A significant proportion of the wealth of people today is held in the superannuation environment and it is not uncommon for superannuation to be an individual’s most valuable asset. Not only is the value of wealth in superannuation continuing to grow but the number of self-managed superannuation funds (SMSF) is also ever-increasing. According to the most recent Australian Taxation Office statistics, over 1.1 million Australians are members of SMSFs with those members holding approximately $747 billion in assets in their accounts[1].
Whilst there is clearly a substantial amount of wealth in the SMSF environment there is, unfortunately, a significant lack of planning and understanding by many members in relation to what happens to their superannuation upon death. Binding death benefit nominations are relatively new in the context of succession planning and the law in this area continues to evolve. There are many things that can go wrong which may potentially invalidate the nomination or, at the very least, lead to a costly argument about the document’s validity.
What is a death benefit nomination and what types of nominations does the trust deed allow?
A death benefit nomination is a notice that the member gives to the trustee of the fund regarding the payment of their member benefits upon death. The ‘death benefit’ includes both the member contributions as well as any insurance held within the fund by the member.
There are several types of death benefit arrangements including:-
Automatic reversionary pension: A reversionary pension is a pension established by the fund member whilst still living that reverts to an eligible income stream dependant (usually the surviving spouse) on the member’s death.
Binding nomination: A binding nomination stipulates who is to receive a member’s benefits on death and is binding on the fund’s trustee, that is, provided the nomination is valid the trustee must comply with it. A binding nomination is valid for 3 years.
Non-lapsing binding nomination: A non-lapsing binding nomination stipulates who is to receive a member’s benefits on death and is binding on the fund’s trustee, that is, provided the nomination is valid the trustee must comply with it. A binding nomination does not lapse.
Non-binding nomination: A non-binding nomination is not binding on the fund’s trustee but is merely an expression of the member’s wishes on who shall receive the member’s benefits on death. The trustee can exercise its discretion not to follow the member’s nomination.
No nomination: In the absence of a nomination, it is the fund’s trustee that exercises its discretion as to how and to whom the member’s benefits will be paid upon death.
The payment of a member’s death benefit is a matter that is determined by the governing rules of the SMSF deed and in non-SMSF funds, the mandated requirements of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SIS Regs), particularly reg 6.17A, must also be met. In order to determine whether a member may make a death benefit nomination, including the type of nomination and the requirements to ensure the validity of that nomination, the first step is to READ THE DEED. Unfortunately, in practice it is all too common to see standard beneficiary nomination templates that have been ordered ‘off the shelf’ or downloaded from the internet. These nominations are often prepared with no regard to the terms of the SMSF deed.
What does the trust deed require for a non-lapsing binding death benefit nomination?
Typically, in non-SMSF funds, a member’s death benefit nomination will be binding on the trustee of the fund if all of the conditions set out in reg 6.17A are met, including:-
The governing rules of the superannuation fund must permit binding death benefit nominations[2].
The person(s) mentioned in the notice is either the member’s legal personal representative or dependant[3].
The proportion of the benefit to be paid is certain or readily ascertainable from the notice[4].
The notice is in writing and is signed and dated by the member in the presence of two witnesses aged over 18, neither of whom is a person mentioned in the notice[5].
The notice contains a declaration, signed and dated by the witnesses, stating that it was signed by the member in their presence[6].
The notice is given to the trustee[7].
Unless revoked sooner by the member, no more than 3 years must have passed since the member first signed, last confirmed or amended the nomination[8]. To remain valid the nomination will need to be renewed every 3 years.
In addition to a binding death nomination, some large superannuation funds may also allow a member to make a non-lapsing binding death nomination under s 59(1)(a) of the SIS Act.
The governing rules of an SMSF may also allow a nomination made in accordance with reg 6.17A to bind the trustee of the fund and a majority of SMSF deeds follow a fairly similar procedure. However, SMSFs have the advantage in that the governing rules of the fund can be tailored to the circumstances of the client and may allow the member to bind the trustee to pay a death benefit without having to comply with all of the conditions set out in reg 6.17A (for example, there may not be a requirement to give the notice to the trustee, renew the nomination every 3 years or have the nomination witnessed). The nomination will simply need to comply with the terms of the deed to be valid (which is why it is important to READ THE DEED).
