While there are no longer any official death duties in Australia, tax liabilities can still be levied on superannuation death benefits. Chris Balalovski examines a strategy to eliminate this type of financial burden.
There is a myth in Australia that there is no tax on death. Unfortunately, this isn’t the case when it comes to superannuation. Without appropriate advice, clients could face taxes of up to 31.5 per cent where superannuation is paid to adult (that is, non-dependent) children. So for a high net worth individual with superannuation savings of $2 million, their beneficiaries could face taxes as high as $630,000 on their inheritance.
In addition, even where a client has a spouse and/or minor children, and the super benefits may be received tax free, advice can still make a difference. It can also give your clients valuable peace of mind that their loved ones will continue to be looked after, in a tax-effective manner, long after they have passed.
The common default scenario – paying a death benefit pension to a minor child
Where a super death benefit is paid to a minor child as a child account-based pension, that pension must be commuted by the time the child reaches the age of 25, unless they are disabled.
For many clients, this may be a suitable planning option. However, for clients who may be concerned about the prospect of their 25-year-old child managing a financial windfall, there is another strategy that may be a viable alternative – a super proceeds trust.
By using a super proceeds trust, your clients have a way of undertaking longer-term planning to ensure their minor children (and possibly grandchildren in some cases) are able to receive a tax-free benefit at a time when they may be mature enough to deal responsibly with that often large lump sum.
What is a super proceeds trust?
A super proceeds trust is a form of trust that is funded by superannuation death benefits. It is generally established under the terms of a person’s will to manage their superannuation death benefits for the ultimate benefit of various beneficiaries, instead of those beneficiaries inheriting the death benefits directly.
How does it work?
A super proceeds trust is generally established in one of two ways:
- by a clause in a will, or
- via the superannuation fund’s trust deed.
Where a super proceeds trust is established by a will, it commences when its trustee receives superannuation death benefits from the executor of the deceased estate.
Beneficiaries of a super proceeds trust should only include individuals and no other entities (such as companies, trusts or charities/tax-exempt organisations). Those individuals should be limited to people who were tax dependants of the deceased at the date of their death, that is, their spouse, their minor child, someone with whom the deceased had an interdependency relationship, or someone who was financially dependent on the deceased.
Key advantages of super proceeds trusts
There are several features of super proceeds trusts that make them an appropriate structure to use for estate planning purposes. These are outlined below.
Taxation efficiencies – there is no additional tax on payment of superannuation death benefits to the super proceeds trust. Minor beneficiaries are taxed at ordinary adult rates, rather than the penalty child rates.
Flexibility – a carefully drafted will can vest the trustee with wide powers and the identity of the trustee is not limited. The trustee of a super proceeds trust could be a professional trustee or other individual/s known to your client.
Longevity – as compared to the child account-based pension option (described above). This occurs because a super proceeds trust, as a form of trust, has a lifespan of up to 80 years in most Australian jurisdictions (notably, however, a trust can exist in South Australia in perpetuity).
Time frame to establish – there is generally no restriction on when this can occur if it is via a will, though a trustee of a superannuation fund will generally be obliged to make the benefit payment as soon as practicable.
Asset protection – the assets of the trust are protected from the creditors of the beneficiaries and other third parties. For example, if your client’s spouse is in a high-risk occupation, putting the money into a super proceeds trust protects it from being available to their business creditors. Similarly, if one of your client’s children has relationship problems, their share of the inheritance remains protected within the trust.
Who is a super proceeds trust suitable for?
A super proceeds trust will be most suitable for clients who have tax dependants who are minors, or who may be vulnerable in some way (perhaps due to illness, injury or an ‘easily led’ personality) or a spendthrift. Due to its long-term nature and inherent flexibility, a super proceeds trust can also be a useful vehicle in which to generally grow wealth.
What if my client doesn’t presently have any tax dependants?
A carefully drafted will containing a super proceeds trust may still be suitable for a client, even though they may not have any tax dependants currently. In fact, it could be argued they are a useful form of protection against adverse events occurring in the future. Circumstances change and unforeseen events (such as illness, injury and relationship breakdown) may mean that even an independent adult child becomes either financially dependent or in an interdependency relationship with their parent.
Super proceeds trust
When Ted died, he was survived by his wife, Sandra, and their two children, Tracey, 17, and Dean, 21.
Dean is fully independent – he is employed full-time, lives in a share house with his friends and doesn’t rely on his parents for any financial support. Tracey is in her final year of high school and is fully dependent on her parents.
Ted had made a binding death benefit nomination, instructing the trustee of his superannuation fund to pay his death benefits of $700,000 to his estate. His will then provided that the entirety of his estate, including the death benefits, be paid to a testamentary trust, the beneficiaries of which were Sandra, Tracey and Dean.
Although Sandra and Tracey were Ted’s tax dependants when he died, Dean wasn’t. Therefore, the consequence of the payment of his death benefits to the testamentary trust is that the entirety of the amount may be treated as if it had been paid to non-tax dependants. If the death benefit was all taxable, then the result is that his deceased estate will be liable for tax of at least 16.5 per cent ($115,500) and as much as 31.5 per cent ($220,500) when it receives the payment.
Had Ted established a super proceeds trust for the benefit of Sandra and Tracey only, that tax could have been saved. Ted could have made alternative provision for Dean, perhaps by allowing him to inherit other assets.
Of course, an added benefit of the super proceeds trust is that it will also enable any earnings on its capital to be distributed to Tracey and be taxed at ordinary adult rates, instead of penalty child rates.