A well-considered estate plan will make life easier for any beneficiaries – the invaluable parting gift. 

For self-managed super funds, now numbering around 600,000 and with assets approaching $900 billion, estate planning has never been more important. This is especially the case when the Productivity Commission estimate of a $3.5 trillion wealth transfer over the next 20 years is added to the mix. A sizeable percentage of this $3.5 trillion will reside in SMSFs.

Yet there is often confusion around this important aspect of SMSF planning, especially among trustees who don’t seek specialist advice in what can be a complex issue.

For those who don’t plan properly, the consequences can be disastrous – both for the intended beneficiaries and even the value of the inheritance. The instances where the lack of clear directions have resulted in bitter and costly disputes are well documented.

The result can be lengthy delays in settling an estate, divided families and the potential for higher taxes reducing the size of the inheritance.

The payment of a death benefit from an SMSF is a good example. The benefit needs to be paid as soon as practically possible but to whom? Under super law, a beneficiary includes a spouse (same sex, husband/wife or de facto), children of any age (including ex-nuptial, adopted or step) and any person with whom the person has an interdependency relationship.

The member may have made a death benefit nomination asking the SMSF trustees to pay the benefit to the nominated beneficiaries. Subject to the fund’s trust deed, a death benefit nomination can be either binding or non-binding on the trustees. Regardless of what type of nomination it is, the SMSF trustees must still ensure the nominated beneficiaries are entitled to receive the death benefit under the trust deed and super law.

It is possible for members to nominate that their death benefit be paid to their estate. The SMSF trustee may also choose to pay a member’s death benefit to the estate if the deceased member did not nominate a beneficiary. If the benefit is paid to the deceased member’s estate, the executor of the estate will then distribute the benefit according to the instructions in their will.

Payable as a pension

Then there is the issue of how they are paid. It can be paid as either a lump sum or as a retirement income stream – unless the beneficiary is an adult child of the deceased, in which case the benefit can only be paid as a lump sum. But if the child of the deceased is under 18 or is 18 or over but under 25 and financially dependent on the deceased or is disabled, it can still be paid as a pension.

When a death benefit is paid as a pension, it cannot be paid to an estate. Then there is the issue of reversionary or non-reversionary pensions. With the latter, it ceases being paid on the member’s death, so any remaining pension balance in the deceased’s super account will need to be paid as either a lump sum death benefit and/or as a new pension to the deceased’s dependants (subject to the rules explained earlier).

A reversionary pension, however, enables a dependant (generally a spouse or a child in the circumstances explained earlier) to be nominated to automatically receive the deceased’s super pension. A reversionary nomination makes it clear to the trustee of your super fund who you want to continue receiving your super pension on your death.

Be aware of tax benefits

There is no doubt that a reversionary pension comes with advantages, including giving the member certainty about who will receive their super benefit on their death. It is also a relatively seamless and easy way to transfer your benefit to your dependants and the assets remain in the super system to continue enjoying preferable tax treatment. But there can be a downside such as having a negative impact on social security benefits, and it eventually (12 months after your death) counts towards the transfer balance cap of the recipient of the reversionary pension.

There is also the issue of whether it is better for the death benefit to be paid directly to the beneficiary or the deceased’s estate. If paid directly, it is typically less complicated and a quicker process as there is no need to wait for probate or a letter of administration.

It also has the benefit of not exposing benefits to creditors of the deceased or notable estate claims, and there can be clear direction if there is more than one beneficiary.

Paying the benefit to the estate means there may be tax benefits as the Medicare levy does not apply and, as the benefit has been removed from the superannuation system, there are no knock-on transfer balance cap issues for the recipient of the benefit. If structured correctly, there may also be asset protection and capital preservation benefits.

All this suggests estate planning requires careful thought long before the inevitable occurs, especially as the sums involved are increasing exponentially. The added bonus is that a well-considered estate plan will make life easier for any beneficiaries – the invaluable parting gift.

Written by John Maroney, CEO, SMSF Association. 
First published in the Financial Review on 27th April, 2022