Why can't superannuation funds handle change?
Superannuation is not keeping up with the evolution of our society, according to Julie Steed.
The pace of change in superannuation is significant. One of super’s most common criticisms is that things are always changing.
Yet despite the dynamic pace of change, superannuation is ill equipped to deal with the evolution of our society and family structures.
There are many issues surrounding the payment of death benefits that have the potential to cause additional grief and uncertainty for superannuation fund members.
When things do go wrong with death benefit payments, it is usually during a time when the family members are experiencing personal loss and emotional strain, which adds an additional degree of difficulty to solving problems.
Examining ways to improve certainty for members in respect to the payment of their death benefit can add significant value by avoiding unexpected outcomes.
The distribution of death benefits has averaged more than 25 per cent of the Superannuation Complaints Tribunal's (SCT's) case load over the past five years.
Correctly identifying competing beneficiaries and/or using nominations that fall outside of the jurisdiction of the SCT may assist in expediting payments and reducing angst if there is the likelihood of family disputes.
The changing nature of dependants
The nature of our family structures and relationships has changed significantly during the modern era in which superannuation has been available to the wider community.
In 2004, the treatment of same sex relationships was finally catered for as a result of a private member’s bill which introduced the ability to make a death benefit payment to an interdependent.
An interdependency relationship requires that two people have a close personal relationship, that they live together, that one or each of them provides the other with financial support and that one or each of them provides the other with domestic support and personal care.
With a few minor exceptions, it is important that all four of the criteria are met.
Since 1 July 2008, same sex couples have been formally recognised as spouses as a result of changes in Commonwealth law.
The interdependency provisions have also provided the ability for fund trustees to pay death benefits to the parents of many younger, single people who are living at home.
The recent trends of younger people not marrying or having children until later in life has resulted in an increasing percentage of superannuation fund members who have no spouse or child to whom their death benefit can be paid.
The rise of compulsory super and minimum insurance levels has compounded this issue. Interdependency is an area that is often overlooked, and worth exploring with the superannuation fund to see if parents may qualify as dependants of their child.
Blended families
Despite the improvements for same sex couples and interdependent relationships, issues with death benefits and blended families continue to present challenges to trustees and advisers.
Often the client will want to use their superannuation to provide an income to their spouse, but then have any residual balance left to children from their first marriage.
A SMSF may be able to cater for this type of arrangement, but it is unlikely to be an option in retail, industry or corporate funds.
Clients should consider directing their superannuation to their estate and establish testamentary trusts via their will. This type of arrangement will generally ensure that the benefit is received as intended, however, there may be tax consequences.
Another issue that arises in blended families is in relation to stepchildren.
A stepchild is considered a “child” beneficiary as long as the natural and stepparents remain married, or the natural parent dies. This has long been a principal in family law and was recently confirmed as the case for superannuation death benefits in ATO ID 2011/77.
The SCT has also used this principal in deciding cases. This means that the stepparent is unable to leave their superannuation benefits to their stepchildren. The children may, however, still qualify under financial dependency or interdependency.
Identifying dependants
Often members nominate people who do not meet the definition of dependant, despite many funds’ efforts to explain the nature of nominations and the legal requirements.
An example of this is where a member nominates their parents to be the recipients of their death benefit, however, they are not living with their parents nor is there any provision of financial support – hence, they do not meet the definition of a dependant.
Working with clients to identify their potential competing dependants and how to best ensure that the desired outcomes will be achieved – can add significant value.
Similarly, identifying that a client has no dependants and therefore needs a will in order to choose who receives their death benefit, is also beneficial.
Other dependants
Superannuation law permits a trustee to pay a death benefit to a person who does not meet the definition of dependant, in the event that the trustee is unable to locate any dependants or legal personal representative.
In many instances, the recipients will be the parents of the deceased.
However, many funds will only allow this type of payment for small amounts (under $5,000 – $10,000).
For higher amounts, the trustees will invariably require the next of kin to obtain letters of administration and distribute the benefit in accordance with the laws of intestacy.
Nomination types
Having identified all potential beneficiaries and to whom the death benefit will be paid, it is essential to have structures in place to ensure that the client’s wishes will be complied with.
Identifying situations where trustees can make payments to beneficiaries other than as the client wishes can enable clients to make alternative arrangements that will ensure their plans are fulfilled.
When nominating beneficiaries, superannuation funds offer a range of nomination options, including:
- Trust deed provisions – directed nominations;
- Binding nominations;
- ‘Non-lapsing’ binding nominations;
- Reversionary pensions; and
- Nominated beneficiaries.
Trust deed provisions – directed nominations
Members of SMSFs and small APRA funds (SAFs) are able to incorporate certainty using a clause in the trust deed.
The clause would typically state that if a member nominates a valid dependant the benefit shall be paid to them, but if there is no nomination – or the nomination is invalid – the benefit shall be paid to the estate.
