There is much confusion amongst some Self-Managed Superannuation Fund members and professionals as to whether a child of a deceased SMSF member can receive a death benefit from their SMSF.
There is much confusion amongst some Self-Managed Superannuation Fund (SMSF) members and professionals as to whether a child of a deceased SMSF member can receive a death benefit from their SMSF. The confusion is caused by the requirements of the superannuation law for death benefit payments, the tax treatment of death benefits under the income tax law and the definition of a ‘dependant’ under both laws.
Compulsory payment of death benefits
Under the superannuation law, once an SMSF member dies, their superannuation must be paid out of their SMSF as soon as practicable (reg. 6.21 SISR). Death triggers a compulsory payment situation and, therefore, the deceased’s superannuation cannot remain in their SMSF and also cannot be added to their beneficiary’s accumulation account.
Who can receive death benefits?
The superannuation law allows for payment of death benefits to either the deceased’s dependants or their legal personal representative (reg. 6.22 SISR). If a non-dependant is to receive the deceased’s superannuation, then they may receive the payment via the deceased’s legal personal representative who can distribute the deceased’s superannuation in accordance with the deceased’s Will.
Dependant under the superannuation law
A ‘dependant’ of the deceased member, under the superannuation law, is a spouse (includes de facto and same sex), a child (includes an adopted child, a step-child, an ex-nuptial child) of any age, anyone who was in an interdependency relationship with the deceased prior to their death, or anyone who was financially dependent on the deceased prior to their death (s10 SISA).
This means any child of the deceased can receive a death benefit directly from their deceased’s SMSF. However, a spouse’s child will only remain the deceased’s child for death benefit purposes, while their parent remains as a spouse of the deceased. If the child’s parent dies first, then the child will not be a child for the survivor’s death benefit, unless the child has been formally adopted or is in a financial or interdependency relationship with the survivor.
An interdependency relationship is a close personal relationship between two people who live together, where one or both provides financial and domestic support, and care of the other. An interdependency relationship also exists if two people have a close personal relationship but do not live together due to either or both of them suffering from a physical, intellectual or psychiatric disability (s10A of the SISA & s302-300 ITAA 1997).
Form of death benefits
Under the superannuation law, a death benefit can be paid in one lump sum or paid over two instalments (reg. 6.21(2) SISR). A death benefit may also be paid as a pension. The deceased’s dependants and non-dependants can receive lump sum death benefits. However, only certain dependants can receive death benefit pensions.
When it comes to the deceased’s children, only children under the age of 18; or up to age 24 and financially dependent on the deceased prior to their death; or children of any age with a disability of the kind described in subsection 8(1) of the Disability Services Act 1986, can receive a death benefit pension (reg. 6.21(2A) SISR).
The age of the child and the financial dependency status is tested on the date of death. It does not matter if the child is no longer 18 or that their financial dependency has ceased on the date of payment.
Also, once the child reaches the age of 25, the balance of their death benefit pension must be paid as a lump sum death benefit. However, a child with a disability can continue to receive the death benefit pension beyond the age of 25 (reg. 6.21(2B) SISR).
Dependant under the income tax law
Under the income tax law, the deceased member’s spouse or former spouse; the deceased’s child under the age of 18; any person with whom the deceased had an interdependency relationship with before they died; or any person who was a dependant of the deceased just before their death, is classified as a ‘death benefits dependant’ (s302-195 ITAA 1997).
This means, not all children of a deceased member are classified as a ‘death benefits dependant’. An adult child who is 18 or over and not financially dependent on the deceased prior to their death, or was not in an interdependency relationship with the deceased prior to their death, is not a ‘death benefits dependant’.
Tax payable on lump sum death benefits
Under the income tax law, if the recipient of a lump sum death benefit is classified as a ‘death benefits dependant’, then no tax is payable on the lump sum death benefit (s302-60 ITAA 1997). Tax payable on a lump sum death benefit paid to a child who is not classified as ‘death benefits dependant’ is at a maximum of 15 per cent plus the Medicare Levy on the taxed element of the taxable component, and a maximum of 30 per cent plus the Medicare Levy on the untaxed element of the taxable component of the lump sum death benefit (s302-145 ITAA 1997).
Tax payable on death benefit pensions
The tax payable on a death benefit pension is dependent on the age of the deceased member, the age of the recipient and the components of the pension. If the deceased member or the recipient was aged 60 or over on the date of the member’s death, then no tax is payable on the death benefit pension on the tax-free and the taxable components (s302-65 ITAA 1997). Tax will be payable on the untaxed component of the pension at the recipient’s marginal tax rate with a 10 per cent tax offset (s302-85 ITAA 1997).
If the deceased member and the recipient were both under the age of 60, then tax is payable on the taxable component of the pension at the recipient’s marginal tax rate plus the Medicare Levy. A 15 per cent tax offset is applied to the taxed element (s302-75 ITAA 1997). No tax offset is applied to the untaxed element of the pension payment (s302-90 ITAA 1997).
