Estate – Planning for When you Die

1. Introduction
2. How is the Members Account balance Paid
3. Who can be paid the Members Account balance
4. Paying out the Deceased’s Balance as a Lump Sum & Save tax & Life Insurance
5. Paying out the Deceased’s Balance as a Pension & Save tax – Reversionary Pensions
6. Steps to pay a lump sum or pension from a deceased member
7. Testamentary Trusts – Asset Protection & Tax Advantages

Introduction

Estate Planning in respect to a SMSF largely involves ensuring that Deceased Account Balance payments are taxed in the most advantageous way. However before we explore the planning strategies its best to give a basic introduction.

Upon Death if you have a WILL your executor will apply for probate to the supreme court. If the supreme court grants Probate, Probate authorises the executor to administer the estate, sell assets, pay debts, pay beneficiaries.

Upon the death of a member, the members account balance must be paid. How the members account balance is paid will be based on what directives the superannuation fund has in place to deal with the payment. In the absence of any directives the Trustee of the Superannuation Fund must exercise its discretion to who to pay the benefits too. This is because a superannuation Fund is governed by a trust deed and like other commonly known family trust deeds the assets do not form part of the WILL.

In Most cases where a WILL is in place for the deceased, the Trustee of the Superannuation Fund would pay the members balance to the Executor of the Estate. However this can cause a tax disadvantage if the WILL does not specifically allow streaming of a death benefit to a tax dependant, ie a spouse. The WILL for example, may bequeath the estate 50% to the spouse and 50% to a non tax dependant, the Executor of the Deceased’s Estate would be required to pay 50% of the death benefit to the non tax dependant and 50% to a tax dependant, resulting in 50% of the death benefit being taxable….not a good outcome.

How is the Members Account balance Paid.

The payment can be facilitated in two ways:

• A Binding Death Benefit Nomination (“BDBN”) is signed by the member before the member dies. The BDBN document should state who will receive a payment and how much, among other things. Executing a BDBN removes an flexibility the trustee has, including in respect to ensuring that maximum tax benefits are achieved in how the benefit is paid. Therefore care needs to be taking in making this BDBN.
• The Trustee Decides on the timing and to whom the payment is made, see who can be paid the members account.

Who can be paid the Members Account balance

Members Account Balance is paid to either dependents, the Executor of the deceaseds estate, or a legal personal representative or a combination.

Dependents for superannuation purposes is similar to a tax dependent, but note the differences. A superannuation dependent includes children. A Tax dependents is more restrictive and only includes a child under 18. A Tax Dependent includes a current and former spouse. A spouse under the superannuation laws only includes a current spouse. Both Superannuation law and Tax Law include any person who the deceased member had an interdependency relationship.

A payment of a lump sum death benefit to a Tax Dependant is tax Free.

Where a death benefit is paid to a non tax dependant from a taxable component tax will be payable, to find out more about how to pay the tax click here, also see <see-ATO Link>.

The members account upon death must be paid in accordance with (1) the Superannuation laws, (2) Tax Laws can influence dates a payment must be made based on tax concessions, (3) Trust Deed, and (4) Binding Death Benefit Nomination.

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Paying out the Deceased’s Balance as a Lump Sum & Save tax

A payment as a lump sum (also known as commuting a pension when paid from a pension) to a tax dependent will be tax free. The lump sum must be paid out in cash to the dependant. A payment to a child of the deceased must be a lump sum unless (1) the child is under 18, or (2) over 18, but financially dependent and less than 25 or has a disability may receive a pension.

Two ways to be tax free:

1. A payment of a Deceased Account Balance (super payment) to a Tax Dependant is tax Free, regardless of whether the source of the super payment is from a tax free or taxable component.
2. A payment of a Deceased Account Balance (super payment) to a Non Tax Dependant is taxable, only if the source of the super payment is from a taxable component. If the payment is from a tax free component then the payment is also tax free

The Strategy involves ensuring that a Deceased Account Balance payment paid from a taxable component is paid to a tax dependant (such as a spouse or tax dependant child) and a Deceased Account Balance payment paid from a Tax Free component is paid to a Non Tax dependant (such as a adult non tax dependant child). Strategies to enable you to do this can be found at Streaming with 1 SMSF using Savings to make a contribution and Streaming with 1 SMSF using a withdrawal and re contribution strategy under 60

Where there is no tax dependant and the benefit payment includes a taxable component, you can pay this to a LPR and save additional Tax as LPR’s do not pay medicare on receipt of Deceased Account Balance payment.

A deceased’s member’s benefits must be cashed as soon as reasonably practicable after the member’s death. There is no guidance on what is reasonable.

Life Insurance
Where a Life Insurance Policy is paid out to the SMSF on death, the amount received needs to be allocated to the following (1) tax free portion of the members balance (2) taxable portion of the members balance (3) taxed element (4) untaxed element. The taxed and untaxed elements are determined when the premiums of the life insurance policy have been or can be claimed as a deduction. To understand more about the treatment and strategies for Insurance in Super <click here>.

