Superannuation is a significant asset for many of our clients. Not surprisingly, they increasingly want to achieve certainty about how their benefits will be paid on death. Some may also want to plan who will be trustee of their SMSF on death.
What is the best way to tie this down? There are now numerous options available to SMSF members, such as binding death benefit nominations (‘BDBNs’) and SMSF Wills. Advisers will be well positioned to assist their clients if they have a sound understanding of exactly what these options entail.
What is the difference between a BDBN and an SMSF Will?
A BDBN is a nomination made by a member during their lifetime which directs the trustee how to pay their benefits after death. If drafted correctly, the deed should allow members to make BDBNs and should also provide that the trustee is bound to follow any valid BDBN in place when the member dies.
An SMSF Will is also a set of directions by the member given to the trustee, but works differently. (Note that, depending on what the member chooses, some SMSF Wills are actually death benefit nominations). However, some choose for their SMSF Will to be what is known as a death benefit rule (‘DBR’). In this case, the member’s directions vary and become ‘embedded’ into the SMSF’s deed (ie, the DBR becomes part of the SMSF’s rules).
It’s all in the implementation
Ultimately, both BDBNs and DBRs require careful implementation and neither will be 100% foolproof.
Certainty about how benefits will be paid
Achieving certainty about what will happen to death benefits is of the utmost importance. If the trustee has a right not to follow a member’s BDBN or DBR when they die because, in the trustee’s opinion, this might create cash flow problems for the SMSF, this could possibly be exploited by an aggrieved party as an excuse not to follow the deceased’s wishes. These kinds of loopholes that create an ‘out’ for the trustee are best avoided if members want to maximise certainty.
Similarly, if the trustee has a choice whether or not to accept a direction when it is given to them by the member, this could also create uncertainty. Giving a trustee a discretion not to accept a direction detracts from the objective that it should be ‘binding’ on the trustee. It may also give rise to evidentiary disputes about what happened (eg, claims that “so-and-so verbally accepted (or rejected) the direction”, etc).
A more certain approach is to compel the trustee to follow any direction that is given to them, provided of course that the BDBN or DBR is made validly (ie, in accordance with the deed and any applicable laws) and has not been revoked prior to death. Having a trustee counter-sign a direction will serve as good evidence it was in fact received by the trustee.
Amending the deed
If using a DBR (which amends the deed to ‘embed’ the member’s directions), bear in mind this could be overridden if the deed is amended. Unless there is a restriction on the variation power that prevents the DBR itself from being amended, this could be an exposure (especially if other parties can out-vote the particular member and therefore vary the deed).
An alternative might be to make a BDBN and enter into a mutual agreement (eg, between spouses) which includes an agreement not to revoke a BDBN.
Succession to the trustee role
Some DBRs also seek to set up trustee succession by providing that, eg, on the member’s death their Executor will become trustee of the SMSF. This is a good idea but the implementation is the key.
Firstly, a person cannot become a trustee of a fund without consenting in writing, so this cannot happen automatically. For a corporate trustee, a person also needs to be appointed as a director in accordance with the constitution and of course there are ASIC/corporations law requirements to comply with. If the trustee was not validly appointed, its decisions (including about payment of benefits) could be void.
Further, if the deceased’s Executors are two or more persons, what are the implications for voting power under the SMSF deed or constitution? Unfortunately, many simply give all trustees equal voting power. This means the deceased’s Executors could out-vote everyone else, even if the deceased had a small account balance! Thus, the SMSF’s deed (or company’s constitution) should make provision for this, eg, an adjustment mechanism if multiple executors stand in for the one person.
The latest on BDBNs
When deciding what path to take, advisers should ensure they are up-to-date with the latest on BDBNs. For example, we now have ATO confirmation that BDBNs can last indefinitely for SMSF members (provided the deed allows indefinite BDBNs): see SMSFD 2008/3. A BDBN is also able to specify the form of benefits (ie, whether as pension or lump sum), provided the deed expressly gives this power.
Insurance inside or outside a fund?
There are several reasons why having insurance in a super fund may make good sense. Firstly, the premium for death and total and permanent disability (‘TPD’) risk cover is tax deductible and proceeds are exempt from capital gains tax (‘CGT’). Members incurring such premiums outside the fund are not entitled to a deduction but do get a CGT exemption.
The premium for income protection cover is also tax deductible but the proceeds are assessable to the fund. This is the same tax treatment as having this type of insurance outside a fund.
Where premiums are claimed on the above insurance in a super fund, then an untaxed element can arise in relation to a lump sum payment which can result in more tax being payable on the benefit. For example, a death benefit lump sum that is paid to a non-dependant such as an adult child may be exposed to a 31.5% tax rate based on the formula in s 307-290 of the Income Tax Assessment Act 1997 (Cth); this is one downside to claiming insurance in a fund.
Having a fund pay for insurance however assists with cash flow. Many have reduced their non-essential expenditure and may therefore be without adequate insurance (as revealed by the recent Victorian bushfires).
So, while it generally makes good sense to have insurance in an SMSF, there can often be hurdles, eg, complex application forms and medical tests. One option may be to seek to obtain cover in a public offer/industry super fund that offers automatic acceptance. Moreover, such funds may offer better premium rates due to their bulk purchasing power. Naturally, having insurance in another fund may minimise the impact of the untaxed element (ie, the 31.5% tax discussed above).
There have also been some recent developments impacting on insurance that clarify certain grey areas.
The first relates to deductibility of premiums for TPD. Amending legislation will shortly be issued providing a deduction for premiums that cover own occupation (typically higher premiums as it relates to ability to perform a specific role, eg, an adviser) compared to general occupation. A general occupation policy has a lower premium and a broader definition of TPD (eg, unable to undertake work the person is capable of doing by education, training or experience). This change will relate to the periods 1 July 2004 to 30 June 2011. From 1 July 2011, deductions for TPD will only apply to the extent of a general occupation premium so the excess will not be deductible.
Hopefully, when the legislation issues the condition of release (‘COR’) will also be amended to allow funds to pay out occupation-specific TPD proceeds even though they have not satisfied a general occupation definition under SIS.
The ATO have generally argued that trauma insurance is not consistent with the sole purpose test. However, the ATO’s draft SMSFD 2009/D1 clarifies that trauma insurance can be held in a fund provided the proceeds are received and form part of the fund’s assets until a relevant COR occurs. (An event such as cancer, stroke or heart attack, by itself, may not satisfy a COR, eg, a 40 year old may suffer a heart attack and re-enter the workforce after a short spell.)
The ATO have therefore confirmed that trauma insurance can be held in a fund and that this can be consistent with the sole purpose test. However, the ATO do state that the size of the premium may be a relevant factor and also whether taking out the policy may be providing a benefit to someone outside the fund, (eg, if the policy taken in the fund lowers the premium on a policy outside the fund).
Insurance can also be very helpful where an SMSF enters into a borrowing arrangement and to provide funding for an anti-detriment payment. However, the SMSF’s trust deed needs to have flexibility for managing insurance. Thus, now is an ideal time to review the appropriateness and adequacy of insurance for everyone and your SMSF deeds!
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DBA News contains general information only and is no substitute for expert advice. Further, DBA is not licensed under the Corporations Act 2001 (Cth) to give financial product advice. We therefore disclaim all liability howsoever arising from reliance on any information herein unless you are a client of DBA that has specifically requested our advice.