Superannuation death benefits - super or not super: that is the question!

What is a superannuation death benefit?

A superannuation death benefit generally refers to a payment from a superannuation fund upon the death of the member.    The payment can be made in the form of a lump sum, but in some circumstances, can be paid to a dependent.   Depending on the super fund’s Trust Deed, the lump sum payment can be made in the form of a cash payment, or an in-specie transfer.  Pension payments can only be made as a cash payment.

Who is a dependent for super? 

The purpose of a superannuation death benefit is to provide for those who would or should have continued to receive support from the member had they not passed away.  The Superannuation Industry (Supervision) Act 1993 (SIS) dictates who can be paid a death benefit.   The SIS Act states that a death benefit can be paid to: 

• A dependent/s of the deceased member;  or
• A legal personal representative of the deceased member (such as the executor of the Will or administrator of the Estate); or
• Another person, only if the Trustee has not found either of the above persons and the regulator has approved the payment in writing (subject to the super funds rules).

 The Act States that a death benefits dependent is[1]: 

• The deceased person’s spouse or former spouse;
• The deceased person’s child aged less than 18;
• Any other person with whom the deceased person had an ‘interdependency relationship’ just before he or she passed away; or
• Any other person who was financially dependent on the deceased just before he or she passed away

What does interdependency relationship mean[2]? 

An interdependency relationship will exist if two people:

• Have a  close personal relationship; and
• They live together; and
• One or each of them provides the other with financial support; and
• One or each of them provides the other with domestic support and personal care.

 Two people may also have an interdependency relationship if they have a close personal relationship and the only reason they fail to satisfy all the conditions noted above is that either or both of them suffer from a physical, intellectual or psychiatric disability, or they are temporarily living apart, for example one is overseas etc.  Interdependency relationships cannot exist between siblings, a parent and child (for example where the other parent has died or is suffering from ill health),  or if one of them is providing domestic support and personal care under an employment contract, or on behalf of another person or organisation such as a government agency.  Regulation 302-200.01 denotes the factors that are to be taken into account to determine an interdependency relationship.   Bearing in mind our article is a summary, we will not note them all here, however factors such as the duration of the relationship, care and support of children, degree of emotional support etc are taken into consideration for determination of an interdependency relationship. 

Who is a financial dependent? 

The superannuation Trustee determines whether a person is financially dependent on the deceased member at the time of the member’s death.  There is no guide to the meaning of financial dependent in the legislation therefore it is subject to interpretation by the individual super fund Trustee. Generally a super fund Trustee will consider whether financial support was required in the normal standard of living and whether the person was reliant on the deceased on a regular, continuous basis to maintain that standard of living. 

Who can receive a superannuation death benefit?

Superannuation legislation governs who can receive a death benefit however it does not indicate who should receive that benefit as a priority of one beneficiary over another.  The actual distribution of a death benefit may be determined by the super fund rules or a binding nomination made by the member.  In the absence of specific fund rules, or a valid binding nomination, Trustees can exercise their discretion as to how a death benefit can be paid among the potential beneficiaries.

What are the choices if you wish to make a beneficiary nomination?  Depending on the super fund trust rules, you may have the choice of a non-binding nomination, a binding nomination, or you may be able to nominate your Estate as the beneficiary.  If you have a superannuation pension or annuity, you can nominate a reversionary beneficiary.   Not all super funds allow a binding nomination so you should check with your super fund as to the beneficiary nomination options available.

Non-binding beneficiary nomination:

If you have made a non-binding beneficiary nomination, the super fund Trustee has the discretion to pay the death benefit to dependents and/or the legal personal representative, and in the proportions the Trustee determines.  A non-binding nomination provides guidance to the Trustee of the member’s preferred death benefit recipient(s), however the Trustee has the ultimate discretion to whom the benefit will be paid.  

Less weight will be attached to the non-binding nomination if the member’s family or financial circumstances have changed since the nomination was made.  For example a member may have separated and moved into another close personal relationship at the time of their death.  If the member had nominated the estranged spouse as the beneficiary, the Trustee may consider the circumstances at the time of death and make a beneficiary payment to the new spouse.  Also, if the member had a valid Will at the time of death, the terms of the Will may also be taken into consideration.

Binding beneficiary nomination:

A binding nomination must meet certain criteria (as stated in the SIS legislation) to be valid.  This type of nomination binds the Trustee to pay the death benefit in accordance with the member’s wishes.  If your fund offers a binding nomination option, you should check with them to see if the nomination has an expiry date and needs to be confirmed, or if the nomination is an enduring nomination with no expiry date.   Quite often binding nominations are only valid for 3 years and need to be re-confirmed by the member upon expiry.

Binding nominations in SMSF’s:

The ATO has stated that an SMSF can have a binding nomination option, but this must be permitted by the SMSF trust deed.  A binding nomination in an SMSF does not need to meet all the criteria for a valid nomination such as the stringent witnessing requirements.

Reversionary nomination:

Upon the death of a superannuation pensioner or annuitant, the income stream would continue and the ownership would transfer to the nominated reversionary beneficiary.  The reversionary beneficiary must generally qualify as a dependent for tax purposes at the date of death otherwise the nomination is invalid.

Taxation of superannuation death benefits.

All of the previous information in this article leads up to the important aspect of a superannuation death benefit payment, and that is the tax consequences of making the payment.  The taxation of a superannuation death benefit varies, depending on whether the beneficiary is a dependent or non-dependent for taxation purposes.   The definition of dependent for tax purposes is different to the definition of dependent for super purposes.  The definition of dependent for tax purposes is:

• The deceased person’s spouse or former spouse (including a de facto spouse or opposite or same sex);
• The deceased person’s (or their spouse’s) child, aged less than 18;
• Any other person with whom the deceased person had an interdependency relationship just before they died;
• Any other person who was financially dependent upon the deceased person just before they died.