It is important to note two points:

1. that the proceeds from the Insurance are not assessable as they are of a capital nature; and
2. That the untaxed element only arises when a Death Benefit LUMP SUM is paid. Therefore a Death Benefit PENSION will not have an untaxed element ie Tax Free.

Paying out the Deceased’s Balance as a Pension & Save tax

Please read the section on who can receive a pension or a lump sum from the deceased member’s super Paying out the Deceased’s Balance as a Lump Sum & Save tax. Instead of cashing out and paying cash to a beneficiary as a lump sum, you can cash out as a pension either as a reversionary pension or a new pension.

Reversionary Pension
A reversionary pension is where the deceased members account is already in pension phase and pursuant to a BDBN or a trustee determination, it continues to be paid but reverts to a reversionary beneficiary (usually the surviving spouse). A reversionary pension can be setup before or after death as allowed by the trust deed. A New pension occurs when the deceased members super is in part or completely in accumulation phase. Also an Insurance Policy payout can add to an existing accumulation account of a member. However if the member is in pension phase then as any amounts cannot be added to a pension, (except in accordance with a prudent reserving strategy) The trustee would need to create a new accumulation account and then create a new pension.

Pension’s can be either Account Pensions (“AP’s”) (prior to 1.7.07) and Account Based Pension’s (“ABP’s) (post 1.7.07). ABP’s can have certain advantages including do not have a maximum annual payment factor and ABP’s minimum payments are lower than AP’s. For more on ABP’s and AP’s click here.

How to Save Tax:

1. If paying from a taxed component and paying to a tax dependant (eg spouse) pay a lump sum as its TAX FREE
2. If paying from a tax free component then a pension is equally as beneficial as a lump sum, both are TAX FREE
3. If paying a pension to a beneficiary who is over 60 a pension is fine as its TAXFREE
4. If paying a pension to a beneficiary who is under 60 AND the deceased is over 60 a pension is fine as its TAXFREE
5. If paying a pension to a beneficiary who is under 60 AND the deceased is under 60 a pension is taxable on the taxable component with a 15% rebate. The Tax Free component is tax free.

Even though the beneficiary is receiving a pension, they can withdraw a lump sum in cash (commute) all or part, because a deceased members benefits become unrestricted unpreserved.

Timing of Commuting (cashing in as a lump sum) a Death Benefit (tax Dependant’s) Pension:
Where a trustee lets say John, as well as other members documented trustee minutes stating that on death of John, John’s present pension would become a reversionary pension to Sally (spouse). Accordingly on John’s death a reversionary pension was implemented and John’s pension continued to be paid to Sally. If Sally chose later to receive it as a lump sum, Sally needs to ensure it is paid to her in cash within strict time frames to access the tax free status as follows:

1. within 6 months of death of deceased member;
2. Three months after the granting of probate or letters of administration
3. 6 months after legal actions ceases
4. delays in contacting recipients, 6 months from that date.
5. Commissioner has discretion

Outside of these time frames then:

1. where the recipient is less than 60 but greater than preservation age then Nil up to the cap of $165,000 <check for threshold changes> and 15% above the cap.
2. where the recipient is less than 60 but less than the preservation age then 20% <check for threshold changes>.

Caution should be made if a child’s death benefit pension is commuted as the time restrictions may apply. However where the pension is commuted under the following circumstances then the lumps sum payment (commutation) will be assessable/non exempt income: (1) before the child is 25, (2) on age 25 or (3) if the child is permanently disabled.

Where a BDBN is in conflict with a reversionary pension a BDBN will usually override the reversionary documentation. The reason is that it is the trustee that determines a reversionary pension, either by way of a trustee minute or some other form of documentation. However a BDBN is binding on the trustee, the trustee cannot change it.

Steps to pay a lump sum or pension from a deceased member:

1. Consider the contents of the Estate Planning Guide
2. Consider the <Anti-Detriment Payment – Save Tax on death 4 yr spouse>
3. Treat Income to the SMSF in respect to the deceased account balance in accordance with the trust deed, it could form part of the account balance or a reserve, where silent we suggest add to the account balance.
4. Trustee holds a meeting and ratifies to pay out the deceased’s account balance either as a pension or lump sum or both and notes the names of the beneficiaries and amounts to be received either as a lump sum or pension.
5. Trustee writes cheques or EFT or any other means to cash out the deceased estate in the case of a lump sum.
6. Trustee in the case of a new Pension or reversionary pension, confirms the recipient is a member & trustee of the SMSF and where they are not admits the recipient as a member/trustee in accordance with the trust deed, etc.
7. Trustee prepares the necessary ATO forms and deducts any tax on behalf of the member/beneficiary.
8. Trustee writes cheques to the pension recipient in accordance with the rules.

Steps for paying out a <lump sum pension> or <pension> in circumstances other than death.

Testamentary Trusts – Asset Protection & Tax Advantages

A Testamentary Trust is a trust setup by a WILL, established using the assets of the estate and comes into existence upon death. There are a number of reasons why a testamentary trust is used (1) Asset Protection (2) Taxation of Minors (3) Death Benefits however before we discuss these its important to explain what happens to the assets.

