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 way out. 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. Example 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 creditor. More on SMSF Wills… In previous editions of the Super Brief, we have discussed the nature and features of an SMSF Will as opposed … Continue reading The Super Brief March 2015