Compulsory payment of death benefits
Under Australian superannuation law, once a Self-Managed Superfund (SMSF) member dies their superannuation must be paid out of their SMSF as soon as practicable. Death triggers a compulsory payment situation and therefore, the deceased superannuation cannot remain in their SMSF and also cannot be added to their beneficiaries accumulation account.
Who can receive death benefits?
Australian superannuation law allows for payment of death benefits to either the deceased’s dependants or their legal representative.
A death benefit cannot be paid directly to a non-dependant from an SMSF. If a non-dependant is to receive the deceased’s superannuation entitlements, then they can receive the payment via the deceased’s legal personal representative.
This means that a SMSF member can nominate a dependant to receive their superannuation entitlements upon their death, or can nominate a legal personal representative to have their superannuation distributed in accordance with their Will to dependants and/or non-dependants.
Who is a ‘dependant’ under Australian superannuation law?
A “dependant” of the deceased member, under superannuation law, is:
- a spouse;
- a child of any age;
- anyone who has an interdependency relationship with the deceased member prior to their death; or
- anyone who was financially dependent on the deceased prior to their death.
This means any child of the deceased, regardless of their age, can receive a death benefit directly from the deceased parent’s SMSF.
How can death benefits be paid in Australian superannuation law?
Under superannuation law, a death benefit can be paid in one lump sum or paid over two instalments (i.e. an interim lump-sum and a final lump-sum). This is known as a “lump-sum death benefit” and it cannot be made in more than two instalments.
A death benefit may also be paid as an income stream which is known as a “death benefit pension”.
The deceased’s dependants and non-dependants can receive lump-sum death benefits. However, only certain dependants can receive death benefit pensions.
When it comes to the deceased’s children, only:
- children under the age of 18;
- Children up to age 24 and financially dependent on the deceased prior to their death; or
- Children of any age with a disability of the kind in section 8.8 (1) of the Disability Services Act 1986 (Cth),
can receive a death benefit pension.
The age of the child and the financial dependency status is tested on the date of death. It does not matter if the child is no longer 18 or that their financial dependency has ceased on the date of payment. Also, once the child reaches the age of 25, the balance of the death benefit pension must be paid as a lump sum benefit. However, a child with a disability can continue to receive the death benefit pension beyond the age of 25.
Dependant under the Income Tax law
Under the Income Tax Law, a ‘death benefit dependant’ can be:
- the deceased member’s spouse or former spouse;
- the deceased member’s child under the age of 18;
- any person with whom the deceased member had an interdependency relationship with before they died;
- any person who was a dependant of the deceased person just before their death.
This means, not all children of the deceased member are classified as a “death benefit dependant”.
An adult child who is 18 or over and not financially dependent on the deceased prior to their death or, was not in an interdependency relationship with the deceased prior to their death is not a “death benefit dependant”.
What is an Interdependency Relationship?
An interdependency relationship is a close personal relationship between two people (whether related or not) who live together, where one or both provides financial and domestic support, and care of the other.
An interdependency relationship also exists if two people have a close personal relationship but do not live together to either or both of them suffering from a physical, intellectual or psychiatric disability.
Tax payable on lump sum death benefits
Under the income tax law, if a recipient of a lump sum death benefit is classified as a “death benefit dependant”, then no tax is payable on the lump sum death benefit.
The tax payable on a lump sum death benefit paid to a child who is not classified as “death benefit dependant”, is at a maximum of 15% plus the Medicare Levy on the tax element of the taxable component and a maximum of 30% plus the Medicare Levy on the untaxed element of the taxable component of the lump sum death benefit.
A lump sum death benefit will only include an untaxed element if the SMSF has claimed a tax deduction for a Life Insurance Policy taken out on the deceased member. If no tax deduction has been claimed, then the proceeds of the insurance policy will be treated as a tax element of the taxable component of the lump sum death benefit.
Tax payable on death benefit pensions
The tax payable on a death benefit pension is dependent on the age of the deceased member, at the age of the death benefit pension recipient and the components of the pension.
If the deceased member or the pension recipient is aged 60 or over on the date of the member’s death, then no tax is payable on the death benefit pension on the tax-free and taxable components. Tax will be payable on the untaxed component of the pension at the recipient’s marginal tax rate with a 10% tax offset.
If the deceased member and the pension recipient were both under the age of 60, then tax is payable on the taxable component of the pension at the recipient’s marginal tax rate plus the Medicare Levy. A 15% tax offset is applied to the tax element. No tax offset is applied to an untaxed element of the pension payment.
Financially dependent
In order for a child to qualify as a death benefit dependant under the financial dependant grounds, the level of financial support must be significant.
The child will need to be financially dependent on the deceased on a regular basis to sustain their standard of living. In tax office publication ATO ID 2014/6, it gave an example of an adult son living with his parents and receiving the Youth Allowance payments from Centrelink. The son was classified as a death benefit dependant on his Youth Allowance payments were calculated at a lower “at home” rate as opposed to the higher “independent” rate. This indicates that the son was substantially financially dependent on his deceased parent.
The Tax Office position on financial dependency is based on whether if the financial support received by a person was withdrawn would the financially supported person be able to survive on a day to day basis. If the financial support provided, merely supplements the person’s income and represents “quality of life” payments, then it would not be considered substantial support. What needs to be determined is whether or not the person would be able to meet the person’s daily needs and basic necessities without the additional financial support.
Interdependency relationship
In the tax office publication OTOID 2014/22, it gave an example of an adult child who had given up work to care for his terminally ill parent and received no financial support from anyone other than the parent. It was stated that the adult son satisfied the interdependency relationship requirement as well as the financial dependency requirement.
Recently in the Administrative Appeals Tribunal case, TBCL and the Commissioner of Taxation [2016] AATA 264, a son born in 1991 (an only child) lived with his parents consistently until 2007, when he moved to Melbourne to undertake pilot training. He returned to live with his parents in 2009 until his death in 2013. The parents paid $40,000 towards to the total cost of the deceased’s course, accommodation of $250 per week and living expenses of $1000 per month when he lived in Melbourne. The parents also bought the son items such as a computer, TV, pilot gear and a motor vehicle. In 2013, the son was working as a pilot and tragically died in a motor vehicle accident. The parents and son shared their living expenses (such as $300 per week for food, $850 for electricity per quarter, council rates of $3,000 per year and water charges of approximately $1,600 per year) equally. The parents provided the son with domestic support in the form of preparing meals, doing laundry, cleaning, and a number of other tasks. In turn, the son helped his parents by performing tasks around the house. The parents and son provided each other with love, care, affection, and psychological assistance.
In November 2014, the AAT provided a private ruling to the parents that they were not death benefit dependants of the son. The parents asked the AAT to review this decision. The AAT concluded that based on the evidence provided, it was not enough to establish an interdependency relationship.
The AAT case indicates that where an adult child only has a regular relationship with their parents and only lives together for reasons of commercial convenience, then an independency relationship will not exist.
For more information on death benefits relating to superannuation or for specific advice tailored to you, get in touch with one of our Estate Planning lawyers at Rockliffs.