“Certainty? In this world, nothing is certain but death and taxes” – Benjamin Franklin

Death and its effect on the deceased member’s superannuation balance. What are the tax implications?

How Superannuation death benefits are paid?

Members of a superfund are often surprised to hear that their superannuation is not automatically paid to their estate when they die. The trustee of the superfund may take account of the terms of a will, but there is no requirement for trustees to follow the will.

A 2013 WA Supreme Court case, Iopplolo & Hesford v Conti [2013] WASC 389, involved a husband and wife SMSF. Wife passed away and in her Will, she didn't want any of her $648,586 super to go to her husband. She wanted it to go to her independent adult children. The SMSF's trust deed gives the surviving trustee(s) discretion to follow the Will. In this case, the husband/trustee did not. He set up a corporate trustee for the SMSF where he became the sole director. The corporate trustee resolved to pay death benefits to the husband/dependant. Sadly, the step-children (from the deceased woman's first marriage) missed out on their mother's super. A valid Binding Death Nomination would overcome this legal problem. In this case, the deceased did have Binding Death Nominations but they were out-of-date (more than three years old).

Please understand a Trustee is only legally bound to restrict death benefit payments to dependants within the meaning of the SIS Act. The definition of a dependant for this purpose is quite broad because it includes people in an inter-dependent relationship as well as independent adult children.

It is only when there are no dependants that the trustee has discretion to make payment to the deceased’s estate. This poses a problem firstly because the trustee of a superfund cannot pay super death benefits to the member’s estate when there are dependants! Secondly, the members cannot choose which dependants are to be beneficiaries.

In most cases, trustees allow themselves to be guided by the member’s will, but they are still unable to make payments to non-dependants unless there are no dependants. Fortunately this uncertainty and limitations can be overcome by members submitting a “BINDING DEATH NOMINATION” (BDN). It is binding upon the trustee of the superfund who must pay super death benefits according to the BDN. A Binding Death Nomination must be renewed every three years. 

Some SMSF trust deeds allow the Binding Death Agreements to be established. Unlike BDN, these agreements don't expire after three years. Please check if your SMSF trust deed allows Binding Death Agreements to be drawn up. If not, you need to update/vary your SMSF trust deed to include the clause.

Super death benefits payment to a dependant
The Part 1, Division 2, Section 10 of the Superannuation Industry Supervisory Act (SIS Act) defines a dependant as :

 dependant, in relation to a person, includes the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship.

1)       Spouse (married, de facto or same sex)
2)       Children (birth, step, ex-nuptial or adopted) under 18 years old
3)       Financially dependant adult child under the age of 25 years old

SIS Act definition of a dependant is slightly narrower in comparison to the tax law definition. SIS Act definition excludes ex-spouse(s) as a dependant. For example, John is divorced from Mary. When John dies, the SMSF is not required to pay Mary because she is a non-dependant under the SIS Act definition. Even if John has in his Will stating that some of his super balance going to Mary, the trustee does not need to follow the Will if John has dependants eg his second wife Ruth. The superfund will pay Ruth first! 

Regulation 6.21 of the Superannuation Industry Supervisory Regulations elaborates more on this:

2A) If a member dies on or after 1 July 2007, subparagraphs (2) (b) (i) and (ii) apply to an entitled recipient only if, at the time of the member’s death, the entitled recipient:
       (a) is a dependant of the member; and
       (b) in the case of a child of the member:
             (i) is less than 18 years of age; or
             (ii) being 18 or more years of age:
  (A) is financially dependent on the member and less than 25 years of age; or
   (B) has a disability of the kind described in subsection 8 (1) of the Disability Services Act 1986

In this scenario, the super death benefit is paid to a dependant.

The table above indicates lump sum paid to dependants are tax-free Non-Assessable Non-Exempt income (NANE).

On the other hand, Income stream payments of super death benefits will depend on the age of the deceased and the age of the recipient. If the deceased and or the recipient is over 60 years old, then the income stream is tax free, that is NANE. However if both the deceased and recipient are below 60 years old, then the tax treatment of the super death benefit income stream would be at the recipients marginal tax rate but reduced by a 15% tax offset on the taxed element of the taxable component.

The Untaxed element of a taxable component is treated differently.  Untaxed element in a member’s account is common in Public Sector Superannuation Schemes. These schemes provide benefits for government employees and are regulated by Acts of Parliament. These schemes are unfunded schemes in that no investment or contribution is actually made. The pension or benefit a retired government employee receives is determined by their latest salary figure multiplied by a formula specified in the trust deed of the fund. Because these schemes are unfunded, no tax is paid. Hence when the member rolls out the scheme and rolls into an accumulation scheme, the untaxed element is subject to more tax when it is paid out as an income stream. The tax is paid by the member’s dependant in their annual tax return. Untaxed element is assessable income in the hands of the individual. If the receipient or deceased or both are over 60 years old, there is a 10% tax offset on the untaxed element.

Super death benefits payment to a non-dependant

A non-dependant is  :

1)       Financially independent child age 18 or more

2)       Any adult child over the age of 25 that’s not disabled

3)       Former spouse (married, de facto or same sex)

Death benefits paid to non-dependants must be in a lump sum. No income stream death benefit is permitted for non-dependants.