The ability to invest directly in real properties (commercial or residential) is often one of the main reasons that clients decide to establish a self-managed superannuation fund (SMSF). The possibility of leasing a business real property (BRP) to the members or a related party of the SMSF compounds the appeal of the strategy. Some clients would take advantage of this by entering into a limited recourse borrowing arrangement to facilitate the acquisition.
However, it is important for SMSF trustees (clients) to consider what will happen to the illiquid real property should the inevitable happen-when a member of the fund dies.
The death of a member could prompt a fund trustee to sell a large illiquid asset such as a real property to fund a lump sum death benefit payment. This may result in a trustee:
- losing control of an asset that might be used in a related party's business,
- selling an asset at an unfavourable time in the investment cycle,
- incurring expensive valuation and transaction costs, or
- triggering a capital gains tax event and realising capital gains or capital losses.
The surviving members of the SMSF may also prefer to retain assets such as a BRP within the fund to keep the asset in a concessionally taxed environment.
What are the SIS and tax requirements following death?
Following the death of a member, it is compulsory for the trustees of the SMSF to 'cash' as soon as practicable a member's benefits in the fund1 after the member passes away. The death benefits can be cashed in any or more of the following forms to beneficiary who is a dependant2 of the deceased at the time of the death:
- a single lump sum; or
- an interim lump sum and a final lump sum; or
- one or more pensions or annuities, each of which is a superannuation income stream that is in the retirement phase.
If the beneficiary is a child of the deceased member, then the child must be either under 18 years of age, or under 25 years of age and financially dependent or has a severe disability before a death benefit income stream can be paid to them.
When making a lump sum death benefit payments to a non-dependant for tax purposes3 (excluding the Legal Personal Representative (LPR) of the deceased), the trustee must withhold death benefit tax at a rate of 17% (including Medicare Levy) on the taxed element and 32% (including Medicare Levy) on the taxable component (untaxed element). No tax needs to be withheld if the lump sum is paid to a tax dependant or to the deceased's LPR.
Where the lump sum is paid to the LPR it forms part of the deceased's estate and the LPR is responsible for distributing the lump sum in accordance with the terms of the will or state based intestacy law. When paying the death benefit to a non-dependant for tax purposes, the LPR is also responsible for including the taxable component in the assessable income for the estate. The maximum tax the estate will pay is 15% on taxable component (taxed element) and 30% on taxable component (untaxed element). The net amount that is then distributed to a non-dependant beneficiary for tax purposes will be non-assessable non-exempt income of the beneficiary.
If the SMSF trustee is paying a death benefit income stream to a beneficiary, trustees generally only need to withhold tax if the pension payments contain a taxable component and both the deceased at the time of death and the beneficiary are under 60 years of age.4
- Superannuation Industry (Supervision) Regulations 1994 sub-regulation 6.21(1).
- Dependant is defined in section 10 of the SIS Act and includes the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship. Note the legal personal representative of the deceased member can also be paid a lump sum death benefit.
- The meaning of 'dependant' in the Income Tax Assessment Act 1997 (ITAA) is defined differently to the SIS Act. Under section 302-195 of ITAA, a 'dependant' is the deceased's spouse, former spouse, child aged less than 18, anyone with whom the deceased had an interdependency relationship, or a dependant of the deceased at the time of death.
- In the rare event that the SMSF trustee is paying a reversionary capped defined benefit income stream to someone aged 60, there could be a PAYG withholding requirement.