What can go wrong?
Not all SMSF deeds are created equal. An SMSF deed is not a generic product but rather should be a document that is tailored to the needs of the client. It is surprising how many SMSF deeds still only allow a 3-year binding death benefit nomination, import unnecessary SIS Act and SIS Reg provisions, are not executed properly, or simply have poor wording which allow binding death benefit nominations to be challenged. Some of the problems you may come across in practice which, if identified early can usually be managed or avoided, include:-
The inclusion of SIS Act and SIS Reg BDBN provisions
There is no need for the SIS Act and SIS Regs binding death benefit nomination rules to be included in an SMSF deed. The ATO has addressed this issue. Despite this, a surprising number of SMSF deeds import the statutory requirements. The Queensland Supreme Court decision of Donovan v Donovan [2009] QSC 26 is an example of such an occurrence with a take home lesson from that case being that the SMSF governing rules should not contain any wording that may import the requirement that a binding death benefit nomination should comply with the SIS Act and SIS Regs.
Whilst it is important to note that an SMSF determination is not law and as such is not binding on the ATO, it is nevertheless useful in light of the fact that the ATO is the regulator of SMSFs. The reasoning of the ATO in SMSFD 2008/3 has since been approved by the courts in both Queensland (Munro v Munro [2015] QSC 61; (2015) 306 FLR 93; Re Narumon Pty Ltd [2018] QSC 185) and South Australia (Cantor Management Services Pty Ltd v Booth [2017] SASCFC 122).
Failure due to ‘faulty’ SMSF variations – review all relevant documents!
In order to ensure a binding death benefit nomination is valid it is necessary to consider the most current deed as well as any previous deeds to confirm:-
Any deed of variation (whether it is an upgrade of an existing deed or change of trustee) is completed in accordance with the variation power in the SMSF deed.
There is consistency with the documents prepared and the terms of the SMSF deed.
The consent of all relevant parties required to effect a variation has been obtained.
Any stamping is attended to in accordance with the relevant State/Territory stamp duty legislation.
The documents have been correctly signed, witnessed and dated the date they were signed by all relevant parties.
The formalities need to be complied with or the fund’s most recent deed may not be valid. A consequence of this is that any binding death benefit nomination prepared based on a ‘faulty’ deed may possibly be invalid.
Inappropriate service requirement
Inappropriate service requirements that compel a member to give a binding nomination to the trustee can easily thwart the intention of the deceased on a technicality if the service requirements are not clearly satisfied.
Failure due to poor wording of the BDBN
For a binding death benefit nomination to be valid the nomination must comply with the specific requirements of the SMSF deed. The Queensland decision of Munro v Munro [2015] QSC 61 provides a cautionary tale where the binding death benefit nomination failed due to poor wording.
Choosing appropriate beneficiaries
Who can receive a death benefit?
For a death benefit nomination to be valid one of the requirements is that the person/s mentioned in the notice must either be the member’s ‘legal personal representative’ or ‘dependant.
Legal personal representative in this context is defined to mean the executor of the will or administrator of the estate of a deceased person.
Dependant in this context is defined to mean:-
the spouse of the person: Spouse is given a wide definition that includes de facto and same sex relationships, registered or otherwise. Of note is that unlike the requirements of the States and Territories relevant Succession legislation there is no requirement for the relationship to be for 2 years in duration. The SIS Act simply requires the couple to live together on a genuine domestic basis.
any child of the person: Child is also given a wide definition and includes an adopted child, a stepchild or an ex-nuptial child of the person, a child of the person’s spouse, and someone who is a child of the person within the meaning of the Family Law Act 1975.
any person with whom the person has an interdependency relationship: Interdependency relationship is defined as a close personal relationship of people who live together, where one or each of them provides the other financial support and one or each of them provides the other with domestic support and personal care.
Who should receive the death benefit?
