SMSFs and estate planning: Issues to consider after the death of a SMSF member

Q: If you and your wife are retired and have an SMSF, what happens when one of you dies? Can you keep the money in the SMSF for the other person to still live off if you are the only person on the binding death nomination? Or does it need to get paid out of the SMSF?

A. The answer, as you might expect, is it depends. But don’t worry, we’re going to work through these issues and what’s relevant for you. But really, in general, the answer here is it depends. It depends on a number of factors. But let me take you through each of them to hopefully answer your question.

First of all, death is the only event that requires benefits held in super to be paid out. It’s what we call a compulsory cashing event. On the death of a member, that results in the compulsory payment of that deceased member’s benefits. The way the super rules and laws are written, it says that deceased member’s benefits must be cashed out of the super system as soon as is practicable following the member’s death. On death, our benefits must be cashed from super. But then we need to dig further because cashing could include the payment of the deceased benefits by way of pension, a lump sum, again or a combination of both pensions and lump sums. Cashing all benefits on death have to be cashed out of super.

That could be met by the starting a pension with the deceased member’s benefits, called a death benefit pension, or paying them out as a lump sum, as a death benefit lump sum. It’s really a combination could be used as well. That’s the background. That’s how it works. The important part of that is that no amount of the deceased member’s benefits can remain inside super in the accumulation phase. If I was to pass away today, my wife can’t just take my member benefit and keep it in accumulation phase. That wouldn’t meet the requirements to cash benefits.

But my wife could, for instance, if she was in pension phase, she could stop her pension and then take my money out as a death benefit pension. She would just be restricted by what we call that transfer balance cap, that $1.9 million limit, which is imposed on balances held in retirement phase. I’ll take you through that in more detail. I mentioned the transfer balance cap. That’s the limit on the amount that can be moved into retirement phase or the amount that can be used to start a pension where those earnings are tax-free. The current cap is $1.9 million. That’s assuming you haven’t taken any retirement pensions in the past.

Now, a death benefit on the part of a member, their benefits can be paid as a death benefit in the form of a pension. You don’t have to take this lump sum. If your trust deed of your SMSF, because you mentioned you had an SMSF, if your trust deed of your SMSF allows death benefit pensions, which I’m assuming it would, you could take the deceased spouse’s balance as a death benefit pension. So long as a it allows it.

You refer to the binding death nomination. So, you’re nominating who’s going to take the benefits. The death benefit amount is within that transfer balance cap limit. It’s within that $1.9 million. If any amount is above the $1.9 million, you’re going to have to take it out as a lump sum, which I’ll talk you through shortly. If the death benefit recipient, so I die today, if my wife has used up all of her own $1.9 million cap, then they can’t take any more death benefits as a pension because she’s used up a cap.

But what I mentioned before is she could commute, she could stop her own pension, and let’s say that her pension was now $1.9 million, she could stop that, meaning that she could start a new death benefit pension with $1.9 million. What that would allow is her own benefits to remain in her accumulation account. But my benefits, the deceased member’s death benefits, could then be paid to her as a death benefit pension. What that does is it allows all of the money to remain within the superfund without having to cash it out.

Let me just walk you through an example of this just to try and clarify some of those points. We got David, who’s 67. He passes away on 1 June 2024, and his pension balance at that time was $1.7 million. He has a wife who started her own pension on 1 July, 2021, and she started a pension using her own 100% of her transfer balance cap being $1.7 million at that time. She’s got no remaining transfer balance cap space. She can’t start any more retirement pension. She’s used it all up. But she wants to keep as much of her husband’s death benefit inside their super fund.

Because she’s used up 100% cent of her cap, she can’t commence any further retirement-based pensions. Remember, no amount of the deceased’s benefit can remain in her accumulation account. What she would need to do is stop her own pension, the $1.7 million, by rolling that back to her accumulation account. This then means she can now start another. She could freeze up $1.7 million in her own transfer balance account, meaning that she can now commence a new retirement phase income stream of $1.7 million. What that would allow is for Sue to take David’s death benefit of $1.7 million as a death benefit pension, and she keeps her own benefits in the fund in accumulation phase. Really, that, I think, is exactly what you’re asking, is can we keep the money in the fund. In that example, we can because the balances line up.

Now, what happens, though, if those balances don’t line up? In example two, it’s pretty much the same scenario. We’ve got David passes away, but he’s got $2.7 million. He had some wonderful growth on his pension. His wife, Sue, same thing, but she’s got $1.7 million. When David passes away, Sue commutes her own pension. She stops it. She takes the current balance of $1.7 million, rolls it back to accumulation. It’s her own money, so that can stay in accumulation.

But it’s freed up that $1.7 million that would allow her to take up to $1.7 million of the deceased husband’s balance as pension. So, $1.7 million of David’s $2.7 million could be used to start a death benefit pension. But the remaining $1 million of David’s benefit has to be paid out from the fund as a lump sum death benefit. Because Sue can’t take all of it, she hasn’t got enough cap space to do that, the remaining amount can’t stay in her accumulation account. The fund would have to pay out a a $1 million lump sum death benefit.

Now, this question that you’ve asked is a really good question because these are the issues that SMSF trustees and members need to be we’re talking about and well before that event occurs. We’ve spoken at different webinars and lots of articles on the website about trying to equal out those member accounts so you don’t have this particular issue. But you need to plan for this in advance.

What would have happened here for David and Sue if the only asset they had was, for instance, a $4 million property? It would probably require that property to be sold to fund the death benefit. That might be at the worst possible time for the fund to do it. When it comes to these sorts of issues, what we call these estate planning issues, it does need us to think years in advance on what we might do. If we’re holding liquid assets and we’re both within the caps, it might not be such an issue.

But I would encourage you to have a look at the estate planning series. There’s a whole series of articles on these particular issues, especially around what happens after the death of an SMSF member. Again, jump on the website and have a look at some of those articles that cover those estate planning issues. I hope that answered your question.