Planning for the distribution of SMSF death benefits is obviously, extremely important.

Instructions for superannuation benefits upon your death are not directly covered by a will. However, you can ensure your funds and benefits are distributed in several ways to either reduce the chance of dispute amongst beneficiaries or eliminate unintended taxes or limitations upon them.

A valid Binding Death Benefit Nomination (BDBN) bypasses the probate process, meaning loved ones will likely have faster access to money. Otherwise, death benefits can be decided by the remaining trustees or legal personal representatives on how to distribute the money. This process can become lengthy and complex – especially if disputes occur.

BDBNs are not without their critics, however. There are several important considerations for trustees when drawing up these documents.

How are Binding Death Benefit Nominations Different for SMSFs? 

In contrast to retail or public superannuation funds, members of an SMSF can opt for a binding death benefit nomination that lasts indefinitely, if the trust deed allows it. Otherwise, documents must be renewed every three years to remain valid.

SMSF trustees can also be far more detailed or prescriptive over dependencies in a BDBN. Unfortunately, this lack of flexibility sometimes creates unintended issues for beneficiaries.

BDBNs: Clarity & Certainty Vs Inflexibility Over Distributions

Individuals may nominate dependents, including a spouse, de-facto spouse, children, and stepchildren of any age, or a legal representative as BDBN beneficiaries. Only the member that owns the BDBN may revoke or change conditions. Therefore, if they fail to update their BDBN when circumstances, such as a divorce or birth of a child, change the BDBN may not work as intended.

Indeed, the value of one’s pension and family circumstances at the time of death can each hold significant implications for nominated beneficiaries regarding non-concessional contributions and taxes.

For example, couples often create conditions requiring the deceased’s pension to be automatically continued to the surviving spouse. Conditions such as these under a BDBN can eliminate valuable choices, depending on the value of their pension and regulatory conditions at the time. For example, if a spouse already has $ 2 million in their super fund and automatically inherits their spouse’s $ 2 million pension, they’ll pay significantly more tax than necessary for that financial year if DIV 296 becomes legislated.

Further, if a child is born and BDBN is not updated before the parent dies, that child will not have access to any benefits.

Regardless, the binding nature of the BDBN and prescriptive detail for the trustee bring many people comfort. This is especially true for those seeking to reduce the potential for family disputes over the distribution of benefits, which are far more common over SMSF benefits than in retail funds.

Important Considerations When Drawing up BDBNs:

Some critics suggest BDBNs can be too rigid.

Indeed, they’re incredibly prescriptive and can override or conflict with other valid documents like reversionary pensions. Therefore, it’s important to get BDBN details right. Planning is complex, requiring a lot more consideration regarding various conditions, including:

Validity Requirements:

‍BDBNs can only name dependents (spouses and children) as beneficiaries. Legal documents must be drawn to reflect this if you wish to nominate people outside this group.

To be valid, unless the trust deed states otherwise, the BDBN must be signed and dated by you in the presence of two witnesses aged 18 or over who are not nominated in the BDBN. BDBNs can be challenged – but not simply if they’re considered ‘unfair’ or ‘wrong’. Rather, they may only be challenged on the basis of their validity.

A nomination will be deemed invalid under the following circumstances:

• A beneficiary you have nominated does not meet the definition of a dependant when you die
• You no longer have a balance in the fund. A new investment opportunity arises that has not previously been considered‍

Beware the Tax Trap:

The tax applicable on death benefits is influenced by several factors, including;

• Whether the beneficiary meets the definition of a dependant in the Income Tax Assessment Act
• Whether the amount paid is in an income stream or a lump sum
• The composition of benefit payment, for instance, the split between the taxable and tax-free components
• The beneficiary's age and the age of the member on the date of death.

Generally, if a dependent receives a lump sum payment, this will be tax-free, regardless of the death benefit component. However, if they receive it in the form of an income stream, different rules may apply considering the above-mentioned factors.

If a beneficiary is considered a non-dependent (ie a child aged 25+), the taxable component of the payment will be taxed at the recipient’s marginal tax rates. This amount can be reduced by tax offsets.

Blended Families:

‍Without a valid BDBN, SMSF Trustees can say how your superannuation is dealt with upon death. Therefore, clarity is key – particularly in blended families. Step-children are considered dependents up until the date of death of the step-parent. The nexus is broken and no longer considered a dependent for the Superannuation Industry (Supervision) Act.‍

The Titanic Rule:

Most SMSFs are held by a married couple, and most BDBNs nominate the surviving spouse as beneficiary. So, what if both members die at the same time? While this all sounds unlikely, it does happen. Consequently, trustees must be aware of the action the legal personal representative(s) must take in such a case.‍

Inconsistency with Other Estate Plans:

If your BDBN is inconsistent with either your will, reversionary pension settings, or other estate planning documents, it may lead to disputes and potential legal challenges.

Reversionary Pensions and Death Benefits:

SMSFs are most often established when members are in the accumulation phase. Eventually, when a member switches into the pension phase, it’s possible they’ll need a BDBN to manage the accumulation of any interest and a reversionary pension to address the income stream.

Therefore, an SMSF member may die with a valid reversionary pension and BDBN documents. As such, trustees will have to deal with two valid documents. This can create many problems regarding which document takes precedence and any possible conflict. In this case, the trustees must rely on the trust deed for guidance. Unfortunately, some trust deeds are silent on this issue.

How to Avoid Binding Death Benefit Nomination Issues

Given the complexity and potential pitfalls of a BDBN, it’s wise to seek legal and financial advice when drawing up your binding death benefit nomination, so it aligns with estate planning goals. It’s also important to regularly review BDBN conditions in light of changes in your family and superannuation regulations to ensure optimal outcomes for beneficiaries. Ensure the trust deed clearly sets out rules regarding BDBN, including managing any competing conditions in your will or reversionary pension.

Our experienced team can guide you through the process, ensuring your wishes are clearly documented and legally binding. Don't leave this important decision to chance—reach out to us at smsf@primefinancial.com.au for personalised assistance today.

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