24 | What Happens To My Super When I Die
It is an uncomfortable topic but you want to know.
What Happens To My Super When I Die
While you are alive, the only way to access your super – upon meeting a condition of release with nil cashing restriction – is payment of a member benefit.
When you die, the only way to access your super is still through a benefit payment. That doesn’t change. But now the benefit doesn’t go to you anymore but to your beneficiaries as a death benefit.
Other types of trusts distribute capital and income, but superannuation doesn’t make this distinction. Super funds – even though they are a type of trust fund – only pay benefits.
So a benefit it is. After you die, somebody will receive a benefit. But who exactly is that? Who gets your super? How and when? With how much tax to pay? And what happens to your SMSF after that?
Question # 1 Who Gets Your Super?
It is a common misconception that your testamentary will determines who gets your super, but it doesn’t. Your will determines who gets your estate, but your super is separate from your estate. And so unless your super ends up in the hands of your legal personal representative – the executor or administrator of your estate – your will does not dictate who gets your super.
Who gets your super depends on six things. Some outside of your control. Some within.
1) SIS Law
SIS law sets the framework. This is a given. It is what it is.
Your super can only go to your SIS dependants or your estate. So anybody who is not a SIS dependant can only receive a super death benefit from your estate.
Your SIS dependants are your spouse or de-facto spouse (but not a former spouse) and all of your children. No matter what age. As well as anybody in an interdependency relationship with you.
s10 SIS Act: dependant, in relation to a person, includes the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship.
An interdependency relationship means that you lived together and depended on the other for financial or practical support and care.
But there is one other group that is your SIS dependant, although not specifically mentioned in s10 of the SIS Act. Anybody financially dependent on you. The definition of dependant in the SIS Act is an ‘inclusive’ definition. It includes a spouse, a child and a person in an interdependency relationship. But that doesn’t mean other forms of dependency don’t qualify. And so anybody financially dependent on you is your SIS dependant as well.
Whether somebody is or isn’t your dependant under the SIS Act depends on their relationship with you at the time of your death.
2) Trust Deed
Your super goes to your SIS dependants and / or your estate. But to what extent – who gets how much – the SIS Act leaves up to you.
So the first step is drafting the trust deed for your SMSF. The trust deed sets out what members and trustees can or can’t do with respect to death benefits.
Your trust deed might establish a reversionary pension. It might allow you to make binding or non-binding death benefit nominations. And it might also include an equalisation clause. Or it might be silent. Or explicitly prohibit you from any of these. All this is in your hands. You drafted it. You signed it.
The new official term is ‘retirement income stream’ but ‘pension’ is shorter and more commonly understood.
3) Trustee’s Discretion
And then you might leave it at that. You let the surviving trustees decide after your death – within the SIS Act and the fund’s governing rules – how much of your super goes to SIS dependants or your estate and in what form.
If you make a non-binding death benefit nomination, you voice your preference but still leave it up to the trustee’s discretion. They make the final call.
4) Specific Instructions
Or you take control. You decide whether to make a pension reversionary. Whether to sign a binding death benefit nomination.
Making your pension reversionary – within the governing rules of your fund – means that it reverts to the reversionary beneficiary – usually your spouse – when you die. A reversionary pension overrides any binding death benefit nomination.
A binding death benefit nomination – provided your deed allows one – will curtail the trustee’s discretion after your death and force them to distribute your super to your nominated beneficiaries or your estate.
If your super goes to your estate, you can nominate any beneficiary you like. For a direct distribution from your fund you can only nominate SIS dependants.
But with all this make sure that your deed and nominations are legally valid. Many aren’t. They are drafted by accountants or financial advisers leaving big gaps that specialised superannuation lawyers will find easy to squeeze open.
5) Choice of Trustee
Choose your fellow members wisely. If you don’t want them to get your super, don’t bring them into your SMSF.
Possession is 1/10th of the law. Once the money disappeared from the hands of a surviving trustee, it is a long way through the courts for the beneficiaries to get it back. So decide upfront who should get your super and only bring those into your fund if at all.
If you share an SMSF with your second wife but want your children from a first marriage to get your super, you are asking for trouble. The legal arsenals are full of second spouses and step-children fighting over trust deeds and binding death benefit nominations.
Question # 2 How and When?
When you die, the legislator wants your super out of the low-tax super environment as quickly as possible. So the legislator established five measures to get your super out of super.
1) Pensions Only to a Selected Few
Pensions move slowly. They stay in the low-tax super environment much longer than the quick-fix lump sum. And so the legislator restricts access to a pension.
Only a selected few of your SIS dependants can receive their benefit as a pension. Your spouse can. Anybody in an interdependency relationship with you can. Any of your minor or disabled children can. And any adult child under 25 and financially dependent on you can as well.
But your other children – financially independent adults – can’t. They can only receive a lump sum from your super per the Superannuation Industry (Supervision) Regulations 1994 (SISR).
