Adult children now able to inherit Super tax free!
Under current rules, a person’s superannuation can be paid on death as a tax-free lump sum, a pension or combination of both if it is paid to a spouse. However, if it is to be paid to an adult child it must be cashed out of the fund and the “taxable component” of the superannuation death benefit taxed at the rate of 16.25%. This so-called “compulsory cashing rule” effectively moves
assets from an asset protected low taxation environment to a potentially non protected higher taxation environment where the benefit is taxed on the
The only way for superannuation benefits to be retained in the fund and paid as a pension (potentially tax-free) is if the beneficiaries of the super are either a
spouse, a financial dependant or in an interdependency relationship with the
deceased member at the time of his or her death.
In these circumstances, the beneficiary is treated for taxation purposes as a “death benefits dependant” permitting the superannuation benefits to be paid either as a lump sum tax-free or a tax-free pension provided either the
deceased member or the beneficiary is over age 60 at the time of the member’s death.
Up until recently there has been debate as to whether an adult child or grandchild over the age of 25 years could receive superannuation benefits at death in the form of a tax free income stream.
It was considered that where the parent, for example, is aged 60 or over, a child or grandchild that was financially dependant on that member or in an interdependent relationship with that parent, could receive the superannuation benefits as a lump sum tax-free or as a tax-free income stream meaning that the assets forming the income stream could remain in a protected superannuation environment.
The cases of Malek, Faull and Noel-v-Cook which allowed the mother of an adult child, and also the boarder of a deceased member to be “dependants” for superannuation purposes were considered to be in doubt as a result of the subsequent “simpler super” reforms in July 2007, when the government introduced compulsory cashing of super on death for adult children. Doubt was also expressed in relation to a parent’s dependency on
an adult child who died, because of the explanatory statement in the legislative instrument that introduced the factors for an “independency relationship”.
However, a recent ATO interpretative decision 2014/22 now opens up an opportunity and more certainty, as far as the ATO is concerned, for an adult child to be treated as a “death benefits dependant” of a parent under the Income Tax Assessment Act. In that ruling, the adult child had given up work to care for the terminally ill parent and received no financial support from anyone other than the parent during that time. The ATO confirmed that the
adult child and parent had a close relationship, they lived together, the parent provided financial support to the child and the child was providing significant care for the parent. Thus the child satisfied the interdependency
relationship and the ATO confirmed that the child was financially dependant on the parent resulting in the child receiving the superannuation benefits entirely tax-free!
It was noted that the ATO considered that the definition of a death benefits dependant set out in the Income Tax Assessment Act does not stipulate the nature or degree of dependency though it is generally accepted that this refers to financial dependence and it is a condition that must exist in relation to the dependant child at the time of the deceased member’s death.
These views will have significant taxation consequences for the children of parents holding large superannuation account balances who, for example, decide not to move into an aged care facility but who may wish to adopt the government’s new home care packages and where a child decides to
care for their parent’s) at home.
Take for example Jake who is the sole surviving son of his mother Martha, aged 82. Martha’s husband Henry (who passed away three years ago) operated a large machine engineering business when he was working and 15 years ago transferred the factory into a self managed superannuation fund. The factory premises is now worth $2.2 million and Martha receives the income from the rent of the property of approximately $155,000 p.a as a means of income support. 80% of the value of the superannuation benefits that Martha inherited from Henry represents the embedded “taxable amount” of the value of the superannuation account although Martha is enjoying a tax-free income under current superannuation rules.
Jake is in a high risk occupation and had been running his father’s engineering business. He is now at risk of being sued as a result of a defect in some structural engineering work on a commercial building site and is considering winding down the business or selling it. If Martha became ill and required support she might move into an aged care facility and upon her death the super would pass to Jake who would be required to find $286,000 as death benefits tax. This might, of course, involve the sale of the property on its transfer out of the superannuation environment. However, if Jake was to support and care for his mother, either giving up work or significantly reducing his work hours and if his mother was to provide income support for Jake as a result of his services, Jake could receive his mother’s superannuation benefits as either a lump sum tax-free death benefit saving $286,000 or he could retain the factory property within the superannuation environment and receive a pension income stream. If asset protection was an issue, Jake could roll the pension back (within six months from the date of death) into accumulation mode where it would be completely asset protected from any
More on SMSF Wills…
In previous editions of the Super Brief, we have discussed the nature and features of an SMSF Will as opposed to a standard death benefit nomination. In simple terms, an SMSF Will is like a death benefit nomination on “steroids”.
Most Superannuation Trust Deeds provide for binding or non-binding death benefit nominations which typically follow the provisions of Section 59 of the SIS Act and the form of a binding death benefit nomination as provided by the regulations.
These regulations provide a simple form of nomination which typically allows superannuation benefits to pass immediately to a dependant spouse, their estate or other SIS Act dependants of the deceased in various proportions.
Typically clients leave their superannuation benefits to their spouse who may elect to receive the benefit either as a pension (common) or a lump sum. It is their intention however that if their spouse passes, the super is to pass to the children usually via the estate.
However, such nominations have no provision for “stepped” benefits meaning they do not provide for a situation or circumstance where one spouse predeceases the other such as in a car accident. In these circumstances, a standard form death benefit nomination even if it was a binding nomination would result in an invalid nomination being in force upon the death of both parents, allowing the Executor of the last surviving member to make an unfettered discretion as to how the superannuation death benefits are to be paid.
