The prospect of having a large tax assessment in respect of an individual’s member benefit in a self-managed superannuation fund is becoming much more relevant in the context of estate planning as a result of:
- The increased level of contributions which have been made over the life of the member;
- The increase in the value of funds invested in superannuation funds (due to the compounding effect of asset growth over longer periods);
- The desire of members to leave the member benefit within the parameters of the fund in the longer term due to the tax effectiveness of income generated on those investments; and
- The prospect of having difficulty in dealing with member benefits in circumstances where a member has lost capacity due to age.
As most of us know, on the death of a member of the superannuation fund, the benefit, if paid to a surviving spouse or dependant, is tax free. Depending on the tax status of the member, if there is no surviving spouse and no dependant for superannuation purposes, all or part of the benefit will be taxed at a minimum effective rate of 16.5% on the death of the member.
If the fund is in pension mode and the member is receiving a pension, the pension paid to the member is tax free in the member’s hand during the member’s life and any income or capital gains arising within the fund itself is also tax free. On the death of the member, the member is no longer in receipt of a pension and from the time of death, the superannuation fund will be taxable on any income or realised capital gain.
So, as estate planners, what can be done to manage the tax risks in relation to superannuation death benefits and what are the issues which we need to focus on in addressing these risks?
The risk to be managed is the death of the member in circumstances where he/she has a significant superannuation balance and no superannuation tax dependants. In our experience there are two critical issues deserving attention. Firstly, is the risk that the “at-risk” member may not have capacity to redeem their superannuation benefits and bring it into their hands. Secondly, having redeemed the benefit (particularly where that has been done by an attorney acting on behalf of the member) careful attention needs to be paid to ensuring that the benefit ends up where the member intends it go and that the attorney is sufficiently protected in the event of a claim by a disaffected beneficiary.
Issues with members and trustees lacking capacity
The starting point is the terms of the superannuation fund trust deed and the provisions of any relevant enduring power of attorney. In this regard, we have identified a number of common shortcomings in the terms of superannuation fund deeds and the terms of an enduring power of attorney held by a member or trustee. Firstly, the enduring power of attorney, if granted:
(a) is not expressed to be sufficiently broad enough to authorise an attorney to act in the event of the member’s incapacity as a superannuation fund trustee; or
(b) is not expressed to be given on behalf of the member in both their personal capacity and also on behalf of the member in his or her capacity as trustee of a superannuation fund.
Secondly, within the terms of the superannuation fund trust deed, there is not a specific power authorising a trustee’s attorneys to act where the trustee is incapable.
Issues concerning the ultimate beneficiary
We have also identified the following issues concerning arrangements for the ultimate beneficiary:
- By redeeming the member’s benefit, and bringing it into the hands of the member (and ultimately the estate of the member following death) rather than having it paid at the discretion of the trustee of the superannuation fund, a different person may receive the benefit than the person who had originally been intended;
- To protect those concerned, the Will itself should have the flexibility of dealing with the member’s estate (with changes to the member’s estate caused by the introduction to the estate of the member benefit); and
- The attorneys of the member, at the time of acting, should be indemnified and protected by the member against claims which may arise from other disappointed potential beneficiaries of the member benefit if the member benefit is distributed by will rather than by the trustee of the superannuation fund.
Superannuation member benefit redemption strategy
To deal with these issues, we have worked with our colleagues in Law Australasia, to develop a strategy and an accompanying suite of documents to assist a member (through their attorneys if necessary) in achieving:
- the payment of the member benefit to the member while the fund is still in pension mode and prior to the death of the member; and
- where time permits, a disposal (immediately prior to the payment of the pension) of all of the fund’s assets while the fund is still in pension mode (thereby achieving a zero rate of tax within the fund on accumulated capital gain).
The core documents involved in the execution of the strategy are:
- A deed of variation of the superannuation fund deed to address the shortcomings referred to above;
- An enduring power of attorney from the member to the member’s attorneys to specifically empower the attorneys to act on behalf of the member as both member and trustee of any superannuation fund;
- A general power of attorney from the trustee (if a company) of the superannuation fund to the member’s attorney(s) or another attorney(s);
- An advanced redemption direction (from the member to the attorneys) requesting the attorneys redeem the member benefit when they are of the view that the member has a condition or illness which, in all probability, is life threatening or terminal;
- The form of notice of redemption to be ultimately signed by the member’s attorney for delivery to the trustee; and
- A deed of release and indemnity by the member in favour of the attorney whereby the attorney is released from any claim which may arise against the attorney through the exercise by the attorney of the powers to act in accordance with the member’s redemption direction.
The strategy is not without risk. Obviously there is a danger that moneys are withdrawn from superannuation before the death of a member who then makes a subsequent miraculous recovery and lives for another 10 years. However, in reality that scenario is unlikely. Generally speaking, most people will know when a medical condition is terminal. Obviously the risks involved need to be weighed up at the appropriate time.
Related: Why you need to check your superannuation death benefit nominations
At DDCS we believe that the superannuation member benefit redemption strategy, provides a great opportunity for financial advisors to add value to their client service. If you would like further information in relation to this strategy, please contact me on (02) 62127600 or fill in the contact us form and we will be in touch.