Reg 6.21 (2A) SISR:..the entitled recipient: (a) is a dependant of the member; and (b) in the case of a child of the member: (i) is less than 18 years of age; or (ii) being 18 or more years of age: (A) is financially dependent on the member and less than 25 years of age; or (B) has a disability of the kind described in subsection 8(1) of the Disability Services Act 1986 .
As soon as your disability-free children are old enough to stand on their own feet – in the eyes of the legislator this is when they reach 25 – they need to cash in the remaining balance as a lump sum.
2) Pensions Only Up To TBC
To put a cap on pensions the legislator also restricts how much you can actually move into pension phase. Just because a certain SIS dependant qualifies to receive a death benefit or reversionary pension doesn’t mean they can. Because there is the transfer balance cap (TBC).
All pensions – be they a reversionary or a death benefit pension – count towards the beneficiary’s TBC. This cap is currently $1.6m and tracked via a transfer balance account (TBA).
For reversionary pensions there is a deferral period of 12 months. So your reversionary pension won’t hit your spouse’s TBA until 12 months after your death.
Here is an example. Let’s say $1.6m hit your TBA on 1 July 2017 and that share portfolio is now worth $2m.. You die and your spouse – with a TBA of nil so far – receives your reversionary pension. To comply with the TBC, they only credit $1.6m to their TBA. The excess can’t go into accumulation and so is cashed out. If your spouse had already exhausted their TBA before you died, then they would need to cash out the entire $2m.
3) No Restrictions on Lump Sums
A lump sum payment is a transfer of funds out of the super environment. That is exactly what the legislator aims for. Moving your super back into the general tax base as quickly as possible. And so all doors are open. Any death benefit can be paid as a lump sum.
4) Compulsory Cashing
Your death is a compulsory cashing event – the only one in super. It means that the remaining balance in your member account needs to go somewhere – be it as a pension or a lump sum. Your super accounts can’t continue as if nothing happened.
Reg 6.21 SIS Reg: (1) …a member’s benefits in a regulated superannuation fund must be cashed as soon as practicable after the member dies.
5) No Accumulation
If a beneficiary’s death benefit is more than they can fit into their TBA, it must be cashed as a lump sum. Their excess death benefit can’t move into accumulation.
If it could, your super could stay there forever – passing from generation to generation – forever enjoying a low 15% tax rate in accumulation.
6) No Mixing
Whoever receives your super, can’t mix it with their other super interests. If they could, it would be impossible to track compulsory cashing. It would be impossible to track death benefits not going into accumulation.
So any new death benefit pension needs to be clearly labelled and tracked to ensure they don’t end up in accumulation. Once a death benefit, always a death benefit.
Question # 3 How Much Tax To Pay?
There is no inheritance tax in Australia. But there is ‘super death tax’, ie tax on the taxable component of your super. And this tax can cost anybody who is not a death benefit dependant – usually your adult children – a lot of money.
Neither your SMSF nor your estate will pay ‘super death tax’ but your beneficiaries might. Whether they do or don’t depends on four things.
1) Tax Dependency
The good news is that your tax dependants will receive their entire death benefit tax-free, including any taxable component they receive. The bad news is that everybody else – anybody else who is not a tax dependant – will pay tax on the taxable component of your super. So being a tax dependant is good.
The official term for a tax dependant is death benefit dependant. That is the term used in s302-195 ITAA97.
But who is a death benefit dependant aka tax dependant? Your spouse is. Including any former spouse. All your children under 18 are. And anybody financially dependent or in an interdependency relationship with you is as well. But your financially independent adult children are not.
So SIS and tax law overlap to some extent but not entirely. The two significant differences relate to adult children and former spouses.
Under tax law only children under 18 are your tax dependants. Children at 18 or older are not, unless …they are financially dependent on you or had an interdependency relationship with you. Under SIS law all your children are your dependants. No matter what age or financial situation.
Under tax law former spouse are specifically included. Under SIS law they aren’t.
So your financially independent adult children are your SIS dependant, but not your tax dependants. And your former spouse is your tax dependant, but not your SIS dependant.
2) Tax-free v Taxable Components
Any super benefit consists of a tax-free and a taxable component. Have a look at your super statement or SMSF’s latest annual return. It will tell how how much of your super sits in the taxable and tax-free components.
Your tax-free component is the total of your non-concessional contributions. It has been paid out of after tax income and so is tax-free to any of your beneficiaries. All your beneficiaries will receive this component tax-free.
Your taxable component on the other hand – which is everything else that didn’t go into the tax-free component – is only tax-free to your death benefit dependants. Your death benefit dependants don’t pay any tax on any death benefit. Full Stop.
But your non-dependants do. They will pay tax on the taxable component of the death benefit they receive. How much tax will depend on the taxed and the untaxed element.
