23 September 2019
By Colin Lewis,
Planning for the inevitability death – while morbid – is important. It gives you comfort knowing that what you’ve accumulated will go to your intended beneficiaries and it gives your loved ones, peace of mind knowing they’ll be looked after.
On death, when it comes to your superannuation, only your spouse (including de facto partner), children (of any age), someone financially dependent on you or with whom you were in an interdependency relationship at the date of death, can receive it directly from your super fund.
If for whatever reason you don’t want your super to be paid directly from your fund to any of these people, or you want it to go to someone else, say a sibling, nephew/niece, charity etc, then you must nominate your legal personal representative (LPR) – typically the executor of your estate – to receive your death benefits. Death benefits paid to your estate will then be distributed to your intended beneficiaries in accordance with your Will. So, make sure you have a Will.
Super death benefits paid to your estate
Death benefits paid to your LPR, who is executor of your estate, are taxed in the hands of the executor in the same way they would have been taxed had those benefits been paid directly to those persons who benefit from the estate.
Accordingly, where a beneficiary who was a ‘tax dependant’ at time of death receives some or all the death benefits, that benefit is tax-free in the hands of the executor.
Tax-dependants include your spouse, minor children, someone with whom you were in an interdependency relationship, or someone who was financially dependent on you (which may include a child between 18 and 25 who was dependent on you).
Similarly, where a beneficiary who was a ‘non-tax dependant’ receives the death benefits, that benefit is taxed in the estate as if it were paid directly to the non-tax dependant. Tax on any taxable component of that benefit is levied at 15 percent (taxed element) or 30 percent (untaxed element). As the estate is not subject to Medicare levy, at least these beneficiaries save two percent.
Ascertaining who benefits from an estate is straightforward where death benefits are bequeathed to specific beneficiaries in the Will.
It’s more difficult where beneficiaries are not specifically nominated, say where death benefits are paid into a testamentary trust for the benefit of a range of beneficiaries, and it may not be possible to determine the extent to which non-tax dependants are expected to benefit. Given this uncertainty, many trustees take a conservative approach and treat the entire payment as being paid to a non-tax dependant, with a tax on any taxable component levied at up to 30 percent.
One way to ensure super death benefits paid to an estate remain tax-free is to establish a superannuation proceeds trust (SPT).
These trusts are suitable for people that have ‘tax dependents’ who are minors, vulnerable, spendthrifts, gamblers, or have a drug addiction.
What’s a superannuation proceeds trust?
An SPT is a trust that is funded by superannuation death benefits.
Generally, it’s established under the terms of a person’s Will to manage their super death benefits for the ultimate benefit of various beneficiaries, instead of those beneficiaries inheriting the death benefits directly from the super fund, say because of asset protection concerns.
Where an SPT is established by a Will, it starts when its trustee receives the super death benefits from the executor of the estate.
Beneficiaries of SPTs should only be individuals who were tax dependants of the deceased at date of death, i.e. their spouse, minor child/ren, someone with whom the deceased had in interdependency relationship, or someone who was financially dependent on the deceased.
There’s no tax on payment of super death benefits to the SPT and minor beneficiaries are taxed at ordinary adult rates, rather than at penalty child rates.
Take Doug. When he died, he was survived by his wife Joan and their two children Janet aged 20 and Gary 16. Janet lives with friends and doesn’t rely on her parents for financial support.
Doug’s death benefit nomination instructed the trustee of his super fund to pay his death benefits of $800,000 to his LPR (being the executor of his estate).
Doug’s Will provided for his entire estate, including the death benefits, to be paid into a discretionary testamentary trust, the beneficiaries of which are Joan, Janet, Gary, his brother Raymond and certain charities.
Whilst Joan and Gary were Doug’s tax dependants when he died, Janet, Raymond and the charities are not. Consequently, the entire death benefit paid to the testamentary trust may be treated as if it had been paid to non-tax dependants. If the entire death benefit comprised a taxable component, then there will be tax of at least $120,000 to pay.
Had Doug established an SPT for the benefit of Joan and Gary, and made alternative provision for Janet, Raymond and the charities by allowing them to inherit other assets, this tax could have been avoided.
Also, the SPT enables any earnings, including capital gains, distributed to Gary to be taxed at ordinary adult rates.
Doug can vest the trustee with wide-ranging powers and the identity of the trustee is not limited, making the SPT extremely flexible.
In addition, trust assets are protected from creditors in the event of bankruptcy of any beneficiary.
An SPT can be a useful vehicle to grow wealth over the long term for Joan and Gary. Had a superannuation death benefit pension been paid to Gary, it would need to cease by his 25th birthday, unless he is disabled.
To ensure your super is paid in accordance with your wishes to your intended beneficiaries in a tax-effective manner, there’s a range of tax, superannuation, asset protection and estate planning issues that need to be considered. The features of SPTs may make them a worthwhile structure to consider.