This may have disastrous circumstances where, for example:
- the members of the fund come from a blended family with children from previous relationships;
- they leave their superannuation benefits to each other even as a binding death benefit nomination;
- the nominations are not stepped, which is typically the case;
- they each appoint as a substitute Executor, children from previous relationships; and
- they both pass away together as a result of a single accident.
In such circumstances, where it is not clear who died first it will be presumed that the older of the parents died first meaning that the younger parent’s child would take control of the superannuation benefits.
As there is no valid stepped death benefit nomination, the child Executor could transfer the superannuation benefits including those benefits of their stepparent to themselves or themselves and their siblings excluding their step-children.
An SMSF Will addresses these issues by providing for stepped nominations with or without conditions specifying when the benefits need to be paid.
It also has the following additional features:
- Dividing specific assets that form part of the member’s death benefit to specific beneficiaries. For example business real property passing to children operating a family business;
- Allowing a restricted income stream to be paid to a child under age 25;
- Adjustment of benefits that are paid to one child who may receive a greater share of other estate or non-estate assets such as assets held in a Family Trust
- Allowing a restricted income stream or “conditional pension” to be paid to the spouse and upon his or her death to the children of a member who dies first;
- Giving a discretion to a dependant to receive the super through the estate or directly if it is likely that the estate is going to be challenged, thereby protecting the super from challenge;
- Specifying which beneficiary is to receive tax-free or taxable account
balances, reducing tax on the superannuation death benefits;
- Appointing a “Guardian” to monitor and protect superannuation benefits that are to be held for the benefit of a dependant beneficiary for a specified period of time and then to pass to a second dependant
Don’t lose control of your SMSF- beware of unpaid fines
At Hill Legal, we often get questions about who is eligible to be an SMSF Trustee. Generally, an individual who is at least 18 years of age can be a Trustee of an SMSF.
However, they can’t be a Trustee if they are under a legal disability (e.g. mental incapacity) or they are a disqualified person. Further, an individual cannot act as either a Trustee of an SMSF or director of a corporate Trustee if the individual is a “disqualified person” and they know that they are a disqualified person. This can arise if there are serious breaches of the SIS Act. A “disqualified person” is a person under Section 126K of the SIS Act who:
- has been convicted of an offence involving dishonest conduct;
- have been subject to a civil penalty order;
- is insolvent such as an undischarged bankrupt; or
- has been disqualified by the regulator.
A company is not permitted to act as Trustee if the company knows or has reasonable grounds to suspect that an office bearer is a disqualified person. Substantial penalties can apply to disqualified persons who act as Trustee and if they become disqualified during the operation of an SMSF they must immediately inform the Commissioner in writing and resigned as Trustee.
As to what constitutes “dishonest conduct”, neither the Act nor the Regulations define this concept. Section 120 (3) of the SIS Act provides the meaning of “convicted of an offence” involving dishonesty includes a reference to an order under Section 19B of the Crimes Act 1914. Basically, this Section allows for a Court to discharge an offender without proceeding to conviction however a dismissal or discharge under Section 19B will still count as being “convicted” for the purposes of the SIS Act.
Furthermore, Section 120(4) provides that the law on spent convictions does not apply. The existence of those convictions is aimed at giving offenders a second chance.
Accordingly, if a person receives, for example, a traffic infringement notice, or an on the spot fine for not having a train ticket, they are NOT being “convicted” within the meaning of the SIS Act. However, if the fine under the infringement notice was unpaid and the matter progressed to Court, this may result in the recording of a conviction and therefore the individual becoming a disqualified person.
Other examples found to be dishonest conduct have included shoplifting, a financial adviser making false statements in relation to financial products, publishing a false statement for financial advantage and making false entries in business records to steal money.
Get out of jail free card
If a person becomes a disqualified person it is not possible to appoint a legal personal representative such as an Enduring Power of Attorney under Section 17A (3) to act as Trustee in their place because this is specifically prohibited under Section 17A (10). Accordingly, the ramifications of a person being a disqualified person are serious because basically it means that the person cannot also be a member of an SMSF. In these circumstances, the SMSF would have to either convert to an APRA regulated fund or that member would have to roll out their superannuation benefits into an industry or retail superannuation fund.
An important exception is the possibility for the person to apply to the Commissioner to have their disqualified status waived and therefore remain as a member of the fund. This exception is found under Section 126B of the SIS Act and provided the offence does not involve serious dishonest conduct and the application is made within 14 days of the person’s conviction.
Serious dishonest conduct involves an offence involving a term of imprisonment for at least two years or longer (even if suspended) or a fine of at least 120 penalty units ($20,400). Application can be lodged outside of the 14 day timeframe only if the ATO is satisfied that there were exceptional circumstances preventing the application from being made within that period.
In the case of Mourched and the Commissioner of Taxation the Tribunal found that the illness of the member and his wife were not “exceptional circumstances” justifying a waiver application being made out of time.
If you have any questions or concerns about the issues raised in this month’s edition of the Super Brief please do not hesitate to contact our office.
Hill Legal – Lawyers and Consultants
Disclaimer: The material contained in this publication is general reading only information and does not constitute advice on the subject matter. While every effort has been made to ensure accuracy you should not rely on the information provided without seeking professional specialist SMSF advice on your individual needs and circumstances and the relevance and appropriateness of the ideas and strategies mentioned. No representation is given, warranty made or responsibility taken as to the accuracy, timeliness or completeness of any information or recommendation contained in this publication and Hill Legal, Lawyers and Consultants will not be liable to the reader in contract or tort (including for negligence) or otherwise for any loss or damage arising as a result of the reader acting upon any such information or recommendation.