When a member of a superannuation fund dies, their superannuation benefits (known as ‘death benefits’) must be paid out of the fund – this is what is referred to in the superannuation industry as a ‘compulsory cashing event’.
If the member’s superannuation is not paid to a ‘tax dependant’ (being someone eligible to receive the member’s superannuation entitlements tax-free), then there will be some tax to pay. The tax can be up to 15% of the member balance, and up to 30% of any life insurance that the member owns within the fund.
Because of this tax, where a person does not have any tax dependants, a common strategy is to consider withdrawing the superannuation into their personal name prior to their death, provided they meet certain conditions to access their super during their lifetime. This is often referred to as a ‘death bed withdrawal’, as many superannuation members do not want to withdraw their entitlements too early, given the concessional tax treatment usually afforded by holding wealth in the superannuation environment.
But there is some grey area here – what happens when someone has requested a withdrawal of their entitlements, but they pass away before the payment hits their personal bank account?
Australian Taxation Office (ATO) considerations
In February 2023, the Australian Taxation Office (ATO) published a list of factors that it will consider to determine with a payment in this scenario is a ‘death benefit’, meaning it will be subject to tax (if applicable) or a ‘member benefit’, meaning that the payment can come out to the member as non-assessable, non-exempt income i.e. essentially it is tax free (noting that other taxes such as capital gains tax and stamp duty may still apply).
Importantly, one of the key factors that the ATO considers is whether the trustee of the fund had knowledge of the member’s death prior to making payment of the superannuation out of the fund, which does not appear to have been considered as a relevant factor in the ATO’s previously published private binding rulings.
How does this apply to self managed superannuation funds?
In the case of a self managed superannuation fund (SMSF), unless one of very few exemptions apply, the member must be a trustee, or director of trustee company, of the fund, and on their death, their legal personal representative (being the executor of their Will or the administrator of their estate) will take their place in the controlling role. As such, there are very few circumstances where the trustee of the fund will not be aware of the member’s death, prior to making the payment pursuant to a request made by a member during their lifetime – perhaps only circumstances where an independent legal personal representative, such as a professional advisor or professional trustee company is appointed.
Following the ATO’s publication of the new factors for consideration, a private binding ruling has been published which sought to clarify whether payment from an SMSF initiated by a request during the member’s lifetime, but paid after their death, was a ‘member benefit’ or ‘death benefit’. The ruling concluded that the payment was a death benefit.
The ATO’s decision in this ruling largely turned on the SMSF trustee’s knowledge of the member’s death prior to making payment and stated that “it cannot be said that the trustee made the payments with the exemption that the member would be alive to receive it”.
Given this updated stance taken by the ATO in considering payments in these circumstances, it is difficult to see many opportunities that SMSF members will have to withdraw their super as non-assessable, non-exempt income, when doing so in the days immediately prior to their death, particularly in circumstances where assets will need to be sold or liquidated. Instead, longer-term planning may be required if a member has a serious health condition and consideration is given to the income tax benefits of retaining superannuation within the fund, versus the death benefits tax that would be payable if the funds are not withdrawn.
It is crucial that all advisors involved in assisting SMSF members are clear on the new ATO factors and how they are being adopted by the ATO through publications of its private binding rulings. Beyond this, all advisors in this area need to be fully across the governing rules of the relevant SMSF to efficiently take client instructions and implement withdrawals, particularly when the request is time critical.
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Disclaimer: This article provides general information only and is not intended to constitute legal advice. You should seek legal advice regarding the application of the law to you or your organisation.