Tax strategies for SMSFs in estate planning

Working closely with estate planning professionals, advisers can add significant value to their self-managed superannuation fund (SMSF) clients by recommending strategies to ensure that:

• the fund remains complying upon a member’s death;
• the potential for conflict between the beneficiaries is managed;
• the benefits go to the right beneficiaries; and
• the tax payable by beneficiaries is minimised.

Trustee structure

When an SMSF member dies, their legal personal representative (LPR) steps into that member’s place as a trustee or a director of a corporate trustee. The fund remains complying during the period from the death of the member until death benefits commences to be payable.

Once a death benefit commences to be payable, the LPR must step down as trustee of the fund.

Two-member funds are currently the most common type of SMSFs (69.2 per cent in 2006-07, according to the Australian Taxation Offices’s (ATO’s) Self-managed super fund statistical report, December 2008)).

Upon death of one of the members, these SMSFs will become a single-member fund.

Superannuation (Industry Supervision) (SIS) Act 1993 imposes strict rules on how a single-member fund must be structured in order to be complying.

An SMSF cannot have only one individual trustee because no ‘trust’ is created where the beneficiary holds assets in trust for himself. A single-member fund must either have two individual trustees or a corporate trustee.

Some options Anna may consider:

• winding up the fund; or
• changing trustee to body corporate;
• admitting an additional individual trustee; or
• admitting a new member/members.

Given the close interaction of parties within the fund, clients should give careful consideration to who will be the members (and trustees) of the fund and their LPR upon death.

Binding death benefit nominations

To ensure that the benefits are distributed in accordance with the member’s wishes, a valid binding death benefit nomination should be put in place.

The ATO’s determination SMSFD 2008/3 states that a member of an SMSF can make a valid binding death benefit nomination if it is permitted by the fund’s trust deed. The ruling also states that the binding nomination does not have to satisfy certain requirements of the SIS, including the need for it to be:

• witnessed by two individuals; and
• updated every three years.

This means that SMSFs can offer binding nominations that do not have to be updated on a regular basis to remain valid (non-lapsing binding nominations). A non-lapsing nomination remains valid until the member changes it or revokes it.

If the member dies and there is no valid binding nomination directing how the benefit is to be distributed, the trustees must refer to the trust deed. Generally, the trust deed includes one of the following options:

• the trustees identify all potential dependants and decide to whom the benefit should be paid. The trustees can also decide to pay the benefit to the deceased member’s estate; or
• automatic payment to the deceased member’s estate.

An SMSF’s trustees are likely to be closely related and emotional issues may impact how decisions are made if death benefits are paid without a valid binding nomination.

Example

Trevor has two children, Hamish and Lucas. Hamish is a member of Trevor’s SMSF and is also his LPR. Lucas is neither a member of the fund nor an LPR. Trevor passes away and there is no binding nomination in place. Hamish, as an LPR, steps into Trevor’s place as a trustee. Hamish has full control over the SMSF and can distribute the benefits to himself to the detriment of Lucas.

If a dispute arises regarding the payment of the death benefit, the only option for SMSF beneficiaries is to seek recourse through the courts, which may be an expensive process. Unlike non-SMSF members, SMSF members or potential beneficiaries do not have access to the Superannuation Complaints Tribunal for complaint resolution.

Recontribution strategy and anti-detriment payment

The recontribution strategy involves withdrawing a tax-free lump sum from, and subsequently recontributing it to, superannuation. As a result, some or all of the taxable component is converted into a tax-free component, thereby:

• allowing a member to withdraw a higher level of income/capital tax-free; and
• minimising tax payable on the death benefit by non-tax dependants.

An anti-detriment payment is effectively a refund of contributions tax paid during the lifetime of the member. An anti-detriment payment is an amount paid to eligible beneficiaries (eg, spouse, former spouse or a child of any age) as a part of the member’s death benefit payment. In the income year the fund makes a payment, it receives a tax deduction for the total amount. The payment is calculated based on the taxable component, therefore, implementing a recontribution strategy (which converts taxable component into tax-free), may reduce or even eliminate this payment.

SMSFs are unlikely to pay an anti-detriment payment for the following reasons:

• insufficient reserves. The trustee cannot utilise other members’ accounts to make the anti-detriment payment (as amounts are vested to the members);
• borrowing is generally not a feasible option. The borrowing term is the maximum of 90 days and the borrowed amount cannot exceed 10 per cent of the value of the fund;
• the tax deduction for the anti-detriment payment may not be valuable (eg, if the remaining members’ benefits are held in pension phase).

As an anti-detriment payment is generally not paid by SMSFs, the recontribution strategy should be considered for members who wish to maximise the after-tax benefit received by non-tax dependant beneficiaries (eg, adult children).

Clients whose beneficiaries are eligible for the anti-detriment payment may consider rolling over into a different fund that does make the payment. If the funds are rolled over in the accumulation phase, capital gains tax may be payable.

Example

Ryan (62, retired) is a member of Ryan’s Super Fund. He has $1 million (all taxable component) in super. If Ryan passes away today, his adult children, Dan and Diana (his only beneficiaries) will pay up to 16.5 per cent ($165,000) tax on the balance of Ryan’s superannuation.

If Ryan implements a re-contribution strategy, his tax-free component increases to $450,000 and the taxable component reduces by the same amount.

In this case, $450,000 (tax-free component) would be received by his adult children tax-free.

The taxable component would attract tax of a maximum of $90,750 (16.5 per cent x $550,000). This is a tax saving of $74,250.

Alena Miles is a technical analyst, Technical Services, at Zurich.