By Mark Ellem

The ATO has issued two interpretative decisions in relation to the payment of death benefits from a self-managed superannuation fund (SMSF). These IDs confirm what most of us already knew, that a death benefit cannot simply be paid by way of journal entry. So what are the options for an SMSF paying a death benefit – time for a review.

The death of a member is a compulsory cashing requirement per SIS regulation 6.21. This regulation also sets out the requirements of the compulsory cashing of the deceased member’s benefit, which includes:

• That it must be paid as soon as practicable;
• The form of the benefit can be either a lump sum, a pension or a combination of both;
• For a lump sum, it can be a single lump sum, or an interim lump sum and a final sum. Note, this means that there can only be two lump sum death benefit payments and consequently a fund cannot “drip feed” benefits to beneficiaries as fund assets are sold and cash becomes available;
• For a death benefit pension, from 1 July 2007, only tax dependants are eligible to be paid a death benefit in the form of a pension (income stream). This basically restricts this form of death benefit payment to a spouse; children under age 18; children aged 18, but under 25 and were financially dependent on the deceased at the time of death; and a child, of any age, who meets the definition of ‘disabled’ per the Disability Services Act 1986.

So how long is “as soon as practicable”?

It would be great if the term was defined, but it’s not and so the short answer to the question is “It depends”. It will depend on whether there are valid reasons for the delay in payment of the death benefit. From experience, if the death benefit is delayed by more than six months, then you will need to be able to demonstrate to the ATO how the fund is meeting the requirement to pay the death benefit ‘as soon as practicable’.

I have seen numerous cases of SMSFs that have a member who passed away some time ago, in one or two it was years, and the deceased member’s death benefit had still not been paid. The reason commonly provided was that there was not sufficient cash in the fund to pay the death benefit. The lack of cash was more often than not related to the type of assets the fund held, including property and a market that was not “right” for selling the asset now – “the trustees are waiting for the market to recover to get the right price”.

Waiting for the “market to be right” will not, in my view, be a valid reason as to why there is a delay in paying the death benefit. It does not satisfy the requirement to pay ‘as soon as practicable’. The fund would have the option to pay the death benefit ‘in-specie’ and for the beneficiary to then decide the “right time” to sell.

In my view, valid reasons for a delay in paying a death benefit would need to be based on either:

• the determination of the benefit, for example calculating the member’s benefit; or
• the determination of the beneficiary, for example there may be uncertainty about the identity of eligible beneficiaries or whether a binding death benefit nomination is valid.

Further, an SMSF trustee is required to prepare and implement an Investment Strategy that has regard to the whole of the circumstances of the fund, as well as taking into account “the liquidity of the fund's investments, having regard to its expected cash flow requirements”. Consequently, an SMSF that has a large portion of its investments in illiquid assets, such as property, may be challenged on how its investment strategy complies, particularly if the members are of an age or health whereby the payment of a death benefit at some time in the near future is more than just a mere statistical possibility.

The death benefit must be 'paid'

As stated, regulation 6.21 makes the death of a member a compulsory cashing requirement. The ATO recently issued two interpretative decisions on the specific issue of paying a benefit by way of journal entry. These were ATO ID 2015/2 and 2015/3. Both dealt with the same question, however, 2015/2 dealt with it from an Income Tax Act perspective, whereas 2015/3 dealt with the SIS compliance requirements.

The facts for consideration, by each of the determinations, were basically as follows:

• The SMSF had two members, husband and wife;
• One spouse died, let’s say the husband, and the deceased member’s benefit was to be paid to the surviving spouse as a lump sum (who is also the remaining sole member of the fund);
• The fund’s assets consisted of publicly listed shares and cash;
• The surviving spouse wanted to re-contribute the death benefit to the fund and consequently, to avoid transaction fees, they wished to effect the payment of the death benefit and the re-contribution by way of journal entry.

As expected, the relevant ID determined that payment of the death benefit by way of journal entry did not:

• Satisfy the requirements of s.307-5(1) ITAA 1997; &
• Satisfy the requirements of reg 6.21 SISR.

That is, the journal entry record of payment of the benefit would not satisfy the Tax Act and SIS Act death benefit payment requirements. Consequently, the fund would either have to sell fund assets to have sufficient cash to pay the death benefit, or transfer fund assets in-specie to the beneficiary. The beneficiary could then re-contribute the benefit, either the cash, publicly listed shares or a combination of both, subject to the contribution rules and taking into consideration contribution caps.

Death benefit pension retains capital in fund

However, where the surviving spouse desired to retain the deceased member’s benefit within the fund, rather than have an actual payment out of the fund, a death benefit pension should have been considered as a means to effectively pay the death benefit, which also satisfies income tax and SIS compliance rules.

As noted above, a death benefit can be paid by way of pension. A spouse of a deceased member is an eligible beneficiary to receive the death benefit in the form of a pension. Consequently, with correct documentation and relevant administration processes (including journal entries), the deceased member’s balance is transferred to the surviving spouse, thus negating any transaction costs of selling assets or transferring them in-specie. It would also eliminate capital gain issues as there would be no effective disposal of fund assets.

Of course, the surviving spouse would not have the benefit of an increased tax free amount of superannuation as a result of a death benefit payment and re-contribution, however, this would simply need to be compared with the death benefit pension option to ascertain which would offer the greater benefits.

Once the death benefit pension has commenced and after the relevant time, such that any commutation of the pension would not be considered a death benefit payment, there is the option for the surviving spouse to cease the pension with the consequence being that the benefits revert from pension mode to accumulation, removing any future minimum pension payment requirement (ensure that the minimum pension payment requirement is met prior to the full commutation of the pension).

Commencing a death benefit pension (income stream) in SuperMate

Commencing a death benefit pension in SuperMate is an easy step by step process which can be commenced from the cash tab in the transaction entry screen (selecting the type as benefit and then click on the more option). This process will automatically take you to the Pension commencement wizard to effect the establishment of the pension for the beneficiary in the usual manner.

For further information refer to help document “Process a Death Benefit as an Income Stream to a Dependant (SMSFs and SAFs only)” (document ID 9039). Please note that there is a separate process for reverting a pension to a reversionary beneficiary from the original pension member (the relevant help document can be accessed from this same document).

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