In order for a child to qualify as a ‘death benefits dependant’ under the financial dependent grounds, the level of financial support must be significant. The child would need to be financially dependent on the deceased on a regular basis to sustain their standard of living.
In the ATO publication ATO ID 2014/6, it gave an example of an adult son living with his parents and receiving the Youth Allowance payments from Centrelink. The son was classified as a death benefits dependant as his Youth Allowance payments were calculated at a lower ‘at home’ rate, as opposed to the higher ‘independent’ rate. This indicates that the son was substantially financially dependent on his deceased parent.
The ATO’s position on financial dependency is based on whether: if the financial support received by a person was withdrawn, would the financially supported person be able to survive on a day-to-day basis. If the financial support provided merely supplements the person’s income and represents ‘quality of life’ payments, then it would not be considered substantial support. What needs to be determined is whether or not the person would be able to meet their daily needs and basic necessities without the additional financial support.
In the ATO’s publication ATO ID 2014/22, it gave an example of an adult child who had given up work to care for his terminally ill parent and received no financial support from anyone other than the parent. It was stated that the adult son satisfied the interdependency relationship requirement, as well as the financial dependency requirement.
In the Administrative Appeals Tribunal case TBCL and Commissioner of Taxation  AATA 264, a son born in 1991 lived with his parents consistently until 2007, when he moved to Melbourne to undertake pilot training. He returned to live with his parents in 2009 until his death in 2013.
The parents paid $40,000 towards the total cost of the deceased’s course, accommodation of $250 per week and living expenses of $1,000 per month while he lived in Melbourne. The parents also bought the son items such as a computer, TV, pilot gear and a motor vehicle.
In 2013, the son was working as a pilot and tragically died in a motor vehicle accident.
The parents and son shared their living expenses ($300 per week for food, $850 for electricity per quarter, council rates of $3,000 per year and water charges of $1,600 per year) equally. The parents provided the son with domestic support in the form of preparing meals, doing laundry, cleaning and a number of other tasks. In turn, the son helped his parents by performing tasks around the house. The parents and the son provided each other with love, care, affection and psychological assistance.
In November 2014, the ATO provided a private ruling to the parents that they were not death benefit dependants of the son. The AAT concluded that based on the above evidence provided, it was not enough to establish an interdependency relationship.
The AAT case indicates that where an adult child only has a regular relationship with their parents and only lives together for the reasons of commercial convenience, then an interdependency relationship will not exist.
Maximum limit on death benefit pensions
Due to the superannuation law changes effective from 1 July 2017, the amount that can be held in an SMSF as child death benefit pensions will depend on whether the deceased parent was in an accumulation phase and/or retirement pension phase prior to their death. If the deceased was in an accumulation phase, then the deceased’s child is entitled to commence a death benefit pension based on their proportionate share of the transfer balance cap.
Example: If two children were to receive their deceased parent’s superannuation in equal share, then each child could commence a death benefit pension of $800,000 (i.e. 50 per cent of the $1.6 million transfer balance cap). The balance of the deceased’s superannuation will need to be paid out of the SMSF as lump sum death benefits.
If the deceased was in retirement phase, then the deceased’s child would be entitled to the total amount in the deceased’s pension account, regardless of the amount exceeding the transfer balance cap.
Example: If two children were to receive their deceased parent’s superannuation in equal share and the deceased’s retirement pension account has grown to $4 million on the date of death, then each child could maintain a death benefit pension with $2 million each.
If the deceased was partly in accumulation phase and partly in retirement phase, the deceased’s child cannot receive a pension from the deceased’s accumulation balance. This is even if the pension account is below the transfer balance cap.
Example: If two children were to receive their deceased parent’s superannuation in equal share, and the deceased had $2 million in the accumulation account and $1 million in their retirement pension account, then each child would be entitled to maintain a death benefit pension of $500,000 and the $2 million in the deceased’s accumulation account will need to be paid out as a lump sum death benefit of $1 million to each child.
Children receive a child transfer balance cap from each of their parents. That is, the cap rules apply independently for each parent’s death benefits.
Example: If both parents died and both had $2 million in the accumulation phase, then a child could receive a $1.6 million pension from one parent’s account, a $1.6 million pension from the other parent’s account and an $800,000 death benefit lump sum.
Also, if life insurance proceeds are paid on the death of an SMSF member, the proceeds are not treated as an accretion to the retirement phase, but instead form part of the deceased’s accumulation interest in the SMSF.
Reversionary pensions to minor children also receive a 12 month deferral period before the amounts are counted towards the child transfer balance cap.
In conclusion, what SMSF members and professionals need to be aware of is that a person can be classified as a ‘dependant’ under the superannuation law to receive a death benefit directly from an SMSF, but not be classified as a ‘death benefits dependant’ under the income tax law to receive the death benefit taxed at the concessional tax rate.
They may also not be classified as a ‘dependant’ under the superannuation law to receive the death benefit in the form of a pension.