02/03/2011

Whilst you might imagine David Attenborough breathlessly parting the deep jungle foliage to reveal science’s latest discovery, in fact the ‘discovery’ of the SMSF Will was considerably less dramatic.

Some would even argue that it is not so much a discovery as an invention.

Whichever, this latest jargon term to sweep through the superannuation and estate planning professions is in fact another popular misnomer (like the so-called 1918 Spanish Flu which in fact started in China).  You see, the SMSF Will is in fact not a Will at all.

What a popular SMSF guru has neatly dubbed the ‘SMSF Will’ is in fact the tailoring of a member’s death benefit nominations to maximise the effectiveness of the passing of their superannuation benefits to their family and other beneficiaries.

The concept essentially is that if you think carefully about your death benefit nominations you might be able to achieve much more than simply moving the benefit across to your surviving spouse.

And if you take nothing else away from this article, at the very least please note that death benefit nominations are an integral part of a person’s estate planning and should be considered in the context of their whole estate and not simply signed in the accountant’s office along with all the other superannuation documents at the time the SMSF is established.

To fully understand the issues we need to go back to a few basics.

There are three types of people in the world of superannuation death benefits –

• those who can receive a death benefit in the form of a lump sum or a pension
• those who can receive a death benefit in the form of a lump sum only, and
• those who are not entitled to receive any death benefit from the fund.

The group entitled to either lump sum or pension includes

• the spouse
• the de facto spouse
• a former spouse
• a child under 18 years of age
• a dependent child under 25 years of age
• a person with whom the deceased had an interdependency relationship just before death; and
• any other person who was a dependant of the deceased just before death.

The second group eligible to receive a lump sum only includes

• non-dependent children over 18 years of age
• dependent children over 25 years of age
• the deceased member’s estate

The third group is made up of everybody else.

Depending on which group you fall into, different tax applies to the amount you receive.  For dependents the benefit is received tax free.  For non-dependents tax may be payable.

So if these are the people who can receive the death benefit how does the member make their wishes known?  The answer is through a death benefit nomination – a direction to the trustee of the fund to pay the member’s death benefit to a certain person in a certain way.

Provided the trust deed does not say something to the contrary, the nomination can be ‘binding’ or ‘non-binding’.  Nominations can be changed whenever the member wishes.  There are no specific formalities but obviously they should be in writing, signed by the member, ideally witnessed by one or two independent adults and delivered to the trustee.

The trustee must follow the directions in the binding nomination.  If the nomination is non-binding then the trustee need only consider it as part of its deliberations.  In the context of self-managed super where the members are the trustees and surviving member/trustees are most likely the surviving spouse of the deceased member it is assumed that the trustee will have no difficulty adhering to a binding nomination – but then you never know, especially when money is involved.

So what are some of the ways that we could turn a humble death benefit nomination into a snazzy ‘SMSF Will’ and why would we want to do it anyway?

It’s all in the detail. The best way to describe this is through an example.  Meet Philip. Philip is retired and aged 61.  He has two older sons – Jim (a businessman who he can trust with the inheritance but who would like to protect it from his potential creditors) and Max (a pothead who cannot be trusted to deal with a large capital sum responsibly). He is divorced from their mother Sybil but wants to give her a small amount from his estate anyway.  He has married 38 year old Britney. He has a 5 year old with Britney named Tinkerbell. He has $1.25 million in his SMSF and $250,000 in non-super assets as well as a residence in joint tenancy with Britney worth $1 million.

The processes for dealing with Phil’s estate using an ‘SMSF Will’-type approach would be as follows.

