Succession planning in the post reform landscape

Succession planning in the post reform landscape

In light of the superannuation reforms, it may be worth reviewing the interaction between pension terms, wills and death benefit nominations within succession planning arrangements for clients.

The aging population in Australia is an issue which continues to confront our government and our population. According to the Treasury, the ageing of the population is caused by two factors. First, Australian families are on average having fewer children. Second, we are living longer. According to the Productivity Commission Report, Australians have over $2 trillion of assets in superannuation funds comprising about 20 per cent of total household assets. Along with the ageing of the population, the significance of superannuation as part of the wealth of Australians is increasing. This increases the need for the succession of that wealth.

Planning limits

SMSF clients are often under the misconception that superannuation is an asset that automatically forms part of their estate. They may also be unaware that superannuation legislation limits the eligible beneficiaries of a member’s death benefits to a member’s dependant or legal personal representative (LPR).

As for many members superannuation has become a considerable asset — they would like to control the passing of that asset to intended beneficiaries. Given the limitations on the range of beneficiaries able to receive death benefits, complete flexibility is only achievable if death benefits are paid to the member’s LPR.

As SMSF practitioners would already be aware, there are only two options regarding how those benefits may be paid. Regulation 6.21(2) of the SISR limits payment to either:

  1. A lump sum, either one single payment or an interim and final lump sum; or
  2. An income stream to an eligible beneficiary, being a spouse or child generally under 25 years of age.

Achieving certainty – is it possible?

The above limitations of potential beneficiaries and payment options place considerable restraint on the payment of death benefits. It is, however, possible for a member to achieve certainty as to how their benefits will be paid with careful planning.

Nominations

Provided that the terms of the relevant SMSF deed allow for it, a member can execute a binding or non-binding death benefit nomination indicating to whom they would like their death benefits to be paid.

A binding death benefit nomination will bind the trustee to pay the death benefits as the member directs in that nomination. Ensuring that the BDBN (Binding Death Benefit Nomination) is valid and executed pursuant to the terms of the SMSF deed is critical in ensuring that the nomination is effective and cannot be disputed.

A non-binding nomination provides an indication by the member to the trustee as to how the member would like their superannuation benefits to be paid but is not binding on the trustee.

Advisers may have differing views on whether a nomination should be binding or non-binding. A BDBN removes any flexibility available to the trustee regarding how to pay benefits. From a purely tax-driven perspective, this may be seen as unnecessarily restrictive requiring that the trustee pay the death benefits in a manner which perhaps, at the time of death, is not the most tax effective. A non-binding death benefit nomination (NBDBN), still allows the trustee some discretion as to where benefits are paid. This leaves the trustee with the option to pay benefits in a more tax-effective manner.

Putting aside the possible tax benefits of flexibility, a NBDBN may create conflict where the trustee chooses not to pay the member’s benefits as indicated in the nomination and a BDBN is to be preferred where it is a part of a member’s broader succession planning.

Either binding or non-binding nomination should only be used after adequate consideration is given to the member’s broader wishes and succession planning. This is particularly the case in deciding whether the nomination should require the trustee to pay the member’s death benefits to their LPR.

Reversionary pensions

For pension members, certainty may be achieved by making a pension reversionary to a nominated beneficiary. This ensures that the pension will automatically revert to that beneficiary upon the primary pensioner’s death. There are two critical things to note about this. The first is that a member can make a pension reversionary after it has commenced provided that the relevant SMSF deed allows for the member and trustee to amend the terms of the pension.

The second is that the relevant SMSF deed must not provide the trustee with any discretion regarding the reversion of the pension. That may result in the trustee exercising this discretion to pay the pension to a person other than who the member intended.

In Taxation Ruling 2013/5 the commissioner states that “if the trustee has the discretion to pay either a superannuation lump sum or a superannuation income stream to a dependent beneficiary, the superannuation income stream ceases on the member’s death”. That is, a pension is not reversionary.

Further, in LCG 2017/3 the commissioner states that reversionary pensions are those that revert automatically to specified beneficiaries because the governing rules and/or pension rules expressly provide for it:

“That is, the preconditions necessary for a superannuation income stream to revert must exist within the rules governing the superannuation income stream prior to the member's death. If this is not the case then the superannuation income stream ceases on the member's death.”

Having superannuation benefits payable by way of reversionary pension ensures that the benefits do not become a member’s estate asset on death.

It is also important for a reversionary pension and the implications for the reversionary pensioner to be considered in light of the $1.6 million transfer balance cap. Having a reversionary pension in place provides some planning opportunities — a reversionary pensioner will not have a credit to their personal transfer balance account for 12 months after becoming entitled to payment of the pension. Reversionary pensions can therefore:

  • Provide some certainty regarding how a member’s death benefits will be paid;
  • Allow time for a recipient reversionary pensioner to make appropriate arrangements regarding their own transfer balance account (if in existence); and
  • Maximise the time during which a member’s death benefits can be maintained in the SMSF.

The trustee – a position of significance

A member may additionally safeguard the flow of death benefits by planning for the individual or individuals who will become or control the trustee.

Superannuation legislation allows for the member’s LPR to replace the member as trustee or as director. This person may only hold that office commencing from death of the member until death benefits commence to be payable, generally required within six months, subject to a further potential six-month period.

Alternatively, a member may nominate a replacement trustee or director. Legislation does not automatically introduce the LPR into a trustee role. Rather, the terms of the SMSF deed must be considered to address how the deceased member is to be replaced as a trustee or director. Further, there is no specification regarding the shareholding in a corporate trustee. This means that the shareholding can be held or transferred to anyone the members wish.

A shareholder has the power to appoint and remove directors. Putting measures in place to provide for the shares to revert to the intended beneficiary of a member’s death benefits can be an effective way to ensure that control of a corporate trustee passes to the most appropriate person.

Case study:

Max is the sole member of an SMSF which has a corporate trustee. He is one of two directors. The second director is his second wife Maxine. Max has a balance of $6 million and a transfer balance cap compliant reversionary pension payable to Maxine. Max wants all of his accumulation benefits to be paid to his three adult children of his first wife.

Planning points

BDBN — nominate either Max’s LPR – with the terms of his will specifically requiring that the superannuation benefits received are paid to his three children (consider testamentary trusts if there are possible family law claims or bankruptcy issues), or his three children directly.

Reversionary pension payable to Maxine – the pension terms need to provide that the pension is reversionary. The understanding that the pension reverts to Maxine may be referred to in the BDBN.

Trustee control – ensure that Max’s children hold the shares in the trustee on his death – give them some control over where the death benefits are paid by allowing them to appoint themselves as directors of the trustee company, subject to the legislative time constraints. They can then act, along with Maxine, to ensure the death benefits are paid as Max intended. The shares could either be gifted to Max’s children under his will, they could hold the shares jointly with Max, or Max could enter into an option agreement with the children allowing them to exercise an option to acquire the shares upon a trigger event of his death.Nicole Santinon, senior associate and Andrew Sinclair, partner, Tax and Revenue Group, Cowell Clarke Commercial Lawyers.

Nicole Santinon, senior associate and Andrew Sinclair, partner, Tax and Revenue Group, Cowell Clarke Commercial Lawyers

Succession planning in the post reform landscape
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