the client’s estate (and perhaps ultimately to a TDT, enabling the client to “have their cake and eat it too”).

So what’s the verdict? If your client has a large super balance, a spouse and young dependant children, a customised “SMSF Will” can provide a winning combination of asset protection, tax efficiency and (coupled with a well-drafted TDT Will) flexibility to provide for your client’s current family and future generations.