1. Before his death, consider maximising Philip’s non-concessional contributions to the fund and immediately commencing an account-based pension for him.
2. Before his death, make Jim and Max financial dependents of Philip’s by paying them a small but material regular emolument (see Malek’s Case and Faull’s Case).
3. Through a binding death benefit nomination pay $250,000 out of the super fund to Jim as a dependant.  Jim can then choose to protect this amount from his creditors by either gifting it to his discretionary trust or by contributing it to his own super fund.
4. Bequest the non-super $250,000 via a testamentary trust set up under Philip’s ordinary Will for Max’s benefit.  The terms of the trust would regulate the income payments and prohibit capital advances except under very strict conditions perhaps controlled by an independent trustee (not the executors because Max may put pressure on his brother to agree to commutation).  No tax is payable on the bequest (unlike if it came from the super fund) but would be payable on the income earned by the trust.  Philip may want to increase the amount to account for that tax.
5. Through a binding death benefit nomination pay a lump sum from the fund to the estate which in turn pays it to Sybil.  Sybil receives this bequest tax-free because as a former wife she is a dependant under the Tax Act (although not the SIS Act).
6. Give Philip’s half of the house to Tinkerbell subject to a life tenancy to Britney which expires on Britney’s death or remarriage.  That way Britney can stay in the house until her death or more likely her remarriage at which point the half share goes to Tinkerbell. This would be achieved through the ordinary Will and will require Philip and Britney to amend their ownership of their home from joint tenants to tenants in common.  Such a conversion is not a CGT event and would be subject to only minimal stamp duty.
7. Through a binding death benefit nomination make Britney a reversionary dependent beneficiary of Philip’s pension.  As Philip is over 60 then Britney as the reversionary dependent beneficiary will also receive tax free pension income.
8. Through a binding death benefit nomination set up a separate account-based pension for Britney.  The second pension will cease on Britney’s remarriage as well as her death. 
9. The precise terms of the two pensions payable to Britney can be set out in Philip’s binding death benefit nomination which can say that the trustees should then use the residue to pay equal amounts to Jim, Max and Tinkerbell.  The latter two payments should be made in the same way as their other bequests.  Tinkerbell’s payment can be as a pension (if she’s under 18 or under 25 and still dependent) or otherwise a lump sum to the estate which can hold in a superannuation proceeds trust for her to safeguard the amount until more is known of her circumstances and likely future.
10. Through a binding death benefit nomination start an account-based pension for Tinkerbell to pay for her upbringing.  The pension should be non-commutable with a minimum pension drawdown and an appropriate pension payment schedule until Tinkerbell reaches 18 (in order to prevent Britney from commuting Tinkerbell’s pension and taking advantage of the situation).  Pension payments to Tinkerbell as a dependent are tax free as would be any commutation before age 25 (s.303-5 of the Income Tax Assessment Act 1997).
    

These 10 steps are simply one way of handling the situation and financial planners much more expert than I could probably come up with even better solutions.  But the example shows that by going through the process Philip will be forced to consider the issues and will be fully advised of all the possibilities.

By going through the process and selecting the right executors, alternate trustees (where possible) and even (if necessary) different trustees for different beneficiaries and different purposes, Philip will understand and be able to ensure against a situation where some of his relatives try to ‘diddle’ the others out of their inheritance.

The tailored death benefit nominations add up to effectively an SMSF Will because Phil has passed his superannuation wealth to his chosen beneficiaries in an elegant way which meets the needs of the various beneficiaries both in the short term and the long term.

His superannuation interests are protected under SIS and bequests outside super are handled in such a way as to give the beneficiary every chance to protect those interests against claims by third parties.

Phil has made allowance for his vulnerable beneficiaries - Max’s trust will ensure no availability of capital advances that he might dissipate.

Phil has minimised tax for both the estate and the beneficiaries as far as possible. He has also minimised the prospects of a successful challenge to the estate, although there is nothing any testator can do to prevent unreasonable claims being made.
   
Whilst not simple, once an interested person spends some time studying this type of estate plan and questioning their advisers there is no reason they would not be able to understand it, appreciate its utility and co-operate in its implementation.

SMSF Wills may not be Wills but like Shakespeare’s rose, they can still smell as sweet.

If you have any questions in regard to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.