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Self Managed Super Fund (SMSF) Article
Who is a super fund 'dependent'?
By Tony Negline.
This article may be out of date.
28th November 2007
Estate planning has always been an essential part of superannuation.
We know this because for many years super funds have had to exist to pay retirement benefits to members and to pay death benefits to a member’s dependants or estate.
Super funds are trusts and as a result it's the trust deed, trust law and the super and tax laws which drive who is a dependant and how the death benefits can be paid to them.
The super laws define a dependant to include a member’s spouse (including a defacto), any child (this specifically includes a step-child, adopted child or ex-nuptial child) and anyone who can verify that they are in an interdependency relationship with a fund member.
An interdependency relationship exists between two people when they have a close personal relationship, they live together, and at least one provides financial and domestic support and personal care to the other person. There are some exceptions to these requirements when physical, intellectual or psychiatric disabilities exist. A range of other matters also has to be considered.
Some super fund trust deeds limit the definition of dependent compared to what the super laws allow. For example perhaps only legally married spouses are dependants. Maybe only minor children (that is, under 18) are dependants.
Self Managed Super Fund members should check their fund’s trust deed to see what would happen to their benefits if they were to die. If a SMSF trustee has issued a Product Disclosure Statement to the member then what happens on death should be detailed in that document. An important question for members is, what do they need to do to ensure their wishes are not thwarted by the surviving members?
SMSF trustees should check their fund’s trust deed to see what is expected of them if a member were to die. To whom would benefits be paid? How can those benefits be paid? What are the chances that the trustees’ decisions might be challenged by an aggrieved beneficiary? What can trustees do to limit the possibility of costly and timely challenges?
Traditionally trust deeds have given trustees total discretion as to whom a death benefit will be paid. This is designed to allow for complete flexibility which is handy in many situations but can bring potential danger.
For example, the Small Super Fund has four members, Bill and Catherine Small and their two early 20s children, Sally and Fiona. Bill’s account balance is $600,000. Total assets in the fund are $700,000. The SMSF owns a life insurance policy on Bill’s life of $500,000.
Nothing has been formally agreed between all the trustees however Bill and Catherine have had a private conversation about what should happen if Bill dies. Catherine will receive a lump sum of $600,000. The remaining funds will be used to pay her a pension. In other words the children would not receive anything. (The intention is that they would receive a distribution when Catherine dies.)
The new super laws change how death benefits are taxed. Lump sum death benefits paid to dependants will be tax-free. Pensions will be taxed (but will also be allowed a 15% rebate) if the dependant is under 60. Once the dependant hits 60 years of age all death benefit pension payments become tax-free. Non-dependants will face tax for lump sums and pensions.
If Bill dies who decides how his benefit should be paid? All SMSF members must be trustees and in nearly all funds all trustees have equal voting rights. It is therefore possible for Sally and Fiona to gang up on their Mum and decide that the death benefit should be paid differently to Mum and Dad’s unwritten and private agreement.
In the majority of situations this example would be settled exactly in accordance with the parent's wishes. Most children would never try and unfairly take money from a surviving parent. Unfortunately a person’s behaviour can become unpredictable when an unexpected windfall is within easy grasp. And if there is a dispute how would Catherine prove that their private conversation actually took place?
So how do Bill and Catherine ensure there are no nasty surprises? For SMSFs the super laws provide two possibilities. Not all trust deeds cater for these two possibilities so trustees should act carefully before enacting either option.
The first alternative entails enacting a binding death benefit nomination. This nomination must be signed in front of two adult witnesses who are not beneficiaries so is like a Will. These nominations may only last for up to three years unless a member specifically declares otherwise. A member may only nominate a dependant, that is, a spouse or any child or their deceased estate.
Another type of binding death benefit nomination is unique to SMSFs. Under the super laws, SMSF trustees may take a direction from a member on how a fund is run. Under this rule a member would direct a trustee that in the event they died, the death benefit has to be paid to certain people (dependants or estate). If drafted correctly these nominations do not expire after three years. Preparing these nominations can sometimes be tricky and much more like a Will. As a result before completing this type of nomination it is often a good idea to carefully review a person’s Will.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.