A good DIY deed

PORTFOLIO POINT: Trust deeds can be powerful documents for asset transfers in the event of a member's death, but there's often some important groundwork to do first.

The prime driver for people getting into self-managed super funds is control.

In rough order, the types of control that SMSF trustees usually want to exert are control over investments, control over tax and control over the costs of managing their money.

However, there are other elements of control that are critically important and demonstrate why SMSFs can be a far superior retirement savings vehicle to APRA-regulated, predominantly managed-fund super.

And one of those is controlling what happens after you die.

For many, what happens after death might not seem as important as building the pot prior to your death. But it should be.

Largely, you can’t search out better tax options when you’re no longer around. You can’t decide after your death who will get what, and how. Like a will, you need to have put thought into it before you shuffle off.

(And if you’re not the sort of person who sees yourself as wanting to exert control after you die, look at it as a tax thing. Getting it wrong can mean there is up to one-third less of your super fund to be passed on.)

Do you want to leave your spouse a tax-free ongoing income stream? Do certain beneficiaries need a lump sum? Do some need both a lump sum, plus an ongoing income stream? Do you have young children you’d like to protect? Do you want to have an SMSF that could deliver tax benefits down your lineage for a generation or two after you’ve gone?

The base documents

It all starts with the two pieces of infrastructure that control SMSFs. The first is the SIS legislation, which covers super funds in general.

The second is your SMSF trust deed.

While superannuation law keeps on changing, your trust deed doesn’t automatically update with those changes to the law. Trust deeds are not living documents – they can’t override the law. But they can place huge restrictions on what you can do with your super, how it can be invested and how it can be passed on to others, among other elements.

It simply doesn’t matter what positive changes there have been to superannuation law – if your trust deed doesn’t allow you to do something, then you, as the trustee, can’t take advantage of new legislation.

Outside of the SIS legislation, which largely covers all super funds, the trust deed you choose for your SMSF can be a wickedly powerful document for transferral of your assets in the event of your death. Or it can be a rigid, archaic document that will deliver much of your hard-earned cash straight into the coffers of the Australian Tax Office when you die.

What flexibility can a trust deed give?

There are four main elements of a trust deed which can help members exert control over death benefits. A trust deed can:

• Allow members to make binding or non-binding nominations.
• Require that benefits be paid to particular beneficiaries (SIS dependants).
• Make agreements with other members/trustees relating to how benefits are paid.
• Give control to a trustee to pay lump sums, income streams or a combination of both.

Binding versus non-binding nominations

The option to allow nominations that were binding on trustees did not exist in law until 1999. SMSF trust deeds older than that might not have allowed for the flexibility to incorporate a binding nomination. And if your trust deed does not allow it, you can’t do it (and this will most likely get discovered by lawyers after your death).

Binding nominations, if made correctly, allow a member to direct a trustee as to how death benefits can be paid.

Prior to 1999, all nominations were non-binding, which gives the trustee absolute discretion as to whom death benefits should be paid. A non-binding nomination gave the trustees the knowledge of how the member would like their death benefit paid, but they weren’t compelled to follow it.

The only other alternative then was no nomination. In this case, the trustees would still only be able to pay SIS dependants, or the deceased’s legal personal representative.

For a longer piece on the benefits of binding versus non-binding nominations, see my column Who'll get your super?

Possibly the most famous case is Katz v Grossman, where the daughter of a couple joined as a member of the fund after the death of her mother. Their son did not become a member. Then the father died, leaving the daughter as the sole trustee. She invited her husband aboard as a trustee. They decided to ignore the non-binding nomination leaving it to both children. The son got nothing.

If a second marriage or two is involved, and the remaining spouse becomes the sole trustee of the SMSF (which raises its own issue if there was no corporate trustee), the deceased spouse’s children might get nothing.

You might not think it could happen in your family. Don’t kid yourself. Weird traits come out in people when there’s money to be fought over.

