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Self Managed Super Fund (SMSF) Article
Types of SMSF Death Benefits
By Tony Negline.
This article may be out of date.
3rd August 2004
In 1789 Benjamin Franklin famously wrote, “in this world nothing can be said to be certain, except death and taxes.”
The fact is that nothing could be more true for super funds even though when Franklin wrote this statement he was not talking about the fledging United States Constitution.
When a member of a super fund dies, the net of tax benefit received by the beneficiaries is highly variable. The amount of tax payable for super fund death benefits is determined by how a death benefit is paid and to whom it is paid.
Death benefits can either be paid as lump sums or as pensions.
A careful examination of a Self Managed Super Fund’s trust deed is essential to understand how a SMSF would deal with a deceased member’s benefits because the wording used varies greatly from trust deed provider to trust deed provider.
Trustees and members of SMSFs must make sure that the type of death benefit they want paid is permitted by their fund’s trust deed. For example a fund may want to pay a surviving spouse a pension. This is only possible if the trust deed allows it.
We has seen trust deeds which allow death benefit pensions only to be paid to the spouse and that pension can only be an allocated pension.
On the face of it this seems reasonably okay. For some SMSFs it will be exactly what they are looking for.
However for other SMSFs this provision is unnecessarily, and even adversely, restrictive. A provision like this stops a trustee from paying a surviving spouse a pension structure which may be more suitable for that spouse’s circumstances.
For example a trustee might want to pay a non-commutable lifetime pension. This may be deemed more suitable for no other reason than the trustee wants to eliminate longevity risk – that is, the threat of the surviving spouse still being alive when the super fund runs out of money.
It might also be needed because the surviving spouse may be a spend thrift and needs to be ‘protected’ from themselves. (Most allocated pensions allow the pensions to convert the income stream into a lump sum – called a commutation - at anytime.) There might also be a concern about a surviving spouse remarrying a ‘gold digger’.
But what different pension structures can your SMSF deed allow? Since this year’s Federal Budget, the government has been moving against term and lifetime pensions within SMSFs (although a complete ban has not been finally put in place, their future is doubtful) so these types of pensions may no longer be used to pay new death benefits.
Only allowing an allocated pension to be paid to the surviving spouse and to no one else might also stop a trustee from paying a child under 18 a death benefit pension. Such pensions can be particularly powerful from a tax planning point of view. The capital value of such pensions may not be counted towards the deceased’s Reasonable Benefit Limit and each income payment may be entitled to a 15% rebate.
These combined tax concessions represent one of the biggest tax benefits available in the Australian income tax laws. It is amazing that so few people seem to know about them or even plan to use them.
With pensions paid to minors there are many issues for a trustee to consider. Firstly what type of pension? Some people think a term pension is best – perhaps payable until the child turns a pre-specified age. The most popular ages are 18, 21 and 25.
However as new term pensions in SMSFs are probably no longer going to be allowed, some other structure has to be found. To the best of our knowledge no one has thought of a suitable replacement product since the government knocked term pensions over.
The new Market Linked Income Streams (which many existing SMSF trust deeds would not be allowed to pay anyway because they are not detailed in the trust deed) are technically term pensions but that term must be for a minimum of the pensioners remaining life expectancy when the pension is first paid. A pension paid to a 10 year old child would have a minimum term of about 70 years and a very low income to match this very long term. These new pension structures cannot be converted into a lump sum.
Allocated pensions for children are also going to be paid for a very long time and the issue of being able to convert this product into a lump sum at any time is an issue that needs careful consideration.
Hopefully the government realises that by disallowing all of these types of pensions it has stopped legitimate arrangements from being implemented.
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