Super trust paves way for wealth transfer

A superannuation proceeds trust is a trust set up specifically to receive a lump sum death benefit payment from a superannuation fund. The trust can be set up either before you die or in your will (a testamentary super proceeds trust). It is most commonly set up as a discretionary trust and the beneficiaries of the trust must be limited to the dependants of the deceased.

There are many reasons for setting up a super proceeds trust including:

• taking advantage of the concessional tax treatment of death benefits paid from a superannuation fund;

• splitting income generated by superannuation death benefits between dependant children and the surviving spouse, with the children’s income being taxed at normal adult rates instead of at the highest marginal rate;

• protecting the super assets from future partners of a surviving spouse by setting aside a capital sum for ultimate payment to dependant child beneficiaries; and

• flexibility in regard to the distribution of income and capital each year.

What is the lump sum tax treatment of the death benefit?

A lump sum death benefit from a superannuation fund that is within the deceased’s pension reasonable benefits limit (RBL) and is paid directly to a dependant, as defined by the Australian Taxation Office (ATO), is tax free. By contrast, a benefit paid to a non-dependant is assessable as an eligible termination payment (ETP) and the non-dependant does not receive the tax-free threshold.

In both cases, excess benefits are taxed at 47 per cent and the Medicare levy applies.

If a death benefit is paid to your estate, the trustee is liable for any lump sum tax payable within the estate. However, the benefit can be passed onto dependants tax-free or non-dependants (taxed as an ETP), or both. Any excessive amount is taxed at 47 per cent and no Medicare levy is payable by the estate.

What is the tax treatment of the trust income?

Normally, the ‘unearned’ income of minors is taxed at the highest marginal tax rate. However, there are some categories of income that are taxed at adult rates in minors’ hands. One such category is trust income where the trust was established using superannuation proceeds on the death of a person.

A properly structured super proceeds trust receiving lump sum death benefits from a superannuation fund can combine these tax concessions with protection of the benefit from potential claimants and flexibility of income and capital distributions.

The best way to understand the benefits is to consider an example.

Homer and Marge

(a) Homer has a wife, Marge, and three children, Bart aged 11, Lisa aged 8 and Maggie aged 2.

(b) Homer has $900,000 (including life insurance) in his superannuation fund.

(c) After consulting his financial adviser, Homer adds a special section to his will to set up a super proceeds trust. The will provides that: (i) any lump sum superannuation death benefit is paid into the trust; (ii) the income beneficiaries are his wife and three children; (iii) the capital beneficiaries are his three children only; (iv) the trustee is Homer’s friend and neighbour, Ned; (v) all the beneficiaries are discretionary, that is, they get nothing unless the trustee decides that they will receive either income or capital of the trust; and (vi) the trust ends on the later of the death of Marge or when the last of the children turns 25 years old, at which time the children will receive the remaining capital and income of the trust in equal shares;

(d) Homer makes a binding death benefit nomination to the trustee of his superannuation fund to pay his death benefits to his estate.

(e) Homer dies and Marge in her grief turns to drink and spends all her time in Moe’s bar.

(f) Moe marries Marge to take advantage of her vulnerable emotional state and financial windfall.

However, as a result of your advice and Homer’s foresight:

• the only beneficiaries of the trust are Homer’s dependants and $900,000 is within his pension RBL, so the death benefit is tax free;

• income generated by the trust and paid to the children while they are minors is taxed at normal adult tax rates;

• Marge is only an income beneficiary of the trust, so Moe cannot get his hands on the trust capital. Ned, as independent trustee, can also ensure that Marge does not get more income than she requires;

• Ned can flexibly and tax effectively distribute income or capital to the children, as and when they need it; and

• the children can each look forward to an inheritance when the trust ends.

A super proceeds trust is not quite as tax effective as a child allocated pension because the income payable does not attract a 15 per cent super pension tax rebate.

However, the trust does combine attractive tax concessions, with a high level of asset protection and greater flexibility of distributions than a child allocated pension. Consequently, they can be a very effective estate planning tool. They can also be used in conjunction with child allocated pensions where super death benefits exceed the pension RBL.

Steve Davis is national manager financial planning withPerpetual Private Clients .