After probate is granted to the executors of the estate. The executors then arrange for the Testamentary Trust to be formed in accordance with the WILL provisions. The Executors of the Estate then arrange for the name the Assets are held in to be changed from the deceased to the name(s) of the Testamentary Trusts “Trustees” otherwise known as the legal personal representative (“LPR”). Often the Trustees of the Testamentary Trust are the same as the Executors, but not always.

A Change in the name of the assets normally would result in a disposal of the asset, which would normally give rise to a number of taxation events such as Capital Gains Tax, Duty, etc. However asset name changes that arise upon death and changed to the Trustees of the Testamentary Trust generally do not trigger these taxes as, in substance, it is considered there is no change in the beneficial ownership at this point in time. For Capital Gains Tax purposes PS LA 2003/12 & TR 2006/14 support that the ATO treats a Testamentary Trustee the same as a LPR for this purpose. However special rules apply to the cost base of assets upon death and these are the subject of a other topic outside of Superannuation see <ask the professional>. Rules relating to Duty differ from state to state, however the concessions are largely the same.

Further an important is that The Executors of the Estate if they have the power, can sell assets, ie property and transfer the cash to the Testamentary Trust and then re-invested into other assets ie high yield blue chip shares.

Asset Protection – Advantages in Asset protection can be achieved in a number of ways (1) as the assets are not held by the beneficiaries, but by the trustees on behalf of the beneficiaries, it prevents any creditors of the beneficiaries making a claim against the Testamentary trusts Assets. This is because the beneficiaries are not taken to have received their entitlement to the assets; (2) Another advantage with the divorce rate being over 50%, there is a greater chance from the divorcee making a claim against the deceased’s child’s assets, again the divorcee is unable to make a claim against a testamentary trust assets that are held for the benefit of the deceased’s child who has become divorced; (3) A final advantage is that not all children are capable of preserving the capital of the deceased, and a deceased may decide it is more prudent that the beneficiary receive an entitlement to income for a portion of the remaining life of the child or entire life of the child, with subsequent distributions of a capital to child’s children (grandchildren of the deceased) for example. As the assets (cash, property, shares, etc) are maintained in a testamentary trust, the income arising from these assets can be paid to beneficiaries, but the capital is protected. Finally a word of caution, a Court can seek to recover assets from trusts in certain situations, to understand more about such a situation read Kennon v Spry; Spry vs Kennon [2008] HCA 56 (‘Spry”)

Income Tax of Minors – normally unearned income of minors is subject to tax at the top marginal income tax rate including medicare of 46.5% <see rate changes>. However where the unearned income is classed as excepted income, ie income from a trust estate arising from the capital of a deceased by way of WILL, etc, the special provisions of the tax act ITAA enable the income tax rate to be the same as a adult taxpayer. Accordingly a child less than 18 can receive income from a Testamentary Trust in the same way as an adult child and be taxed in the same manner, at normal income tax rates. An important point is even when the Executors of an Estate sells deceased assets and transfers the proceeds to the Testamentary Trustee who in turn re-invests the cash say in shares, the dividends from the shares will continue to qualify as excepted income and therefore taxed as a normal adult in the hands of the child under 18.

Other Points to note in operating a Testamentary Trust, Super Benefits Trust or a Proceeds Trust.

1. Must make a family trust election where the FTC equal or exceed $5,000. This is because there is a 45 day holding rule to enable the use of a franking credit, trusts do not hold assets as they hold on behalf on another (beneficiary) consequently to ATO brought in an exemption for the small shareholder trustee, i.e. franking credits less than $5K. If your franking credit attaching to the dividend is higher then a family trust election needs to be made to avoid the loss of the franking credits.
2. If the WILL did not provide for a Testamentary Trust then after the date of death then the Executor of the Estate could create a “Estate Proceeds Trust. Cash could be transferred to this trust to enable the Income Tax of Minors to be the same as adults. There are certain conditions that are required to be met in creating an Estate Proceeds Trust. Further there are anti avoidance provisions to ensure no deliberate non armslength transactions occur to make income excepted trust income to enable minor’s income to be taxed like normal adults.
3. Death Benefits can be paid out to the LPR (Executor) who can then create a Super Benefits Trust or Super Proceeds Trust. After 1.07.07 an adult child must receive a superannuation benefit paid out as a lump sum. Accordingly the SMSF can pay out the Benefit as a lump sum to the beneficiary’s LPR (the executor of the estate). The Executor then creates a Super Benefits Trust/Super Proceeds Trust which receives the super benefit and then the trustee of the trust pays out the benefit to the beneficiary over a period of time. This facilitates asset protection strategies as outlined above. A Super Benefits Trust is a trust that is specifically provided for in a WILL. A Super Proceeds Trust is a trust created by a Executor but not provided for in the WILL.

Taxation of Income/Capital Gains will depend on the nature of the recipient and the components of the income received.

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