Choosing the appropriate beneficiaries is important. An ill-considered choice can give rise to potentially avoidable problems. Beneficiary nominations are often made as part of the framework of the member’s estate planning needs and are usually considered in the circumstances of:-
A desire to ensure the most tax effective structure for succession
There are taxation issues which are unique to superannuation, notably the tax on superannuation death benefits, which can influence a member’s decision. The tax payable on a death benefit depends on several factors including:-
whether the recipient is a “death benefits dependant” of the member as defined in s 302-195 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997);
whether the benefit is to be paid as a lump sum or income stream;
whether the income stream is an allocated pension or a capped defined benefit income stream;
the age of the recipient and the age of the member when they died; and
whether the death benefit is taxable or tax-free and whether the fund has already paid tax on the taxable component.
Under s 302-195 a death benefit dependant means:-
the deceased’s spouse or former spouse;
a child of the deceased aged less than 18 years;
any other person in an interdependency relationship with the deceased just before he or she died;
any other person who was a dependant of the deceased just before he or she died.
A lump sum payment to a death benefits dependant is tax free. The tax implications on payment of an income stream will differ depending on the age of the member and recipient.
Where the recipient is not a death benefit dependant, they can only receive the benefit as a lump sum. The taxable component of the payment will be entitled to a tax offset that ensures that the rate of income tax is as follows:-
tax-free component: tax-free
taxable component (element taxed): 15% excluding Medicare levy
taxable component (element untaxed): 30% excluding Medicare levy
The issue of tax is often a key factor in determining who should benefit from a member’s superannuation death benefit. That being said, tax should not always determine who receives what benefits. Consider – is it better for the right person(s) to receive the funds and pay some tax rather than for the wrong person to receive the funds and pay no tax? What is important is that the member understands the tax implications of payment so they can make an informed decision.
Protection of the superannuation proceeds for the intended beneficiaries
It is often the case in estate planning that an individual will express a desire to protect the inheritance of their intended beneficiary (or beneficiaries) from certain “predators” and “creditors”. Whether it is a desire to protect a beneficiary:-
from a future material breakdown
that is a minor
who is in an at-risk profession
who is bankrupt or has creditors chasing
who has impaired capacity
that suffers from an addiction
the list goes on.
The downside of a beneficiary directly receiving the superannuation death benefits, as opposed to nominating the legal personal representative (i.e. the member’s estate) as beneficiary, is that if the member dies and the beneficiary is in an at-risk situation the death benefits may be exposed. By paying the death benefit to their estate the member has the option of protecting the inheritance of the intended beneficiary by way of testamentary discretionary trust established under their Will. The beauty of a testamentary discretionary trust is that if the intended beneficiary is experiencing difficulties in their life (e.g. matrimonial issues, personal bankruptcy, or the inability to manage funds due to disability) the funds do not pass into their personal name, but rather to a trust for their benefit.
The tax treatment of superannuation death benefits when received by a trust in a person’s Will will depend on who the beneficiaries of the trust are. If all the beneficiaries of the trust were death benefit dependants (using the tax definition under s 302-195 of the ITAA 1997) then the amount paid to the trustee of the testamentary discretionary trust would be treated as if paid directly to a death benefit dependant. However, if the beneficiaries of the testamentary discretionary trust were not all death benefit dependants, which would be the case in a testamentary discretionary trust with a broad discretionary class of beneficiaries, then the total amount of the superannuation death benefit would be treated as if paid to a non-financial dependant.
In circumstances where there are death benefit dependents (e.g. spouse and minor children) and a member wishes for their superannuation benefits to be protected by a trust set up in their will then there is the option of allowing for the establishment of a separate ‘superannuation proceeds trust’ (SPT), in addition to any testamentary discretionary trusts, under the member’s will so that the most tax effective distribution of the superannuation proceeds can be achieved via a protected structure.
The potential for a claim to be made on the estate
A binding nomination may be used as a tool to pay death benefits directly to a member’s dependant/s so as to avoid a member’s estate in circumstances where there may be a potential claim.
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