The taxed element is any amount the fund already paid tax on, hence the term taxed. Most Australians only have a taxed element. Your tax non-dependants will pay 15% tax on any taxed element in their death benefit.
An untaxed element is any amount the fund hasn’t paid tax on yet, hence the term untaxed. Outside of public sector super schemes and constitutionally protected funds you will mainly see an untaxed element when the SMSF receives life insurance proceeds from a policy held within the fund. Your tax non-dependants will pay a higher tax rate on the untaxed element – 30% instead of 15%.
You can’t pick and choose bits of the tax-free component and taxable components to give to this beneficiary or that one. The proportioning rule stipulates that any benefit is paid out in the same proportion as your super account. If your super account is 10% tax-free component, then the benefit will be 10% tax-free component.
3) Type of Benefit
Your super can be paid out in four different ways. As a lump sum, a reversionary pension, a TRIS or a death benefit pension.
Tax law applies a look-through approach. Whether a beneficiary receives the death benefit directly (from your fund) or indirectly (via your estate) doesn’t change how the benefit is taxed. But it might affect whether the Medicare levy applies or not.
Lump sum payments are straight forward. They are either fully tax-free when paid to you or a death benefit dependant or they have their taxable component taxed at 15% – assuming there is no untaxed element – when paid to a non-dependant.
A lump sum is a transfer from your super out of the super environment. It often is a simple bank transfer from the SMSF bank account to another non-super bank account.
A lump sum can be paid in specie. So the trustee doesn’t necessarily have to liquidate your super assets – for example a farm or business real property – to pay them out.
The taxation of a reversionary pension depends on how old you and the receiving beneficiary are at the time of your death. As long as one of you is 60 or older, the pension is entirely tax-free. The reversionary beneficiary doesn’t need to meet a condition of release.
But if neither of you is 60 or older at the time of your death, then the taxable component is taxed at 15% – assuming there is no untaxed element. As soon as the receiving beneficiary turns 60, the pension is tax-free.
A transition to retirement income stream (TRIS) is non-commutable while you are alive. Meaning you can’t cash it out as a lump sum. But all this stops when you die. The TRIS stops and the non-commutable restriction stops. Your super just goes into the general pool of benefits to be paid out.
A reversionary TRIS can only revert if your chosen beneficiary has met a condition of release with nil cashing restrictions. If they have, it becomes a death benefit pension since they have met a condition of release. If they haven’t, then the TRIS is excluded from the retirement phase under s307-80 (3) ITAA97.
Death Benefit Pension
For a death benefit pension your super doesn’t leave the super environment. It just goes to a new pension for a new beneficiary.
Your non-dependants don’t pay ‘super death tax’ at once but rather on each pension payment. The proportioning rules determines the tax-free and taxable components of each payment. And then just as with a lump sum payment, your tax non-dependants pay tax on the taxable component of each payment, while your tax dependants don’t pay any tax.
An insurance payment to your SMSF – a life insurance policy within your SMSF for example – goes into the untaxed element of a taxable component. That portion of the death benefit is then taxed at 30 per cent for non-dependants.
4) Medicare Levy
Whether or not the 2% Medicare levy applies on top of a 15% or 30% tax rate depends on how the death benefit is paid.
If it comes directly from your super fund, the 2% Medicare levy applies. If it comes via your estate, the levy doesn’t apply. This little detail can easily cost your adult child $20,000 on a $1m lump sum death benefit.
Question # 4 What happens to my SMSF?
Your SMSF is a fiduciary relationship between trustees and beneficiaries in respect of fund assets. As long as all three elements are present, this fiduciary relationship will continue.
If there is at least one other surviving member, your SMSF will have a trustee and member as well as assets. But what happens if you were the only member?
With your death your SIS dependants and/or estate will replace you as beneficiaries. So until your super is paid out, your fund has beneficiaries, fund assets and a corporate or second individual trustee.
But once your super is cashed out, your SIS dependants and estate have no more claims against your fund. So the fund stops having beneficiaries or fund assets, sealing the end of your SMSF.
The loss of a director – even if you are the sole director – does not end a company and hence does not end your SMSF’s corporate trustee as such. But with no fund assets or beneficiaries left, the fiduciary relationship ends and your corporate trustee becomes an empty shell.
So this is what happens to your super when you die. It is all in your hands if you want it to be.
Disclaimer: numba does not provide personal financial or tax advice in this article. All information on this website is of a general nature only. It might no longer be up to date or correct. You should contact us directly or seek other accredited tax advice when considering whether the information is suitable to your circumstances.
Liability limited by a scheme approved under Professional Standards Legislation
Last Updated on 12 March 2019
Share this entry
CONNECT WITH US
Got a question? Just call, email or use the contact page.
Our email address is firstname.lastname@example.org.
We are also part of Australia's tax news podcast - Tax Talks.