Home | Contact Us | Join Now | Log In | Search
Page last updated Friday, 05 February 2010
Self Managed Super Funds Bulletin - Issue 57: February 2010
Many wish to enforce not just to whom their super benefits are paid upon death, but also how those benefits are paid. This wish is common in clients with spendthrift spouses. Often such clients are concerned that if their spendthrift spouse receives a death benefit lump sum, those benefits will be quickly spent leaving the spouse financially unsupported. Such clients often seek to ensure super death benefits will be paid out as a ‘drip-feed’ pension.
It is well accepted that a binding death benefit nomination (‘BDBN’) can specify to whom death benefits are paid. However, many are unclear as to whether a BDBN can specify how benefits are to be paid.
Subject to the SMSF’s governing rules, a BDBN can specify how benefits are to be paid. However, there are some niceties that trustees, members and their advisers should bear in mind.
A BDBN is a nomination made by the member of an SMSF that is given to the trustee of the SMSF. Receipt of the BDBN binds the trustee to pay the member’s benefits upon death as specified in the BDBN.
However, not all SMSFs allow members to make BDBNs. In order for a member to be allowed to make a BDBN, the SMSF’s governing rules must allow for the BDBN. These rules are typically contained in the trust deed of the SMSF.
The general law position is that, if the governing rules of any trust — including an SMSF — require the trustee to follow a direction etc, the trustee must comply. This is due to principles articulated in the decision of Armitage v Nurse [1998] Ch 241. Accordingly, at general law, if an SMSF’s governing rules specify that members may give trustees BDBNs detailing how super death benefits are to be paid, this is valid and binding.
The super legislation modifies the general law position somewhat. Section 59(1) of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) provides that the governing rules of a super fund other than an SMSF must not permit a discretion under those rules to be exercisable by a person other than the trustee. However, there is an exception to s 59(1). This exception is contained in s 59(1A).
Section 59(1A) provides that — subject to a trustee of the fund complying with the conditions contained in the super regulations — the governing rules of a super fund may permit a member to give a notice to the trustee that binds the trustee to pay any super death benefits to persons mentioned in the notice.
The super regulations specify that the notice must meet certain conditions such as:
Naturally, such a notice is a BDBN.
The exception in s 59(1A) makes it clear that a BDBN can specify to whom super death benefits are paid. However, the exception is silent on whether a BDBN can specify how super death benefits are paid. Because the exception is silent, the original prohibition in s 59(1) applies to this aspect. However, the original prohibition never applied to SMSFs!
Therefore, there is a well accepted view in the industry that the exception and the conditions contained in the regulations have no application to SMSFs. This is why — although non-SMSF super funds may only have BDBNs that last for three years — the Commission of Taxation has released a determination stating that SMSFs may have BDBNs that last indefinitely (SMSFD 2008/3).
Accordingly, there is nothing stopping an SMSF’s governing rules from allowing a BDBN to specify how benefits are to be paid.
However, there are certain risks that must be considered.
Firstly, despite the Commissioner’s determination, the view that the requirements in the regulations do not apply to SMSFs is not universally accepted. The recent case of Donovan v Donovan [2009] QSC 26 considered the validity of an SMSF BDBN. The judge was aware of the Commissioner’s determination, but nevertheless left the door open to the possibility that even SMSF BDBNs must conform to the super regulations.
Secondly, the most popular type of SMSF pension (including death benefit pensions) is an account-based pension. Account-based pensions can generally be commuted (ie, exchanged for a lump sum) at any time. Furthermore, there is generally no limit on the size of account-based pensions annual payments. These characteristics can be sought to be addressed by having the BDBNs also add extra rules as to how pensions are paid (eg, with a cap of maximum pension payments, without the ability to be commuted etc). In order to achieve this, the SMSF’s governing rules would need to specify limitations and in so doing ensure that there is no conflict with the super regulations. Moreover, in order for these limitations to be irrevocable, the SMSF’s governing rules would need to contain special provisions to preclude the surviving spouse from opting out. This type of strategy has yet to be tested in court.
Thirdly, remember that the members of the SMSF must also be trustees (or directors of the trustee company). This means that members also can write the SMSF’s cheques! Consider an example where dad fears that mum is a spendthrift and will quickly dissipate any super death benefits. Accordingly, dad makes a BDBN that specifies that upon his death, mum (as the surviving director of the SMSF’s corporate trustee) must pay herself a pension. If mum truly is a spendthrift, she may well ‘rip’ the money out of the SMSF and waste it. Although an action could then be brought against the trustee in the supreme court, this would not help in achieving the goal of ensuring that mum is financially supported.
To overcome the first risk, some advocate inserting provisions directly in the SMSF’s governing rules. However, this does little to address the second or third concern.
Another technique is for the client to accept these risks. The client can merely accept that by using the super environment, tax efficiency is being achieved but this comes at the cost of being able to fully control super benefits from the grave.
The final technique can be split into two ‘sub-techniques’.
The first sub-technique is to make a BDBN specifying that upon death super death benefits be paid not to the spouse, but rather to the deceased’s estate. The terms of the deceased’s estate (ie, the will) can then specify that the surviving receive an annuity of $x per annum as increased for inflation each year. Naturally, an independent third party would be the executor of the estate and the trustee of any trust that arises under it. However, the first sub-technique opens the door to the new risk of the estate being challenged.
Therefore, the second sub-technique should be considered. This is to withdraw benefits from the SMSF during lifetime and then put the benefits in an inter vivos trust (eg, a family discretionary trust). The governing rules of the inter vivos trust can specify that the surviving receive $x as increased for inflation each year and an independent third party would be the trustee. For completeness, note that in New South Wales the ‘notional estate’ provisions can mean that technique this is also subsequent to a challenge against the estate.
Both these sub-techniques involve a loss of tax efficiency.
If the SMSF’s governing rules so allows it, a SMSF BDBN can allow members to specify not just to whom super death benefits are paid but also how. However, if the client wants to go this path, they must understand that they are bearing risk and that there is a trade off between the tax efficiency of keeping money in an SMSF and the ability to control how it is paid.
© Copyright 2008 AIA | Website design by XCEL Internet Solutions