How to avoid the painful tax consequences of SMSF
There's a lot to cope with a self-managed super fund, including new tax consequences, says Peter Freeman
It may be a grim task but every member of a self-managed superannuation fund (SMSF) should closely consider what will happen to their super when they die. In particular, it is important to understand what happens when the last member dies.
"It is not just a matter of the assets in the fund being transferred to the deceased's estate," says Stephen Bone, a technical manager with the ANZ's financial services subsidiary, OnePath.
This, he points out, is not what happens with your super. Rather, the SMSF will continue to operate but with the deceased's legal personal representative (essentially, the executor of their estate) stepping in to take their place.
Since it was a one-member fund it would be being run either by a corporate trustee, probably with a sole director, or by the member as one trustee and another, unrelated party chosen by the member as the other trustee. In the case of a corporate trustee, the executor must notify both ASIC and the tax office that he has taken over as the sole director.
If there are individual trustees the executor notifies the tax office that he has taken the place of the deceased member, the main complication being the need to transfer the fund's assets into the names of the new trustees.
What eventually happens to the assets of the fund will depend on what the trust deed says and whether there is a binding death benefit nomination.
In general, at this point the fund's assets are sold and the realised amount paid out to the member's nominated beneficiaries. However, if the nomination is not binding the trustees have a lot of flexibility when deciding to whom the benefits are paid.
If the fund was in the accumulation phase, tax would be paid in the usual way until the final payout is made. That is, income would be taxed at 15% and capital gains, in most cases, at an effective rate of 10%. In contrast, if the deceased member was receiving a tax-free superannuation income stream, no tax would be payable.
While there has been some uncertainty about this in recent years, particularly following tax office draft ruling TR 2011/D3, the federal government acted to clarify the situation by stating that the assets would remain in the tax-free pension phase even after a member's death.
Commenting on this, SMSF specialist Heffron Consulting points out that draft legislation to give effect to this policy was released earlier this year and was backed by administrative guidance from the tax office.
As for tax, none will be payable if the super is paid to one or more dependents. If the payout goes to non-dependents the amount of the accumulated super classified as taxable will be taxed, in most cases, at 16.5%.
The taxable component consists of the proportion of the fund's assets attributable to concessional contributions, that is, the part that benefited from a tax break when contributed. The remainder can be paid out tax free irrespective of who are the beneficiaries.
The death of the last member of an SMSF can pose more challenges than those covered in this simplified summary, which means it is important to get expert help.
Super tip
The proposed 15% tax rate on every dollar of annual earnings over $100,000 generated by a superannuation pension could have painful tax consequences when a member of an SMSF dies.
Unless the pension reverts to another member of the fund, the assets backing the pension will need to be sold and paid to the deceased member's beneficiaries.
It is more than likely this will result in a lot of realised capital gains, in many cases pushing the relevant earnings well over the $100,000 threshold.
While lengthy phasing-in provisions apply to assets bought before April 15, if the tax is implemented without this anomaly being addressed, even modest account balances could be affected.
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