To say paying super death benefits to an adult child or children should always be made via the estate is of course a silly way to start an article about superannuation and estate planning. There is no such thing as ‘always’ when it comes to this complex and legally fraught area.
There will of course be circumstances where superannuation should bypass the estate, for example, if the estate has debts or there is a dispute brewing that risks super intended for the deceased’s children landing in the hands of other people.
But what about the most common scenarios where there is no risk in paying the superannuation to the estate and the member is genuinely weighing up all the options before preparing a death benefit nomination for an adult child?
Estates are a great place to pay superannuation where the money is going to independent adult children or basically anyone who is not a death benefit dependant for tax purposes and/or is unable to take the super as a pension.
The most well-known benefit is that estates don’t pay the Medicare levy. That’s great news whenever the superannuation death benefit includes a taxable component and is being received by someone who will actually pay tax, such as the adult children in this article. While Medicare is a small percentage, only 2 per cent, remember it is applied to capital, meaning the amounts can be surprisingly large. A $1 million death benefit that consists entirely of a taxable component will trigger a Medicare levy of $20,000. Who wouldn’t want to save this sum if all that’s required is paying the amount via the estate?
A more subtle tax benefit is the impact payments from the estate have, or more correctly don’t have, on the calculation of income for a number of important purposes, including Division 293 tax (a special tax that people who earn more than $250,000 pay on certain superannuation contributions), family tax benefits, Higher Education Loan Program debt and the Commonwealth Seniors Health Card.
When a superannuation death benefit is paid directly to a person who will pay tax on it, it’s income, albeit special income with special tax rules. When paid to the estate, it is income to the estate but a capital distribution when eventually paid to the beneficiary. While the tax on the super benefit itself is the same either way, apart from Medicare, capital payments don’t get counted in income tests for other things like Division 293 tax, et cetera.
When the benefit is paid to the estate, the SMSF doesn’t have to withhold and pay tax on the benefit; that’s for the estate to worry about. This can be extremely useful if, for example, the superannuation fund’s assets don’t lend themselves to making large cash payments to the ATO.
What if the superannuation fund largely owns a property and not much cash? It may not have enough cash to withhold tax from the death benefit unless it sells the property. But what if the family wants to hang on to the property? The SMSF could pay the death benefit to the estate in specie by transferring the property and the tax bill could be paid from other estate assets. And remember the amounts can be large. A $1 million death benefit consisting entirely of a taxable component paid to an adult child will generally result in a tax bill of at least $150,000 and possibly more if the deceased was under 65 and had insurance when they died.
Estates can accommodate far more complex arrangements that are difficult or even impossible to accommodate in an SMSF.
For example, imagine the member has three children and intends their super to be split equally between the three. What do they want to happen if one of the children pre-deceases them? This is probably catered for in the estate, but not necessarily well thought out, nor accommodated, in a superannuation death benefit nomination.
In fact, if the intention is to share the child’s portion between their own children, that is, the member’s grandchildren, it will generally be impossible to make the payment directly in any case. Grandchildren are typically not on the list of approved beneficiaries for superannuation death benefit purposes.
Similarly, estates can provide for testamentary trusts, added protections for vulnerable family members, distributions to other people or entities (charities) that can’t be handled easily, if at all, directly in an SMSF.
Finally, whether we like it or not, clients usually take their will more seriously than a binding death benefit nomination for their SMSF. We would all like this to be different, but realistically we know it is true. Hence pushing the superannuation benefit to the estate when the money has to leave the super environment anyway (there are no longer any potential pension recipients) can help ensure it goes exactly where the deceased intended.
Meg Heffron is managing director of Heffron.