Payments to dependants

There are only certain people that death benefits can be specifically paid to – SIS dependants. Outside of that, the only other option is the deceased’s legal personal representative.

SIS dependants are limited to spouses and de facto partners (including same-sex relationships), children, financial dependants and interdependent relationships.

Your trust deed can’t override the law. But it can be more restrictive, reducing your choices as to who you can pay your benefits to.

Lump sums versus income streams

Super fund trust deeds might specify how death benefits are to be paid. If they do specify, it’s more likely to be a lump sum, rather than an income stream.

But an income stream left to the right dependant could potentially produce an overwhelmingly better outcome. The money would be in super and, if in pension phase, gains and income could remain tax-free, while the beneficiary might have to pay reduced tax on the income stream. And when the dependant turns 60, it’s tax-free.

In many other cases, it might make sense for beneficiaries to receive a lump sum, or part lump sum and part pension.

For more information on reversionary pensions and the ATO’s recent determination on the tax implications of reversionary pensions that are not automatic, see my column Step lively on super pensions. If the deceased is in the pension phase and an automatic reversionary pension has not been put into force, the pension could revert back to accumulation, with potentially serious tax consequences.

Trustee side agreements

Outside of binding nominations, under the SIS legislation, super fund trustees cannot be directed as to how to pay death benefits. However, this does not apply to funds of fewer than four members (such as SMSFs and SAFs).

Members and trustees can, in SMSFs, enter into legally binding agreements on the payment of death benefits. The agreement should be stamped by the state’s Office of State Revenue.

They have less administrative requirements than a binding death benefit nomination, but should be drawn up by a solicitor.

Today’s column is not exhaustive and is by no means a replacement for proper estate planning, which should take in a review of your SMSF trust deed, along with other estate planning issues, including wills, powers of attorney and trusts.

Dealer group Securitor is offering to partner with accountants to help them adjust to the removal of the exemption for working with SMSFs. It’s offering training to help accountants meet new licencing requirements, as well as providing access to technical and research support, for an annual fee of $4000. The proposal comes just before Financial Services Minster Bill Shorten announces the finer detail of what will replace the accountants’ exemption. The government hasn’t gone far enough to rectify the balance between penalties and inadvertent excess super contributions, says the SMSF Professionals’ Association (SPAA). CEO Andrea Slattery says that allowing the first breach of up to $10,000 to be refunded and assessed at an individual’s marginal rate penalised those who might have accidentally contributed $10,001. "Linking eligibility for the refund to a dollar threshold will deny many taxpayers the option of a refund even though their circumstances are broadly the same as other taxpayers who are eligible for the refund," Mrs Slattery said. SMSFs not only realise smaller losses than large public funds, but also have the majority of their assets in cash and term deposits, the ATO says. In a preview of the 2009-10 SMSF data, to be released later this month, the tax office said in the five years to June 30 2010, DIY funds were the fastest growing sector and the age of new trustees was trending lower. It also found that trustees were responsive to government policy and economic shifts when investing, and that even though SMSFs made negative returns in the same years as large funds, the losses were of a lower magnitude. The tax office is warning SMSF members that all trustees must be involved in fund decisions, because they’re all liable for the consequences. In its latest newsletter, the ATO said cases such as Shail Superannuation Fund v Commissioner of Taxation, where the husband withdrew almost all the fund’s capital and left the country, leaving the wife with a multi-million dollar tax bill, was an example of the possible consequences of having one trustee not fully involved in the running of the fund. The ATO will be watching property transfers into SMSFs much more closely after a warning to trustees about what they can and can’t transfer into a fund. "The only real estate you can transfer into your SMSF is business real property. You cannot transfer a residential investment into your SMSF. You also cannot transfer a property that has both business and non-business uses," the ATO said in its latest SMSF newsletter. Although about a quarter of all SMSF property investments are residential, the ATO says these kinds of property should effectively be a business asset and therefore generate income for them to claim a justifiable place in an SMSF.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.