For most Australians, superannuation is their largest financial asset outside the family home.
Estate planning is the process of ensuring that your family and dependents are financially secure when you die. Not only do you want your super to end up in the right hands, but you also want it distributed in the most tax-efficient way.
For that reason alone, many people decide to take control of their future financial well-being by starting their own self-managed super fund. This is important not just as a means of maintaining a certain living standard upon retirement, but also further down the track: in how much, and in what manner, assets are left to the children or other beneficiaries.
A well-managed SMSF offers potential strategies to maximise your family’s inheritance that are unmatched by other types of super funds and savings vehicles.
A non-estate asset
Superannuation is called a non-estate asset because it is not controlled by your will. This is because super is not personally owned but held in trust by a super fund.
When you die, the balance of your super will be paid out to your beneficiaries in the form of death benefits. The way these death benefits are paid is governed by your SMSF trust deed.
The only way you can ensure that your super is distributed according to your will, is to nominate your personal legal representative as your beneficiary, who will then distribute all proceeds of your super into your estate.
Consider a binding nomination
One of the benefits of running your own SMSF is the ability to make a binding death benefit nomination that does not lapse, unlike those in mass market super funds which must be renewed every three years.
To be valid and safe from challenge by disgruntled relatives, a binding nomination must be completed correctly and it must be permitted by your SMSF trust deed.
Unless you make a valid binding nomination specifying how your super will be distributed among eligible dependents, your fund’s trustees have full discretion over who receives what. That means trustees can override a non-binding nomination and direct your death benefits to other eligible dependents or your estate.
Who can inherit my super?
Superannuation law is strict about who can inherit your super. Generally speaking, super death benefits can only be paid to your estate or ‘eligible’ dependents.
Eligible dependents include a surviving spouse or de facto, children of any age, financial dependents or someone who had an ‘inter-dependency’ relationship with you such as a carer or someone who lives with you.
Super benefits can’t be left indefinitely in your SMSF. They must be either paid out as a lump sum to your beneficiaries or continue to be paid as a reversionary pension to your spouse.
When considering who to leave your super to, and in what amounts, you should also give consideration to the tax status of your beneficiaries.
How will my beneficiaries be taxed?
Super death benefits are split between taxable and tax-free components. The taxable component includes salary-sacrificed and compulsory contributions as well as fund earnings. The tax-free component is basically all contributions you have made to super that have not been claimed as a tax deduction.
As the term suggests, the tax-free component of your super death benefits will be paid tax-free to your beneficiaries in all cases.
The taxable component of a lump sum death benefit is taxed at 16.5 per cent unless it is received by a so-called ‘tax dependent’, that is, your spouse or former spouse, children under 18, financial dependents or someone with an inter-dependency relationship. While adult children are eligible dependents they are not regarded as tax dependents unless they depend on you because of a disability.
If you want to leave super to your adult children there are legitimate strategies to reduce the taxable component of your death benefits and hence the amount of tax your children pay on their inheritance.
Not all benefits must be paid in a lump sum. A reversionary super pension can be paid to a tax dependent, generally your spouse, if you or your spouse is over 60 at the time of your death.
Consider a corporate trustee
Having a corporate trustee provides greater flexibility and certainty in estate planning. It also opens up the possibility of perpetual succession and a more tax-efficient transfer of intergenerational wealth.
If family relationships are strong, adult children can be brought into the fund and made directors of the corporate trustee while both parents are still alive. The only limitation is that the maximum number of members in a SMSF is four.
Even in two-person funds, it is easier to find a replacement director than an individual trustee if one member dies or is incapacitated. A corporate trustee will continue to hold a fund’s assets despite a change of directors.
If you hold shares in a corporate trustee then your SMSF effectively becomes an estate asset and this can also open up some attractive estate planning strategies.
Whether you opt for a corporate trustee or individual trustees, estate planning will run more smoothly if you nominate a successor. This will also reduce the stress on a surviving spouse, especially if the more active fund member dies first.
Your overall estate plan and your SMSF trust deed need to be kept up to date to take into account any changes in your family or financial circumstances. Births, deaths, marriage, divorce, major asset purchases or sales and children becoming adults need to be incorporated into your planning.
While it is important not to try and govern from the grave, the more explicit the trust deed is the less open it is to challenge after you die.