Critical planning outlined for death benefit and lumpy assets

When a member passes away, Mr See explained that the death benefits of the deceased member have to be cashed out as soon as practicable.

If an SMSF has a property with very little cash, the SMSF trustee needs to think about how the corresponding death benefits will be paid if one of the members suddenly passes away but the surviving members want to keep the property in the fund.

In the case of SMSFs with husband and wife members, Mr See said one option could be to execute BDBNs nominating each other as their respective death benefit dependants.

“If one of them passes away, the death benefit dependant can opt to receive the death benefits as a pension with annual payment set to statutory minimum which may alleviate the need to sell the property straight away,” Mr See said.

“This option does not apply to a beneficiary who is not a death benefit dependant. As a non-death benefit dependant, the death benefits of the deceased member can only be cashed out as a lump sum, thereby forcing the SMSF trustee to come up with either cash or property to distribute to the non-death benefit dependant.”

If there are two members in the fund, for example, they may also consider taking out term life insurance over the life of the other member outside of the SMSF, he said.

“The drawback of this option is that it does not work well with death benefits of large amounts, as the amount of insurance proceeds to be contributed to the SMSF cannot exceed the beneficiary’s contribution caps,” Mr See cautioned.

“As the life insurance is taken outside of the SMSF, the members pay for the premiums out of their own pockets.”

He also pointed out that the same kind of strategy cannot be implemented within the SMSF, as cross-insurance arrangements where the insurance proceeds are paid to someone other than the insured member are prohibited under the regulations.

“Insurance proceeds from a policy taken out by the trustee and paid for from the deceased member’s account in the fund only add to the deceased member’s death benefit and can’t be used as a substitute for payment of their share of the fund’s property’s value,” he said.

A surviving member who has cash outside of the SMSF, he said, could also make contributions to the SMSF to enable the SMSF trustee to pay the death benefits to the death benefit dependant.

“However, a surviving member can only contribute cash up to the contribution caps provided by existing laws. It only works if the amount of death benefits to be cashed out is within the contribution caps,” he noted.

Mr See said the members may also consider an in-specie transfer of part of the property.

“While there is a requirement to make a cash out of the death benefits as a lump sum — if a pension is not possible — there is no requirement that the lump sum be paid solely in the form of cash,” he said.

“The SMSF can also make an in-specie transfer of part of the property to a death benefit dependant as a non-cash lump sum. The disadvantage of this option is the serious tax consequences of the transfer especially if the SMSF is in the accumulation phase.”

If no other strategy is possible, the fund will be forced to sell the property at market value and use the proceeds of the sale to pay the death benefits, Mr See warned.

“Issues to be considered include the length of time it takes for the property to get sold, the amount of money it earns from the sale and the expenses and taxes to be paid after the sale,” he said.

“If the surviving members want to retain the property as part of their overall investment portfolio, they can buy the property from the fund as long as the necessary compliance requirements are met. They could in theory even contribute it back to the fund, though issues like contribution caps could make this an unlikely strategy.”

Mr See urged SMSFs with a lumpy asset to plan well ahead so that the value of the property and potential tax savings in an SMSF environment are maximised to the fullest while at the same time making sure that the SMSF is able to meet its cash obligations when an emergency arises.

“The property was placed in the SMSF as a long-term investment, so the goal is to keep it for as long it can until it is the right time to sell,” he said.