While it is often uncomfortable to initiate a conversation with clients about their mortality, encouraging responsible thought about how clients would like their wealth to be transferred to a surviving spouse or other loved ones is something that deserves some consideration. Many clients are aware of the importance of making a Will and keeping it up to date, but estate planning doesn’t start and end with the Will.
Superannuation, which is often the largest asset a person has apart from their home, also deserves some close attention. This becomes even more important when life insurance benefits are attached to a superannuation accumulation or pension account. Furthermore, it is not uncommon for individuals to have multiple superannuation accounts, often each with insurance attached, thereby compounding the need for some careful super estate planning.
A well-versed mantra in superannuation circles is that superannuation benefits do not form part of a deceased person’s estate, to be dealt with under the Will or laws of intestacy. But, increasingly, superannuation death benefits may find themselves forming part of an individual’s estate either intentionally or unintentionally. Providing appropriate super estate planning advice requires advisers to pay very close attention to the ‘fine print’.
Failing to do so may result in superannuation death benefits passing to the wrong people, resulting in advisers potentially assuming unanticipated liabilities.
In this article we will address a number of the common questions that arise when it comes to conversations around superannuation death benefits and some of the recent trends regarding death benefit nominations.
What happens to super when a client dies?
Superannuation law (namely, SIS Regulation 6.21(1)) requires a member’s benefit be ‘cashed’ as soon as practicable following the member’s death.
This may take some months, as investments may need to be sold down to create the cash to facilitate the payment of the death benefit. In addition, before paying a superannuation death benefit, the trustees of the superannuation fund will need to identify potential beneficiaries to whom the death benefit will be paid to.
Having a valid death benefit nomination in place may help to alleviate delays in the payment of death benefits as it eliminates the need to identify alternative beneficiaries.
How can super benefits be paid?
When a member of a superannuation fund has passed away, their benefit may be paid as:
- A single lump sum;
- An interim and a final lump sum – but not multiple lump sums;
- One or more pensions;
- Used to purchase one or more annuities; or
- Potentially, any combination of the above.
These alternatives are prescribed in SIS Regulation 6.21(2). However, limitations apply to the payment of a death benefit as a pension to a child of the deceased. This is dealt with a little later.
While the death benefit payment options prescribed in SISR provide flexibility in the form of payment, individual superannuation funds may be more restrictive in the options they offer.
For example, a recent examination of disclosure documents from several well-known major industry superannuation funds revealed that death benefits would only be paid as a lump sum, unless a member was in pension phase and had nominated a reversionary pensioner. A surviving spouse or eligible children of a deceased member, could not receive a death benefit paid in the form of a pension.
For years, it has generally been accepted that trustees of superannuation funds, even where a binding death benefit nomination is held, would exercise their discretion and negotiate with a beneficiary the most appropriate form in which the death benefit should be paid – i.e. a pension, a lump sum, or a combination of both.
This is no longer the case. Advisers need to understand the benefit payment options available under their client’s superannuation fund in the event of the death.
I recently came across a case of a client who had recently passed away, aged 55. They left an accumulation account of almost $1.1m, including a life insurance benefit of $260,000. The intention was for the death benefit to be paid to the surviving spouse as a pension. However, on enquiry, the fund would not provide this option. The super fund merely intended to pay the benefit as a tax-free lump sum to the surviving spouse.
With the changes that came into effect from 1 July 2017 allowing superannuation death benefits to be rolled over, the fund agreed, after protracted negotiations, to roll the benefit to another superannuation fund that could pay a death benefit pension. Unfortunately, this option is compounded by anomaly in tax laws, that would see the rollover form an untaxed element of $245,000, resulting in tax of almost $37,000 being payable on rollover of the death benefit that includes insurance proceeds. The dilemma is then:
- Should the death benefit be paid as a lump sum and be invested outside the superannuation system, with the option to progressively recontribute; or
- To pay the tax on the untaxed element and commence drawing a death benefit pension.
Advisers and their clients, are starting to run into more difficulties, pertaining to superannuation death benefits!
Who can a death benefit be paid to?
A superannuation death benefit can be paid to:
- One or more of a member’s ‘dependants’;
- The member’s ‘legal personal representative’; or
- Where there are no dependants or legal personal representative – to another person.
A dependant includes the spouse of the deceased, children of the deceased, and any person who was in an interdependency relationship with the deceased member immediately before their death.
The definition of spouse extends to include, “a person the deceased was legally married to or, if not legally married, lived in a genuine domestic relationship (e.g. a de facto partner).” A spouse may include a same-sex partner.
Generally, a former spouse (i.e. divorced - not merely separated), parents, brothers and sisters, nephews, nieces and grandchildren of the deceased are not dependants for superannuation purposes, unless some other form of financial dependency exists. For example, a grandchild living with and being financially supported by their grandparents may be a dependant for super purposes.
