The introduction of the $1.6 million transfer balance cap and the reduction in contribution caps mean many clients need to consider structures outside of super for the distribution of wealth via their estate plans.
If a death benefit is paid as a pension, the maximum amount that can be used to start the pension is restricted by the transfer balance cap, currently $1.6 million. Amounts above the transfer balance cap must generally leave the super system.
It is essential members with larger super balances and/or insurance review their estate plans to ensure any benefits that may be forced out of the super system are directed to structures that can be controlled, such as testamentary trusts established via a will.
While the tax-effective distribution of assets is an important consideration, many members with children will favour greater control over how their super benefits are distributed. An effective distribution structure for excess super benefits is a testamentary discretionary trust created by the member’s will. Alternatively, if members have met a condition of release, they can take a benefit payment from the SMSF either in specie or as a cash payment. The proceeds can then be moved to a family trust, used to commence an investment bond or simply held by the client personally.
Testamentary trusts
A member can make death benefit nominations to pay any amount above the transfer balance cap to their legal personal representative to be distributed in accordance with their will. This enables clients to stream income from their super benefit to death benefit dependants.
Many parents appreciate the tax efficiency of paying death benefit pensions to minor children, but balance this with their fear of what their children may do with a large sum of money. Generally, a death benefit income stream can be commuted at age 18, however, many SMSFs are able to incorporate into the fund rules that the benefits cannot be accessed until age 25. Age 18, or even 25, is not an age where many parents feel their children would make responsible financial choices (red sports car anyone?). Directing some or all of the super balance to a testamentary trust can address this issue because the parent can control when a child has access to funds.
Clients may have other beneficiaries who will benefit from not having direct control over an inheritance. These can include spendthrift beneficiaries, those with gambling, alcohol or drug addictions, or people who are easily influenced by others.
Beneficiaries pay income tax at their individual marginal rates on the amount of income they receive from the trust. However, unlike tax on income from other sources, beneficiaries of testamentary trusts under age 18 are taxed at normal adult rates rather than the penalty tax rate applied to minors. As a result, the potential for tax savings when trust income is allocated to children can be substantial.
As the assets of the trust are not legally owned by the beneficiaries, testamentary trusts provide a level of protection in the event of a beneficiary’s relationship breakdown or bankruptcy.
Family trusts
Discretionary family trusts are a popular business and investment structure in which the trustee holds assets in trust for a group of beneficiaries, usually family members. They offer asset protection and taxation advantages.
If a member has met a condition of release, they may cash their super benefit and transfer assets to a family trust. The trust’s assets will not form part of a client’s estate, however, they can influence the future control of the trust through their will and by appropriately structuring replacement trustee arrangements.
Investment bonds
Investment bonds can provide a very simple method of transferring wealth. The investment bond is an insurance contract and does not form part of a client’s estate, thus cannot be the subject of estate disputes. Generally, clients would structure the bond so they are the policy owner and the life insured, and the person to whom they want the proceeds paid to is the beneficiary. Amounts deposited in the bond receive investment returns that are not distributed but are fully tax paid when received after the death of the life insured.
An additional advantage of an insurance bond is, that unlike super, there are no restrictions as to who can be nominated as a beneficiary. Charities, trusts or companies can also be nominated as beneficiaries.
