Escaping the 17% Super Death Benefits Tax for Adult Children …. and Grandchildren?

Introduction

We all know that when a member of a superannuation fund – retail, industry or SMSF dies, any taxable component will be taxed in the hands of non-dependants at a rate of 17%. This is a death benefits tax and a huge sting in the tail for superannuation estate planning, particularly for adult children. But there may be a way out thanks to recent private binding rulings from the Commissioner of Taxation.

I. The Law

    1. SIS Act 1993

Section 62 of the Superannuation Industry Supervision Act 1993 (the sole purpose test) provides the Trustee of a superannuation fund can pay a death benefit to a dependant or the legal personal representative of the deceased’s estate. For SIS purposes a dependant is defined in section 10(1) as “the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship.”

2. ITAA 97

If the beneficiary of the deceased member’s superannuation death benefit is a “death benefits dependant” for taxation purposes then there is no taxation on the death benefit – section 302-60 of the ITAA 97.

302-195 Meaning of death benefits dependant

A death benefits dependant, of a person who has died, is:
(a) the deceased person’s spouse or former spouse; or
(b) the deceased person’s child, aged less than 18; or
(c) any other person with whom the deceased person had an interdependency relationship under section 302-200 just before he or she died; or
(d) any other person who was a dependant of the deceased person just before he or she died.

II. The ATO has ruled that Financial Dependency means NO taxation

Section 302-195(1)(d) provides that a person who is a financial dependant at law to be treated as a dependant for death benefit taxation purposes. In the Commissioner’s private binding ruling – 1051231612657 ruled that there was NO death benefits tax in the following circumstances:

The Beneficiaries did not reside with the Deceased. Rather, the Beneficiaries lived with their parent. The Beneficiaries did not receive any financial support from their parent.
The Deceased provided the Beneficiaries with ongoing financial support including the following:

●  Regular payment of tertiary education course fees for the First Beneficiary;
●  Provision of supplementary income to the Second Beneficiary for living expenses; and
●  Provision of supplementary income to the Third Beneficiary for living expenses.

The facts indicate that the Beneficiaries were financially dependent on the Deceased at the time of the Deceased’s death. The Beneficiaries were reliant on the regular continuous contributions of the Deceased to maintain the standard of living to which they were accustomed. Consequently, the Beneficiaries are death benefits dependants of the Deceased for the purposes of section 302-195 of the ITAA 1997.

III. SMSF Adviser Solution

There are a number of private binding rulings that show the Commissioner deems financial dependency established under the ITAA 97 where a person provides a better standard of living to another person on a regular and continuing basis. As advisers are aware many parents provide for their adult children and the adult child’s family on an ad hoc basis.

The LightYear Docs Family Allowance Agreement formalises the relationship between parents and adult children that may substantiate and evidence financial dependency. The family allowance agreement is a monthly or quarterly payment made by a member of a superannuation fund to an adult child and their entire family for the purposes of enhancing their standard of living.

Note: it is not just for SMSFs but for all superannuation funds…

Quick Example

John and Sally Smith, aged 60 provide a $1,200 per month family allowance to their son, Max’s family. This is directed for the living expenses of Max, his spouse Anne and two sons William and Harry. This is under a formal and binding Family Allowance Agreement.  The test of whether Max and his family members are dependants is at the time of John or Sally’s death.

How to create the Family Allowance Strategy

If the client is in a retail or industry super fund:

1. Identify who is to be a financial dependant including families
2. Ensure the client has a binding death benefit nomination directing the member’s death benefits to family members identified
3. Complete a family allowance agreement (which can cover a couple and any child or other family, such as brothers or sisters). 
You can find this document when logging into your account and clicking on the Document Wizard in Templates / Estate Planning / SMSF Wills and Other Documents folder or simply search: ‘Family Allowance Agreement’

If the client has an SMSF:

1. Upgrade the clients deed to a current strategic SMSF deed enabling family allowances. You can find this document when logging into your account and clicking on the Document Wizard in Templates / SMSF Establish, Maintain & Upgrade / Standard SMSF folder or simply search: ‘SMSF Deed of Variation’.
2. Complete a family allowance agreement (which can cover a couple and any child or other family members, such as brothers or sisters).
3. Provide a Dependancy declaration by the member of the fund detailing each financial dependant and why – “the provision of ongoing living expenses”. This is completed per member and you can include multi-dependants

Recommended Pricing

This will depend on the tax saved. If the client has $1M of the taxable component in their superannuation fund and is leaving it to their two adult children and their respective families, an effective complying Family Allowance agreement leading to the adult children and their families being “death benefits dependants” will result in tax savings of $170,000.

Advice and documentation fees should range between $2,500 – $6,000.

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