The legal personal representative is the trustee or executor of the deceased’s estate.
How do super funds determine who a death benefit should be paid to?
While superannuation funds are bound by superannuation law, they are also subject to specific conditions contained in their governing rules. This includes the fund’s trust deed. These conditions may be more restrictive that the law. While there may be some commonality between super funds, it is important to appreciate that not all funds deal with death benefits in the same way.
In many instances, superannuation fund trustees may have the capacity to exercise discretion when determining to whom and in what form a member’s death benefit will be paid.
This may include the trustees undertaking a ‘claim-staking’ process to identify all potential dependants of the deceased before making a final decision regarding the payment of a death benefit.
While trustee discretion remains common, many superannuation funds have inserted specific conditions into their governing rules. That is, the trust deed removes the discretionary powers of the trustee when it comes to paying death benefits.
It is becoming increasingly more common for superannuation fund trust deeds to prescribe that trustees pay a deceased member’s benefit as a lump sum directly to the legal personal representative. Where this exists, a superannuation death benefit automatically passes to the deceased’s estate.
For example, several well-known superannuation funds operating in the retail space have ‘hard-wired’ their governing rules to require the trustee, in the absence of a valid death benefit nomination having been made, to pay a member’s death benefit as a lump sum to the legal personal representative. The ability for the trustee to exercise discretion and to pay a death benefit to a surviving spouse, as a death benefit pension, has been removed.
Introducing certainty to super death benefit payments
Most, if not all super funds allow their members to nominate beneficiaries to receive their benefit in the event of death. Nominated beneficiaries must be of a class of person defined in superannuation law.
The types of nominations generally available will vary between super funds. However, the most common options include:
- Binding death benefit nomination – remains valid for a maximum period of three years and must then be renewed. A binding death benefit nomination may be revoked by the member at any time. Provided a binding death benefit nomination is valid at the time of death, the trustees of the super fund must pay the death benefit to the nominated beneficiaries, provided they meet the SIS definition of a dependant immediately before the death of the member, or the legal personal representative is nominated;
- Non-lapsing death benefit nomination – a non-lapsing death benefit nomination is binding on the trustees of the super fund. Yet, unlike a binding death benefit nomination that expires after three years, this nomination does not require renewal. That is, it doesn’t lapse;
- Non-binding nomination – is a nomination that is not binding on the trustees of the fund. On the death of the member, the trustees will exercise their discretion in determining who a death benefit will be paid to. However, it does provide the trustees with guidance as to the member’s wishes; and
- Reversionary nomination – only applies where a member is in the pension phase. When a reversionary beneficiary – usually the member’s spouse – is nominated, the pension seamlessly continues to be paid to the reversionary beneficiary on the death of the primary member.
Paying death benefits as a pension
In many cases, it may be desirable for a member’s death benefit to be paid to a beneficiary as a pension, rather than as a lump sum. This allows a deceased member’s super to remain in the tax-effective superannuation system.
Super laws allow a deceased member’s benefit to be paid to a dependant (refer above) as an income stream. However, there is an exception.
While children of any age are dependents for superannuation purposes, a deceased member’s benefit can only be paid to their child as a pension if the child is under the age of 18 or, if aged between 18 and 25, the child was financially dependent on their parent at the time of the parent’s death. In any case, and unless a child is severely disabled, a death benefit pension being paid to a child must be commuted and withdrawn as a (tax free) lump sum when the child turns 25.
While superannuation law allows a member’s death benefits to be paid as a pension to eligible beneficiaries, many super funds do not allow this option under their governing rules.
If the intended strategy is to have all or a part of a client’s superannuation death benefit paid to their eligible dependants as a pension, or at least have the flexibility to do so, it is imperative for advisers to confirm that their client’s superannuation fund will provide that option, in the event of the member’s death. This importance of having a clear understanding of how an individual superannuation fund will deal with death benefit cannot be overstated.
At the outset, I mentioned that a superannuation death benefit does not automatically pass to a deceased member’s estate. However, in certain situations it will, particularly where the super fund’s governing rules prescribe that death benefits are to be paid to the legal personal representative, or where a binding or non-lapsing death benefit nomination is made in favour of the legal personal representative.
Making a valid death benefit nomination can deliver certainty to clients on how their superannuation death benefits will be handled. However, it is important to understand exactly how superannuation death benefits will be paid by the super fund and ensure it fits within your client’s overall estate plan. That is, the Will and superannuation benefits must be viewed collectively, and not in isolation of each other.
Peter Kelly is a superannuation, SMSF and retirement planning specialist at Centrepoint Alliance.