Superannuation and succession

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Article | Superannuation and succession

May 2020 | Stephen Heath

Published in the Law Society Bulletin, May 2020 - written by Stephen Heath, Partner

Superannuation and succession

The significance of inheritance to superannuation benefits upon the death of a superannuation fund member has escalated in the last 20 years.

Factors contributing to this include:

• many retail/industry superannuation funds offering life insurance as a matter of course;
• benefit design gravitating to preference for income stream benefits over lump sum benefits;
• the superannuation guarantee era, now on foot for almost thirty years, having provided increased coverage of superannuation benefits and in absolute terms an unprecedented pool of assets under management by value;
• increasing average age of Australian superannuants; and
• increased complexity of family structures with acknowledgment and acceptance of blended families and same sex relationships.

Historical Position

The position historically has been that a member’s benefits in a superannuation fund do not pass automatically to the person’s estate on death. By virtue of what are known as the vesting rules, historically governed by the superannuation fund trust deed, the interest of  a deceased member, however, has always been accepted as subsisting and continuing after death. Typically, the trust deed will have provided a power to the trustee, in its discretion, to pay a deceased member’s benefit, usually a lump sum, to any one or more of the member’s estate and/or dependants.

The significance of superannuation in the average person’s wealth profile has warranted and demanded that superannuation benefits be accorded escalated status as “property”. This is manifested most notably by family law changes recognising superannuation benefits as splittable property and by superannuation law changes authorising binding death benefit directions.

Binding Death Benefit Directions

The legislative framework for binding death benefit directions has a rather curious history. It started with the Superannuation Industry Supervision Legislation in 1993 (SIS) whereby death was affirmed as a compulsory payment event and with death benefits only able to be paid to the member’s estate, surviving spouse/children or a dependant of the deceased.

There has never been an historical impediment, whether under tax law, superannuation law or equitable principles generally, to superannuation benefits being “hardwired” to specified persons on death. In the writer’s experience, however, it just never happened.

From inception, section 59 of the SIS Act provided a general rule prohibiting a superannuation fund trustee from being subject to the exercise of a discretion by a third party. That rule, however, has only applied to superannuation funds not being self managed superannuation funds (SMSFs).

In 1999, Regulation 6.17A was inserted into the SIS Regulations, whereby, for the first time, superannuation law in Australia recognised the capacity of superannuation fund members to make death benefit directions, binding as against the trustee. Prior to that time, any expressed preference of  a superannuation fund member only ever operated as a guide to the trustee rather than prescribing anything mandatory.

Death benefit directions taking effect under the auspices of Regulation 6.17A lapse three years after being made and must be witnessed by two adults, not being beneficiaries under the nomination. Only the member’s estate or dependants may be nominated.

Regulation 6.17A is silent in terms of differentiating between member’s benefits held as income streams or accumulation interest or between benefits subject of a nomination being receipted as lump sums or pensions. There is also an open question of  whether Regulation 6.17A tolerates or accommodates a nomination made by a member through an authorised attorney or a nomination providing for cascading beneficiaries (see re Narumon Pty Ltd [2018] QSC 185).

In the end result, Regulation 6.17A has not directly had the effect of being a “game changer”. The most likely reason for this is that the market place has recognised almost insurmountable administrative and commercial difficulties with nominations lapsing after three years.

Now

Both the law relating to superannuation death benefit directions (most frequently described as “binding death benefit nominations”) continues to evolve as does market place practice.

The indirect consequence of Regulation 6.17A in terms of market place practices has been as follows:

1. most modern superannuation deeds contain express provision for binding death benefit directions;
2. many retail/industry funds have side-stepped section 59 SIS Act / Regulation 6.17A SIS Regulations by effecting express provision under the trust instrument for the trustee to be bound by a member’s death benefit direction. Whether this is logical is perhaps an open question but the argument presumably proceeds on the basis that if the trustee was never empowered in the first place, it cannot follow that the trustee can be made subject to the exercise of a third party discretion;
3. the “flood gates” have opened for SMSFs, with SMSFs having never been bound by section 59 / Regulation 6.17A in the first place. In consequence it has become commonplace for SMSF members to make nominations which are both binding and non-lapsing;
4. the market place remains undecided whether binding nominations apply to accumulation interest only, and if so, what happens to a superannuation income stream on the pensioner’s death.

