Contributed by Stephen Gethin, Director, Fortuna Legal
Estate planning challenges of passing super to non-dependants
Passing superannuation to adult children upon a superannuation member’s death poses estate planning challenges. Adult children will not usually be dependants, as defined in the Income Tax Assessment Act 1997 (Cth) (ITAA Dependant) of the deceased. As a result, the taxable component of a death benefit paid to adult children is normally taxed at 17%1.
This article proposes that – while it may appear to be a death benefit – a superannuation lump sum paid after a member’s death in response to a withdrawal request made during their lifetime (a post-death withdrawal) is in fact a member benefit. It is, therefore, non-assessable, non-exempt income2 (NANE) of the fund member, even though they are deceased. Potential succession opportunities are then considered involving intentionally incorporating the possibility of a post-death withdrawal into an estate plan, in contrast to the accidental way in which payments of this kind have largely (if not entirely) arisen to date.
A post-death withdrawal is a member benefit
The tax treatment of a post-death withdrawal as a member benefit follows from the Income Tax Assessment Act 1997 (Cth) (ITAA 97) definitions below, as modified by s 307-15. Member benefit means:
“A payment to you from a superannuation fund because you are a fund member”3.
Death benefit means:
“A payment to you from a superannuation fund, after another person’s death, because the other person was a fund member”4.
But for s 307-15, a post-death withdrawal would have the legal character of a payment to the deceased’s legal personal representative5 (LPR) or their bank6. The reason that the payee (the “you”) in the definition of member benefit receives the payment is not because they are a fund member. Therefore, the payment would not appear to meet the definition of member benefit. As the deceased and the payee are different persons, a post-death withdrawal is a payment to the payee after another person’s death because they were a fund member. The payment would, therefore, appear to be a death benefit.
ITAA97 s 307-15, however, alters the operation of these definitions, with the result that a post-death withdrawal is a member benefit. It states:
(1) This section applies for the purposes of:
(a) determining whether a payment is a superannuation benefit; and
(b) determining whether a *superannuation benefit is made to you, or received by you.
(2) A payment is … made to you, or received by you, if it is made:
(a) for your benefit; or
(b) to another person or to an entity at your direction or request.
The post-death withdrawal payment is to either another person or an entity at the deceased’s direction, within s 307-15(2)(b). That provision thus treats the payment as made to the member, despite them having died. The payment thus falls outside the definition of death benefit and within the definition of member benefit.
From private rulings it appears that ATO will accept that post-death withdrawals are member benefits when s 307-15 is cited7, but will otherwise treat them as death benefits8. No public ruling or court decision has addressed s 307-15 in this context.
Despite the favourable rulings, it remains necessary to establish a solid basis for that proposition. Because s 307-15 is a deeming provision, the fact that the member has died does not exclude that interpretation. That interpretation makes the payment taxable as if made to the member while still alive. There is another instance where an ITAA achieves a similar result. A payment to a deceased’s estate which would have been income of the deceased if made during their lifetime is taxable as if so made9. This establishes that the proposed interpretation is not inconsistent with the scheme of the ITAAs.
This interpretation is also consistent with a plausible dichotomy under which the taxation of a superannuation lump sum depends on whether it is paid in response to the “death” condition of release in the Superannuation Industry (Supervision) Regulations 1994 or another condition of release, rather than on the accident of whether it was made before the member’s death. This interpretation avoids the injustice which would otherwise occur where a member makes a withdrawal request but dies before it is processed.
Estate planning opportunities involving post-death withdrawals
On the basis of this argument, a post-death withdrawal is thus a de-facto death benefit, but without liability for death-benefit tax. The question then arises of how a post-death withdrawal can be included in an estate plan? Incorporating the possibility of this kind of withdrawal improves on the well-known arrangement under which a fund member withdraws their super just before their death, rendering death-benefit tax inapplicable (referred to as basic timed withdrawal). A basic timed withdrawal has inherent risks, however, outlined below. Allowing for a post-death withdrawal on a certain contingency can be used as part of a strategy which eliminates them – referred to here as modified timed withdrawal.
A basic timed withdrawal may be made for legitimate estate-planning and personal reasons. The member may wish to remove their superannuation from potential will challenges under the Family Provision Act 1972 (WA) (or equivalent10) by giving it to their chosen relatives during their (the member’s) lifetime. The member may wish to witness the joy which such gifts would give to family members, instead of simply passing their super to beneficiaries after their death with a binding death-benefit nomination (BDBN). They may use some of their super to take one last cruise, or pre-pay their funeral to reduce the administrative burden on their loved ones and ensure that they get the send-off they desire.
In a basic timed withdrawal, the member risks withdrawing their super too early. If a prudent fund member survives significantly longer than expected after cashing out, they will need to invest the proceeds. Investment income would then be earned in a higher-tax environment than if they had left their super in the fund. They may pay the super proceeds to their children, to avoid them falling into their estate and becoming the subject of a possible challenge to their will. If they live significantly longer than expected after the withdrawal, however, they will still need access to the money, but will have given it away too soon. In attempting to avoid the risk of an early withdrawal request, they may put it off for too long and die without having made it.
Delaying the lump-sum payment instead of the withdrawal request
The inherent risks of basic timed withdrawal could be avoided by the member making a lump-sum payment direction as soon as they satisfy a condition of release, but which instructs the trustee to delay the payment until a time which it judges to be as close as possible to, but before, the member’s death. The direction would also permit the trustee to make the payment after the member’s death (a post-death withdrawal) as a “back-stop”, in case it has insufficient warning of that event to make the payment beforehand. This avoids the risk under basic timed withdrawal of the member not making the payment direction before their death.
