The last thing anyone wants after having worked hard, paid their taxes, and financed their own retirement is to leave this life – and their dependants – with a large tax bill. But that’s exactly what could happen if the government passes controversial pension reforms.
In July, the Australian Tax Office (ATO) released some proposed changes to pensions, and one of the most talked about aspects of the draft is the likelihood that death benefits will soon be liable for tax of up to 31.5%.
Whether or not the bill passes, Dan Butler from DBA Lawyers, one of the country’s top SMSF practitioners, says there are some things you can do now to make sure your dependents never get lumped with a hefty tax bill on receipt of your death benefits.
So, what’s changing?
The draft ruling states that a pension “ceases as soon as the member in receipt of the [pension] dies, unless a dependent beneficiary of the deceased is automatically entitled under the superannuation fund’s deed, or the rules of the [pension], to receive [a pension] on the death of the member”.
Put simply, that means that a pension can only be tax-free while it is a pension. “When a pension stops, the tax exemption stops,” Butler says.
Many consider the ATO to have always held this view and that the draft ruling is not really new, but clarifies wording written in a shade of grey. Even so, the clarification will likely result in more tax paid by beneficiaries.
But, as Butler points out, there’s a way around this. The key is to make sure the benefit is ‘auto-reversionary’, that is, it’s automatically transferred to the beneficiary upon the trustee’s death.
But before you run off and do this, Butler has some sound advice:
“Naturally, tax should not be the driving consideration in succession planning,” he says. “It is better that the right person receive wealth and pay some tax than the wrong person receive wealth and pay no tax.
“Of course, as a secondary consideration, it is great if the right person can receive wealth in a tax effective manner.”
Also, keep in mind that adult, independent children are generally not eligible to receive pensions. So, you can really only consider this option if you intend to make the pension auto-reversionary to your spouse or to children under 25-years-old.
How to make a beneficiary automatically entitled to a pension
To make sure your death benefits are auto-reversionary, you’ll need to have this provision carefully worded in your SMSF’s trust deed. You’ll also need a separate document – either a resolution or an agreement – to support the provision.
Be careful. Butler says many people mistakenly think they’ve completed this step correctly, but it’s actually more fiddley than it sounds. It’s best a lawyer prepares this document for you.
He says making a simple ‘pensioner request’ and drawing up a trustee resolution, or signing an agreement specifying that the beneficiary will receive the reversionary pension, are not enforceable.
Butler says this is because making such requests puts a restraint – or to use the legal term, ‘fetter’ – on how any surviving trustee wants to run the fund, and trustees have the right to use their own discretion in regards to the SMSF’s matters.
“Nevertheless, it is possible to validly fetter a trustee’s discretion,” Butler says. “This can occur where the governing rules of the SMSF allow it.”
So, it’s important that the trust deed and the reinforcing document acknowledge the ‘fettering’ of the trustees discretion. An SMSF lawyer can make sure you get this right.
If you don’t want to create an auto-reversion, it’s important to know that tax will accumulate on the deceased person’s income and capital gains until someone, such as another trustee, transfers the funds, and the tax liability, into their name.
It’s therefore best to claim death benefits as soon as possible, although in reality, it understandably takes grieving spouses some time before this happens.
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: How much do you need in your SMSF for retirement [1]
- Charlie Aitken: Don’t be fooled by the relief rally [2]
- Tony Negline: Going overseas? Read this first! [3]