Death benefits payments to dependents.

As we have previously mentioned, a death benefit can be paid as a lump sum or a pension.  A lump sum death benefit is paid to a dependent tax free, (that is not assessable income and not exempt income).  A death benefit pension is an income stream paid by the super fund to the dependent of the deceased member.  Not all super funds offer a death benefit income stream option so you should check with your super fund if this is available.  The tax free component of a death benefit pension is always tax free.  The tax treatment of the taxable component of the super benefit will depend on the age of the deceased and the age of the dependent as noted in the table below.

Table 1: Tax treatment of the taxable component of a superannuation death benefit.

There are many other aspects of a death benefit pension which cannot all be included in our article, such as commutations from a death benefit payment and child death benefit income streams.  You should speak to a duly qualified adviser to ensure that you fully understand the implications of making a death benefit pension nomination to your dependent beneficiaries.

Anti-detriment benefits.

Death benefits paid as a lump sum to a spouse, former spouse or child (of any age) may be increased by an amount that represents the tax deducted from contributions which funded the death benefit.  This increase in the death benefit is known as the ‘anti-detriment’ amount and may be paid in respect of a deceased member’s accumulated superannuation benefit or superannuation income stream. Not all funds offer to pay an anti-detriment amount and therefore this may be something you would like to consider when you are looking to choose a super fund. 

Death benefit payments to non-dependents.

Since 1 July 2007 non dependents can only receive a lump sum death benefit payment.  The tax free component paid to a non dependent is tax free.  The taxation of a taxable component paid to a non dependent is outlined in the following table:

Table 2: Tax on taxable component of a lump sum death benefit payment.

Life insurance in super.

We talked about life insurance in super in a recent article, and noted that when a person has life insurance in superannuation, the insurance proceeds form part of the death benefit.  That is, in a super accumulation fund, the insurance benefit is added to the account balance and paid to the beneficiary(ies).  If the super fund has claimed a tax deduction for the insurance premiums, and the beneficiary is a non-dependent, the taxable component of a lump sum death benefit includes an element untaxed in the fund.  This untaxed element will be taxed at 30% (plus Medicare levy) as opposed to the taxed element which is taxed at 15% (plus Medicare levy).  Medical levy surcharge and Flood levy may also apply.

The calculation of the taxed and untaxed elements follow a formula which includes the amount of the super lump sum, the number of service days, and the days to retirement.  The taxable component (taxed element) formula is shown as:

Amount of superannuation lump sum                    x              services days

    Service days + days to retirement

The untaxed element is the taxable component minus the result as calculated in the above formula.

How does this formula work?  Let’s use the following example.  George has been a member of a super fund for 15 years, and he passed away at age 55 on 1 July 2011.  A lump sum death benefit including insurance proceeds is payable to his adult children who are non-dependents.  The amount of the lump sum being paid is $200,000, all of which is taxable component.  The taxed and untaxed element of the taxable component are calculated using the formula above:

    $200,000          x              5,479

(5,479 + 3,654)

5,479 represents the number of days from 1 July 1996 to 1 July 2011

3,654 represents the number of days from 1 July 2011 to 1 July 2021 (when George would have been eligible to retire)

The taxed element         = $119,982 ($200,000/9,133 x 5,479)

Untaxed element            = $200,000 - $119,982

                                                = $80,018

Looking at the tax that would be payable by his adult children using the rates show on Table 1 above, the taxed element would be taxed at 15% ($119,982 x 15% = $17,997) plus Medicare and other charges if applicable, and the untaxed element would be taxed at 30% ($80,018 x 30% = 24,005) plus Medicare levy and other charges if applicable.  That comes to a total tax of $42,002 that would be paid on the benefit payment amount of $200,000.  As you can see this represents a substantial amount deducted from the benefit payment; approximately 21%.  That means that rather than the beneficiaries receiving the benefit payment that was intended for them, approximately 21% of the benefit will be paid to the tax office as the beneficiaries were non-dependents at the time of George’s death.  This is probably not what George had intended when he made his beneficiary nominations.  Would it have been better for George to have insurance cover outside of super for his non-dependent adult children as an inheritance to help compensate for the effect of tax on his super account?

Finally!

Superannuation, and the legislation governing it is very complicated.  Everyone’s circumstances are different and it is very important to regularly review your arrangements to make sure that they reflect your wishes.  Having insurance cover within super may be a cost effective and tax effective way for you to have the term life insurance cover, but the impact on the beneficiaries may not be what you have intended for them, so if it very important to understand the role of the SIS Act and Tax regulations play on superannuation death benefit payments.

If you have not nominated a beneficiary for your super, or if you are unsure if you have nominated a beneficiary, please contact our office and we will try to assist you with this.  Remember, the information in our articles is general in nature, and while it may be a good reference source for you, you should always speak to a qualified adviser in the areas of financial planning, tax and law as everyone’s circumstances are different, and your adviser is best placed to help you with your particular needs. 

REFERENCES:

OnePath Technical Services, Superannuation death benefits, October 2011

CCH Australian Master Superannuation Guide, 15th Edition, 2011/12

[1] As defined in section 302-195 of the SIS Act, 1993.

[2] Definitions as noted in s302-200 of the SIS Act.

[3] Marginal tax rate includes Medicare levy, Medicare levy surcharge and Flood levy if they apply.

[4] Maximum tax rates.  Medicare, Medicare surcharge levy and Flood levy may also apply.