The payment direction may also instruct the trustee to pay the lump to the fund member’s discretionary trust. The payment standards in the Superannuation Industry (Supervision) Regulations 1994 permit the payment of superannuation benefits to a third party at the member’s direction11 . The member would establish a mechanism to pass control of the trust on their death to those relatives to whom they wished to leave their super.
Paying the super proceeds to a discretionary trust leaves the member in control of them until their death via their control of the trust. This avoids the necessity for the member to pay them to their children while they are alive while still ensuring that they cannot fall into their estate and hence into any potential will challenge. It allows income splitting to ameliorate the higher tax rate on ex-super investment returns, if the member survives significantly longer than expected after the withdrawal. That is, it largely avoids the risks in a basic timed withdrawal of cashing super too soon.
Potential application of Part IVA
The author is unaware of any ATO view on whether Part IVA may apply to basic timed withdrawal. It is proposed that the substantial non-tax benefits of the strategy outlined above should be a sufficient defence to any challenge on that basis. Modified timed withdrawal however involves additional elements: intentional delay between the payment direction and the payment and the payment of the super proceeds to a trust.
It must be considered whether the same result as achieved by modified timed withdrawal could be achieved by simpler, alternative means – without the tax benefit (a “counterfactual”). The potential counterfactuals to modified timed withdrawal are:
- A basic timed withdrawal, involving minimal delay between the withdrawal request and the lump-sum payment; or
- The member making a BDBN, directing the trustee to pay their superannuation death benefit to their LPR or their superannuation-law dependants.
Where the member makes a withdrawal request, if the payment is made before the member’s death the result under the first counterfactual will be the same as under a modified timed withdrawal. In either case the payment would be a member benefit. This counterfactual is untenable, however, because of the risk of the member dying without making a withdrawal request. In that scenario, the super proceeds would then be distributed by their successor(s) as director(s) of the fund trustee; potentially not being passed on according to the member’s wishes.
In this counterfactual, avoiding that risk would require the member to also make a BDBN. That would, however, in effect be unnecessary duplication. A prudent fund member would make a BDBN at the earliest opportunity – not try to leave it until they can (if they can) predict that their death is imminent. Under a modified timed withdrawal, a payment direction made at an early stage, the trust succession plan and possibility of the trustee paying the lump-sum after the member’s death together serve the same purpose as a timely BDBN: ensuring that the member’s super is passed on according to their wishes.
The requirement in the counterfactual for the trustee to pay the lump-sum promptly after the withdrawal request fails, because the member does not need the money at that time. It hardly needs stating that a member may legitimately retain their super inside the fund for as long as possible. This desire would usually have the same well-accepted, non-tax justification as contributing money to super in the first place: provision for retirement. The member’s instruction to the trustee to delay paying the lump sum until just before the member’s death meets that objective. Given, as shown above, the legitimate non-tax reason for the member to make the payment direction itself at a much earlier time, the extended delay between the payment direction and the payment is arguably, entirely appropriate.
The BDBN counterfactual is valid only if the fund member has no legitimate interest in receiving a lump sum before their death. There are, however, various genuine reasons why a member may wish to withdraw their super at that time, as stated above.
Taxation of member benefit paid to trust
If the lump sum is paid to a trust, s 307-15 will nevertheless deem it to have been paid to the member. It follows that the payment will not be a payment to the trust and, therefore, cannot be trust income. As a deemed member benefit, it will have the same tax status as if actually paid to the member. If they were over 60 at their death, the payment will be NANE.
If, despite that, the payment is treated as having being to the trust, it will be either NANE, on the basis that it has the same tax character as if paid to the member, or it will be a capital amount, because a superannuation lump sum is not income according to ordinary concepts. No provision of either ITAA makes a payment in these circumstances statutory income. The proceeds will also be either NANE or a capital amount when distributed to beneficiaries of the trust. Trust distributions will thus be non-assessable to the beneficiaries.
The above analysis expands the current understanding of member benefits significantly. A person otherwise liable for death-benefit tax where a post-death withdrawal is made may thus wish to obtain a favourable private ruling before filing a tax return on this basis. The principal objective of the strategy is for the member to withdraw their super during their lifetime, not for a post-death withdrawal to occur. Statistics on manner of death show that this will be achievable in a substantial majority of cases. If the deceased member’s superannuation beneficiaries cannot obtain a private ruling and do not wish to challenge that, they would be in no worse a position than if the member simply made a BDBN in their favour.
The views expressed in this article represent the opinions of the author and not those of CCH. Fortuna Legal is a business and tax law practice in Perth.
1 This article assumes no untaxed element or insurance premium deductions in the fund, when a 32% rate would apply.
2If paid to a member who has attained 60 – see ITAA97 s 301-10.
5LPR refers to either an executor or the administrator of an intestate estate, but not an attorney (which is also included in the definition of LPR in the Superannuation Industry (Supervision) Act 1993).
6It is unnecessary to determine which for the purposes of this argument.
7PBRs 1051598540809 (2019), 1051525346142 (2019), 1051437446368 (2018) and 1012754382264 (2015).
8PBRs 1051556580076 (2019), 1013094364952 (2016), 1012828904612 (2015), 1012447922734 (2013) and 1012396130339 (2012).
10Except potentially NSW, due to the notional estate provisions in the Succession Act 2006 (NSW). Future references to inheritance claims are subject to this exception.
11Asgard Capital Management Ltd v Maher  FCAFC 156.