SMSFs and binding death benefit nominations - where is your limit?

The superannuation environment may offer great tax efficiency in passing a member’s death benefits to their dependents, however there is a rider - the member will not have full control over how the benefits will be used by the beneficiary.

One of the beauties of SMSFs is that members can be flexible with their directions to the trustee through their binding death benefit nominations. Subject to the SMSF’s governing rules, members can go beyond simply nominating which of their dependents will receive benefits.

Because of s59 of the SIS Act and the binding death benefit rules in SISR 6.17A, which apply to APRA funds but not SMSFs, binding death benefit nominations (‘BDBNs’) used by APRA funds are often not afforded the same level of flexibility.

With APRA funds, the member’s decision in most cases would only extend to who will receive their death benefits, and other decisions such as the form of the death benefit payment (i.e. lump sum or beneficiary pension) are ultimately at the trustee’s discretion or at least require the trustee's consent.

Even with the benefit of greater flexibility for SMSFs, how the superannuation death benefits will be used by the beneficiaries is generally beyond the control of the member making the binding death benefit nomination, due to the mandatory cashing out requirements and the pension rules.

For example, if the death benefits are to be paid in a lump sum, the compulsory cashing of death benefits requirement under regulation 6.21 mandates the death benefits be cashed in a single lump sum or an interim lump sum and a final lump sum. Once in the hand of the nominated beneficiary, there is no effective control over how the money is spent by the beneficiary.

The member could try to have control over the use of the death benefit by specifying terms and conditions the beneficiary must agree to before receiving the death benefit. However there will be no practical way of enforcing the beneficiary’s adherence to the terms and conditions once the beneficiary receives the benefit money or property.

If death benefits are paid as an account-based pension, which is the most popular type of SMSF pension, generally there is no limit on maximum amount of pension the beneficiary can take in any year and also the beneficiary may choose to commute the pension for lump sum payment at any time.

Arguably, one could specify in their binding death benefit nomination that the pension must not be commuted by the beneficiary and also set maximum annual pension payment limits.

If the member’s child is the beneficiary, there is a mandatory commutation requirement under SISR which must override any such additional rules set by the member (i.e. the pension must be commuted and the resulting sum must be cashed out when the child turns 18 or, for a financially dependent child, 25, unless the child has a disability). 

If the deceased’s spouse is the beneficiary, there is no mandatory commutation requirement for a beneficiary pension in the form of an account-based pension.

If the governing rules and the pension documents are appropriately drafted, such pension may still qualify as a complying pension. However the effectiveness of this strategy has not been tested in court and there is some uncertainty as to whether or not the beneficiary with the sole beneficial interest in the pension can successfully challenge the limitations and access the benefits at will.

If the member’s major concern is having control over the death benefits after the member’s passing, there are other options for consideration including a BDBN directing the death benefits to be paid to the executor of their estate with a testamentary trust set up in their Will.

Of course this option would come at its own costs such as loss in tax efficiency and potential risk of the estate being challenged. Members and trustees should seek both legal and tax advice when considering different options. Please call us on 02 8296 6266 to see how we can assist in the preparation of appropriate BDBNs for yourself or your clients.

Visit the SUPERCentral product range if you would like more information on binding death benefit nominations.