SMSF Death Benefits
Over the age of 60, while you remain alive you can withdraw as much of your super as you wish from your SMSF(subject to the ATO formula annual minimum pension payments) tax-free, and dispose of the proceeds tax-free to whomever you wish, including gifts to family members.
However, if you die while you still have money in your SMSF super account, the tax becomes a significant issue.
Death a Compulsory Cashing Event
The ATO describes the deceased’s death as a ‘compulsory cashing event’. The deceased person’s account balance has to be ‘paid out’ to specified beneficiaries. The balance cannot just be retained within the SMSF for the benefit of the remaining fund members in general.
Death Benefit Income Stream or Lump Sum Death Benefit
There are two generic ways to ‘pay out’ the deceased member’s account balance. These are a ‘death benefits income stream’ and a ‘lump sum death benefit’. A ‘death benefits income stream’ is usually affected by way of a ‘reversionary pension’. In this case, the beneficiary receives pension income generated by the deceased account’s assets, as distinct from the asset balance itself, and the assets remain within the SMSF. With a lump sum benefit the beneficiaries receive the assets ‘in specie’ or their cash proceeds, the assets are removed from the SMSF and the deceased’s account is extinguished.
Only Dependents are Tax Exempt
The only beneficiaries exempt from tax on their SMSF bequests are the deceased member’s spouse, children under the age of eighteen, and a few other identified cases where a strong dependency relationship exists. Bequests to adult non-dependent children are taxable, whether by way of reversionary pensions or lump-sum payments.
Only One Tax Exempt Reversionary Pension Permitted
There are strict limitations on the use of reversionary pensions. Only one reversionary pension is allowed from each deceased’s account. The SMSF law does permit reversionary pensions to a fairly broad range of family members and connections. However, as noted above, the tax law only allows a tax exemption of the pension if the beneficiary is one of its far more restrictive group of ‘tax dependents’. Reversionary pensions to anyone else are taxable income in the hands of the beneficiary.
Tax-Free and Taxable Components of Members’ Accounts
Each SMSF member account is composed of two components – the ‘tax-free’ component and the ‘taxable’ component. The ‘tax-free’ component is essentially non-compulsory member contributions on which no tax deduction was claimed by the member’s employer or the member himself. Everything else – employer contributions, tax-deductible contributions by the member himself, and all income generated by the SMSF – comprises the ‘taxable component’. These two components are identified in each member’s accounts within the SMSF and all pension distributions and death benefits paid out of each member’s account are composed of ‘tax free’ and ‘taxable’ elements in the same proportions as the ‘tax free’ and ‘taxable’ components in the member’s account at the time of the distribution.
The following table summarizes the taxation of SMSF distributions by living and deceased members over the age of sixty. In a nutshell, while living, there is no tax to pay at all. Upon the member’s death, non-dependent beneficiaries are liable for tax at the rate of 15% on the ‘taxable’ portion of their receipts.
Taxation of SMSF Distributions
*Plus Medicare Levy if paid directly to an individual. No Medicare Levy if paid to the deceased’s estate.