Mention death benefits, and people’s eyes glaze over. The super laws can be tricky when it comes to defining who you want to leave benefits to and how you can do it, and as a result death benefits have become a point of continual confusion.
This issue was brought home the other week when I appeared on Peter Switzer’s 2GB radio program The Super Show. A listener called in to ask Peter and me how the tax laws defined dependants and non-dependants in relation to super fund death benefits.
Under the super laws, a dependant includes the deceased’s spouse, any child of the deceased and any person deemed to be in an ‘interdependency relationship’ with the deceased.
That sounds simple enough, but things can easily become complicated. For instance, it’s possible for a person to be considered to have more than one spouse at the time of death.
Spouse
The term spouse includes a married partner, a defacto partner and – if the couple is not legally divorced – a separated partner. Since July 2008, the term spouse has also included same sex couples that live together and are registered under a State or Territory law.
So, under this definition, it’s possible for a person who is separated, but not divorced and living in a defacto relationship, to have two spouses.
The issue can become more complicated because in some cases it can be difficult to be certain that a defacto relationship existed at the time of death. This is especially the case with short-term defacto relationships and those involving frequent separations and reunions.
Child
A child includes a biological child, an adopted or stepchild, and since July 2008, it has also included children of the deceased’s spouse as well as children born through artificial conception and surrogacy arrangements. However, the ATO has recently announced that a stepchild ceases to be your dependent upon your death.
Interdependency relationship
An interdependency relationship exists when two people have a close personal relationship, live together, one or each of them provides the other with financial support, and one or each of them provides the other with domestic support and personal care. A concession is available for any or all of these requirements if a couple are separated due to physical, intellectual or psychiatric disability.
Getting your trust deed right
It’s important that you understand the implications of these definitions when writing your SMSF’s trust deed. For example, your trust deed may provide a definition of a dependant that is less expansive than the super law definitions and this could result in your death benefits being distributed in a manner you didn’t intend. You may want to seek legal advice to make sure the specific people you do and don’t want to receive your death benefits are defined correctly in your trust deed.
So we’ve had a look at who potentially can receive a death benefit. I’ll now turn my attention to how death benefits are taxed.
Death benefits and tax
The super laws allow your spouse and children aged under 18 to receive lump sums, pensions or mixtures of these two benefit types. Adult beneficiaries may only receive lump sums. A concession from this lump-sum-only rule is available for some disabled adult children.
Again, your super fund’s trust deed may restrict how the benefit is paid. For example, it’s common for very old trust deeds to only allow lump sum death benefits and this will cause problems if you try to leave the benefit to an adult child.
When a death benefit is paid, the tax-free component will be paid to the beneficiaries tax-free.
However, the treatment of the taxable component differs depending on who receives it. To non-dependant beneficiaries, it will be taxed at 15% plus the medicare and flood reconstruction levy. If a lump sum is paid to dependants, then it will always be tax-free.
For pensions, the amount of tax payable depends on the type of benefit, the age of the deceased and the age of the beneficiary.
The following table sets out how the age of the deceased, the age of the beneficiary and the type of benefit to be paid is taxed:
So, as you can see, it’s important to make sure the definitions of the people you wish to leave benefits to match those of the super laws, and that the type of benefit you intend to leave is also consistent with what the laws will allow. If you fail to do this, you could leave your dependants with a messy legal situation.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Also in today’s Switzer Super Report
- Peter Switzer:Â Europe has really made a big mess of the markets
- Paul Rickard:Â Is Perpetual’s buyback right for your SMSF?
- Roger Montgomery: Should you add Woolworths to your portfolio