Practical Issues

The writer’s experience gives rise to some practical issues as follows, including:

1. Just in the last week our practice has experienced the following events:

• enquiry as to the status of  a client’s death benefit nomination revealing one original held in the client’s deed packet, together with their current Will and, another original nomination held by the accountant. The accountant’s nomination is dated several years after the deed packet nomination and makes materially different directions as to the beneficiaries of the death benefit payment;
• instructions seeking advice as to how to interpret “pension terms” incorporating a direction that the pension be paid to the deceased’s spouse as a reversionary pension coupled with a later death benefit nomination directing lump sum payments to the deceased’s four children from a first marriage.

2. The requirement that superannuation advice be dispensed, other than by legal practitioners, by authorised representatives of holders of Australian Financial Services licensees may have created the false impression that the matter of death benefit direction advice resides within the exclusive domain and capability of those advisers. The writer’s view is that the issues are often complex and should be entirely within the purview of suitably qualified legal practitioners.

3. Is there any impediment to a nomination which provides:

“To my spouse as an income stream benefit if my spouse survives me by 28 days and, if not, for my four children in equal shares”.

What then if the pension direction gives rise to an “excess transfer balance” for the surviving spouse? What if the nominating member is not survived by their spouse and one or more of  their children?

4. In the writer’s opinion, there is no theoretical impediment to a nomination which states:

“The real property contained in Certificate of Title Volume 1 Folio 2 to my eldest child and the balance equally between my other surviving children”.

What though if CT Volume 1 Folio 2 is not a fund asset at the date of the member’s death or if at death the real property asset is worth $5m and the balance of the assets are worth $50,000? Do the younger children have any actionable rights for inadequate provision?

In the writer’s view, a death benefit nomination is not a testamentary disposition and may be difficult to challenge unless the assets are first directed through the estate. Other practical issues can arise as to the identity of the person/s who step into the role of trustee/director of the trustee and the not unlikely eventuality that one or more such persons refuse to act in accordance with a nomination.

5. Can a person acting under power of attorney make a nomination? What happens if the nominated person is the spouse and at the time of death the parties have since separated or divorced?

6. One of the most vexing benefit design issues is the question of whether a binding death benefit nomination applies to an income stream interest. Income streams are often documented by “pension terms” incorporating their own death benefit directions which begs the question of interface with a separate binding death benefit nomination and also of whether the pension terms themselves are to be construed as a binding death benefit direction. It is important that advisers understand that superannuation and tax law only accept that one accumulation interest can be held under a superannuation fund but that multiple income stream benefits can be held.

Current Practice

The significance of succession planning for lawyers as a practice area has never been as acute as it is now. The current economic disruption in train is likely to be a catalyst for diminished income for many taxpayers and to fuel disputation over significant, albeit diminishing estates. Embedded within that is the relevance of superannuation death benefit directions and payments. Difficult and extensive litigation is likely to be a consequence.

Current practices adopted by our office include:

1. the adoption of clear written guidelines to describe the rules applicable to the making of a nomination. This should address matters such as the power of an attorney to make a nomination, that the nomination terminates if a nominated spouse ceases to be a spouse and the requirement that the nomination be witnessed by two adult persons not being beneficiaries;

2. using death benefit nominations for accumulation interests only and pension terms for income stream benefits;

3. where possible, we provide the benefits payable to a spouse to be payable as a pension/reversionary pension;

4. making clear on the face of the nomination instrument which superannuation interest the nomination applies to and that the nomination is binding and non-lapsing;

5. tax considerations, whilst always not paramount, should nevertheless be considered. For example, it is relevant to ascertain the taxable/tax free components of each superannuation interest and whether a nominated person is a “death benefit dependant” for tax purposes. One issue often forgotten is that the Medicare levy applies to the taxable component of a death benefit derived by a nondependant whereas there is no Medicare levy applied to death benefit payments to an estate;

6. it is often appropriate to implement superannuation death benefit directions at the same time as the person is reviewing their Will. One way to avoid corruption of  mathematical outcomes is for death benefit payments to be directed to the estate;

7. other matters which are often underestimated include:

• planning with respect to succession to trusteeship following death/legal incapacity of a fund member;
• governance and storage of important documents;
• the ability and inclination of family members/successor generations to tolerate the commercial outcomes where there has been limited communication and explanation with all stakeholders at the time succession plans are put in place;

Upskilling on estate law generally with skills building around peripheral practice areas such as broader equity practice, inter vivos commercial transactions, property, tax advice and superannuation law.

For more information please contact our Tax team.