Understanding super death benefits

Summary: Before the death of a member, it's important to understand the weaknesses of binding and non-binding death benefit nominations.  

Key take-out: Non-binding nominations give the trustee total control, which could be good or bad. Binding nominations are more definite, but there are also potential risks under certain circumstances. 

Self-managed superannuation funds are powerful vehicles for the living, but they can be even more powerful in death.

Making sure you plan the best you can so that in the event of your death your super goes to the right person, in the most tax-effective way, is one of your critical roles while you're alive.

If you have specific aims for where your money should go following your death, then making basic errors in the planning can have disastrous consequences.

Would you like to lose a large wad to the Tax Office? How about everything going to a bankrupt son which then goes to his trustee, and on to his creditors? And what about your daughter, married to that idiot you've never liked? (You still hold out hope that she'll come to her senses one day.) Do you want him to end up with a large wad of your super?

There is a misunderstanding that feeding your super to the right person is as simple as filling out death benefit nominations correctly.

It's not.

While this will suitably cover many, as soon as there is a chink in the ‘perfect family' you are possibly going to run into problems with getting that money to the right people at the right time.

Who can you leave your super to?

We need to start with a brief understanding of this topic.

You can leave your super to your spouse or partner, your children, anyone financially dependent on you when you die, or your legal personal representative (LPR).

Your super cannot be dealt with specifically in your will, without the money being left to your LPR.

You can't leave it to your brother or sister, uncles, aunties or the Lost Dogs Home.

How can you leave it to them?

Your super can be left in a couple of ways through a vehicle largely known as ‘death benefit nominations' (or reversionary pensions, which we will deal with on another day).

Death benefit nominations come in two forms – binding and non-binding.

Non-binding death benefit nominations are the ‘original' way of doing it. Binding death benefits are the new kids on the block, by legislation, and many super funds still do not offer binding nominations.

Essentially, with a non-binding death benefit nomination, the member nominates who they would like the money to pass to. It is then up to the trustee of the fund to determine if that's where it goes. The trustee will, in most cases, follow that nomination, but they are not bound by it.

When it comes to funds regulated by the Australian Prudential Regulation Authority (APRA), trustees may look for others who might have a claim on the deceased's superannuation.

A simple example of how this can be a failure would be where the deceased remarried, left all his super to his second wife, and nothing to his first wife, who is still raising two young children. In that example, the trustees of the super fund, faced with a non-binding nomination, might decide to leave a portion of the super to the first wife and the family. Potentially a large portion.

At best, the deceased has lost control of where their super has gone. They might have wanted to look after both spouses and the kids. But they have lost the control over the percentages of what goes where. He might have wanted to look after the kids when they turned 18, but not the ex-wife.

On the other hand, a binding death benefit nomination takes away the discretion of the trustee/s.

If you were to make a valid binding death benefit nomination (BDBN), the trustee must pay the money according to those instructions. If you nominate your two children, equally, then they will each end up getting 50 per cent of the fund.

Where could a BDBN go wrong? Let's say one of the kids was bankrupt. In the event of funds being left by a BDBN, half the money might pass directly to the bankruptcy trustee and then straight on to creditors.

What would be a solution here? One option might be for the money to be left to the legal personal representative (LPR) where it might have been included as an asset in a testamentary trust, to be distributed under different laws and potentially saved until after the child was released from bankruptcy.

Given the nature of trustees at APRA-regulated funds (unknown, impersonal, with legal obligations) BDBNs are often seen as a stronger form of ensuring that your money passes to the right people at the right time.

But you're still running risks. And they're everywhere.

SMSFs and death benefit nominations

It's a different proposition when it comes to SMSFs.

Normally, in the event of your death, the other trustee will be your spouse. But dealing with that one trustee can mean that checks and balances are limited in making sure your wishes are carried out.

One argument goes that if you have a spouse and no complications about where you want your money to go, then a non-binding death benefit is the best option for the trustee.

This leaves the trustee (your husband or wife) to have some discretion around how the money will best be paid out. And if there are issues surrounding beneficiaries, that came up after the most recent signing of the nomination, this would allow the spouse flexibility to make the right decisions.

Again, the best examples are probably a bankrupt beneficiary, or potentially a marriage breakdown of one of the deceased's children. If the trustee has discretion, the money stands a better chance of going to a good cause – if not necessarily the intended cause.

Complexity requires advice

If your situation is complex, you need advice. It might not come down to a simple decision on a binding, versus non-binding, nomination.

The more complex, the bigger your requirements for proper estate planning. This will generally involve an estate planning lawyer running the show, but also being assisted by accountants and financial advisers where appropriate.

Yes, it might cost a bit. But a few thousand dollars for advice beats the heck out of losing tens or hundreds of thousands of dollars, even millions, care of the alternative.

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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 strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.