Death benefits: Tax exemption win for super funds

The government has shone some light on SMSF death benefits after a long period of uncertainty with the recent release of its “Mid-Year Economic and Fiscal Outlook” paper for 2012-13.

The welcome news for the many retirees who are taking pensions from their SMSF is that super death benefits will be spared the prospect of being doubly taxed where a benefit must be paid from a fund on the death of a member.

This means that the tax exemption on investment earnings that support a pension can continue to apply following the death of a member until the member’s benefits have been paid out, even if there is no reversionary pension recipient nominated. The pension of a fund member who dies will continue to be viewed as a pension for tax purposes until the death benefits are paid to beneficiaries. This will need to be achieved however as soon as practicable.

The previous situation threatened an SMSF with double taxation in the form of a 10% or 15% capital gains tax (CGT) being levied on any investment assets sold by the fund to pay out death benefits, plus a 16.5% tax on certain benefits if they were destined to go to a beneficiary who was not a dependent of the late member, such as an adult child (which is frequently the case with superannuation death benefits).

The mid-year review paper revealed that the government will eliminate — effective from July 1, 2012 — any obligation on superannuation funds to pay CGT where a super pension is cashed out to pay a death benefit.

The previous view, hanging over the heads of SMSF trustees since being published by the Tax Office as draft ruling TR 2001/D3, was that when a fund member dies and there is no reversionary beneficiary arranged, a pension account reverts to accumulation phase. This exposes the pension-supporting assets to CGT when sold to pay out benefits.

One as-yet-unresolved issue is that the previous draft ruling was seeking to have that particular interpretation of the rules retrospectively applied to July 2007. The latest announcement only states that a pension retains pension status until benefits are paid with effect from July 2012.

The intervening five years, if not addressed by the government, may remain an area of uncertainty until this is clarified — however experts expect that the final ruling will incorporate the mid-year review announcement in some way when it is finally handed down. Whether this will address beneficiaries who have already paid taxes on benefits being eligible for refunds is yet to be seen, however we will inform clients as the facts are made known.

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