Superannuation law generally prohibits fund trustees from being subject to a direction, however, SMSFs and SAFs are exempt from the prohibition.
Accordingly, it is not a breach of superannuation law for a SMSF or a SAF trust deed to stipulate that the trustee shall make a payment to a dependant or to their estate in line with a member’s direction.
Binding nominations
Binding nominations are an exception to the rule that no-one other than the trustee can exercise a discretion.
The SIS Regulations (Regulation 6.17A) prescribe the nine conditions that must be satisfied for the exception to be granted. In addition, a fund’s trust deed must permit binding nominations to be made.
If a trustee accepts a nomination that meets the conditions contained in the SIS Regulations, the trustee is bound to make the payment in accordance with the nomination.
There are two common problems with binding nominations, firstly that they expire after three years, and secondly people not updating their nominations when their personal circumstances change.
Superannuation funds have gone to considerable lengths to remind members as to when their nominations expire, however, many members simply let their nominations lapse.
In this instance, it is generally up to the trustees to exercise discretion and determine to whom the benefit should be paid.
The second issue is even more problematic.
Consider the situation of Joe who separated from his wife and is living with his current de facto, Louise.
Louise is pregnant with their first child. Joe made a binding nomination in favour of his wife Carla two years ago.
If Joe dies, the trustees of his fund will be required to pay his death benefit to Carla – Joe has a valid binding nomination and Carla meets the definition of a dependant. Louise and Joe’s child will receive nothing.
‘Non-lapsing binding’ nominations
These nominations are also an exception to the rule that no-one other than the trustee can exercise a discretion.
This exemption permits discretion to be exercised by a party other than the trustee, provided that the governing rules require the trustee’s consent to the exercise of such discretion.
Provided certain requirements are met, a member is allowed to exercise discretion as to the recipient/s of their death benefit.
Whilst the use of this provision exempts the trustee from the requirement to exercise discretion, it does not necessarily mean the nomination can’t be disputed by competing beneficiaries.
In addition to the legislation, APRA Circular 1.C.2 provides a framework for this type of nomination.
Although there is no legislative requirement, the APRA Circular indicates that a periodic review should occur when there is a change in the member’s circumstances, or at least every three years.
This is also consistent with the trustee’s duty to act in the best interests of all members.
The other ‘non-lapsing binding’ nominations
A small number of retail funds have incorporated specific provisions into their trust deed which enable them to accept binding nominations that do not expire.
The nomination may require the member to declare that they will always keep their nomination up-to-date to reflect any changes in their personal circumstances.
Whilst there appears to be no case law yet, it will be interesting to see how an aggrieved beneficiary will be treated if they can prove that – given a change in the member’s circumstances – the payment to another person is unfair and unreasonable.
The confusing dual use of the term ‘non-lapsing binding nominations’ makes it important for clients and advisers to understand the legal basis under which their nomination is made and any terms and conditions which apply.
Reversionary pensions
Upon the death of the pensioner, payments from reversionary pensions revert to the reversionary beneficiary.
These types of nominations generally provide certainty for members. Nominations are made at pension commencement and cannot generally be changed without commuting the pension and commencing a new pension.
If the reversionary beneficiary pre-deceases the pensioner, the benefit would ordinarily pass to the pensioner’s estate.
From 1 July 2007, death benefits cannot be paid in the form of an income stream to adult children. Therefore, adult children cannot be nominated as reversionary beneficiaries.
Nominated beneficiaries
An ordinary beneficiary nomination is an expression of wishes which is not binding on trustees. As with all other types of nomination, a nominated beneficiary must meet the SIS definition of a dependant.
The legal landscape
Whilst superannuation law is Commonwealth law, the distribution of non-superannuation assets after death is state based law, which varies across the country.
In NSW, the Family Provision laws allow an eligible person to challenge the estate, which may result in the NSW Supreme Court overturning a binding nomination.
The conflict between state based law provisions and Commonwealth superannuation laws provides a system which is structurally flawed and makes advice more complex.
Whilst there is generally merit in having consistent application of laws across the country, the current variation in laws makes harmonisation discussions difficult.
When discussions do occur, it is likely the more restrictive terms of the NSW system will be suggested – which many states and territories will firmly resist.
The Cooper Review recently recommended that binding death benefit nominations cease to be valid when certain life events occur (ie, divorce) and that the nominations should subsequently only lapse every five years.
Whilst such amendments may assist members avoid a situation where their benefit is automatically paid to an inappropriate dependant, it will not assist trustees who will then be required to undertake the full decision-making process.
As always, nothing will provide the security of a comprehensive estate plan – but sadly, this is undertaken by so few.
As an industry, we need to work with the Government to bring in appropriate legislation that keeps pace with the changing nature of family structures and superannuation.
Julie Steed is the technical services manager at IOOF Holdings.
