Binding death benefit nominations • 6 traps to avoid
Avoiding pitfalls actually starts well before the binding death benefit nomination is prepared. It starts with the fund’s trust deed. The first (and maybe most important) trap to avoid is having a trust deed that doesn’t clearly spell out some critical things about binding death benefit nominations (BDBNs). And if you’re wondering what exactly is a “binding death benefit nomination” or “BDBN” read more here.
SMSFs are currently considered to have significant flexibility when it comes to BDBNs – for example, they can last indefinitely and they are not automatically subject to the same rules about witnessing as in large funds. But the trust deed does need to make it clear what the requirements are and then they need to be followed. Unfortunately several court cases looking at trust deeds that were a bit vague here and just referred to doing things “in line with the relevant legislation” found that this meant the usual rules for large funds also applied to those SMSFs. This includes a requirement that they expire after 3 years.
The second pitfall to avoid is having a BDBN that contradicts another arrangement relating to death that the member already has in place. The most common one here is that when a member sets up a pension, they will often specify that the pension is to continue to (say) their spouse when the member dies (a “reversionary pension”). It’s a bit of disaster if the member also has a BDBN saying that their super is to go to their estate when they die. In that scenario, what should happen to the pension if the member dies? Should it continue to the surviving spouse or be stopped and paid to the member’s estate?
That brings us right back to the trust deed for the third pitfall to avoid: having a trust deed that doesn’t make it clear which document “wins” when there is a conflict, the BDBN or the pension establishment documents. There are good arguments to make in favour of either approach. The important thing is that it’s clear one way or the other.
My fourth pitfall to avoid is having a BDBN that gives a lousy outcome. For example, we routinely see BDBNs that stipulate super is to go to the member’s estate and yet there is a surviving spouse. It is almost always beneficial for the spouse to at least have the option of taking the super they inherit as a pension. A BDBN to the estate rules out that option.
Or what about a BDBN that specifies the super is to go to the adult, financially independent children rather than the spouse? Money paid to the children will be taxed while anything inherited by the spouse is tax free. (Generally only children who are still dependent on their parent can inherit super tax free.)
Even if there is no spouse to receive the super, there can still be downsides to a BDBN that stipulates the super is to go directly to the children rather than the estate. It can result in more tax – people pay the Medicare Levy but estates don’t. Let’s say Tim and Sarah (42 and 44 respectively) receive a $1m super inheritance from their 75 year old father’s SMSF. All his super came from contributions by his employer and earnings – he has never made any contributions from his own money for which he has not claimed a tax deduction (“non-concessional contributions”). If this money is paid directly to Tim and Sarah, they will not only pay a terrifying amount of tax ($150,000) but the benefit will also incur the Medicare Levy ($20,000). In contrast, if the benefit was paid to the estate, Medicare is not paid at all. We normally think of Medicare as being a fairly small cost because it’s applied to income. But don’t forget, when it comes to paying tax on death benefits, it’s effectively being applied to some or all of the capital.
A related pitfall (number five) is a BDBN that can’t actually be followed. Again, a common problem we see is BDBNs where the super is to be paid to a sibling or a parent. It’s common for neither to be eligible to receive super monies because death benefits must be paid to either the estate or a very limited group of people who are considered “dependants” for super law purposes. Generally siblings and parents aren’t on the list. The only time a super death benefit can be paid to someone like a sibling or parent is if there are no dependants at all and no estate is formed. This is rare.
It might be even worse if the BDBN required the super to be split between (say) a son and a brother. Then only some of the instructions are valid. What does the trust deed say about that? If the BDBN can’t be followed in full, is the whole document invalid or just the instructions that can’t be followed. Again, the trust deed becomes critical.
Finally (pitfall six) BDBNs that don’t consider all possibilities can be a disaster. Think about a BDBN that says the super is to be divided evenly between the member’s two children, Fred and Mary. What if Mary died before the member? Unless the BDBN actually covers that (for example, by stipulating that Mary’s share will go to her own children if she has predeceased her parent), the BDBN will quite possibly mean all the super goes to Fred.
My personal (and probably unpopular) view is that template BDBNs are right up there with Will Kits from a newsagent. Doing something as important as creating a legally binding instruction for your super without proper estate planning advice is likely to end up in tears.
What exactly is a “binding death benefit nomination”?
Binding Death Benefit Nomination. But have you ever wondered exactly what it is? Or how it works? Or whether you should have one?
A BDBN is exactly as it sounds – a set of instructions you can provide to the trustee of your superannuation fund that tells them how to deal with your super when you die. And as long as the right paperwork is done, those instructions are legally binding for the trustee – they can’t do anything but follow them. You can stipulate who gets the money and how they get it (as a pension or a lump sum). For a BDBN to be valid, the fund’s trust deed (its legal rule book) must allow for one to be made and say how that can be done. The instructions must also comply with the super laws – for example, only your estate and certain other people (such as spouses, children and people who are financially dependent) can receive a super death benefit when a member dies. There is an even shorter list (generally just a spouse and children under 25) that can receive the benefit as a pension.
Pretty much any superannuation fund with the right trust deed can accommodate a BDBN, not just SMSFs. That said, different rules apply to large funds and SMSFs.
Perhaps most importantly, as long as an SMSF has the correct rules in place in its trust deed, SMSF BDBNs can last forever (it’s often called a “non lapsing binding death benefit nomination”). In contrast, the normal rules for large funds require BDBNs to expire every three years. They can obviously be replaced with exactly the same instructions but the existing document stops being valid. Some large funds get around that by specific rules in their trust deed that say any instructions given on death benefits are binding forever but mostly the three year rule applies.
BDBNs in large funds also have to be witnessed by two people over 18 who aren’t getting the money from the BDBN. This extra requirement doesn’t have to apply for SMSFs (unless the trust deed says so) although bear in mind that getting anything really important witnessed isn’t such a bad idea anyway.
So are they good?
They can be. It certainly makes life simple for the people left behind – they don’t have any decisions to make, and they can be absolutely certain about who should get your super.
But remember that BDBNs are binding. This makes the decisions about what they say incredibly important – much like you would think very carefully about your Will (which covers all your non super assets), you should think very carefully about your BDBN (which is just as powerful when it comes to your super assets). And you should make sure that the decisions you make about who gets your super comply with the law, are exactly what you want and will stand the test of time. If your circumstances change, you must remember to update your BDBN because in an SMSF it might otherwise last forever. There are lots of examples where bad BDBNs completely muck up good super planning.
For example, what if your BDBN says that your super is split between your three children because when you put it in place you were a single parent? But that was 15 years ago. Since then, you’ve remarried and now you would rather your super went to your new spouse with your children inheriting the rest of your estate. That might make perfect sense because a spouse doesn’t pay tax on super inheritances but adult children do. Unless you change your BDBN before you die, your family will be stuck with a bad tax outcome. It could be even worse – what if your Will was drafted on the assumption that your new spouse will get the super while everything else goes to the kids? It might mean your spouse is completely cut out. Wills usually lapse automatically when someone gets married but a BDBN doesn’t. So yours would still be valid.
Even in simpler situations where you don’t have a blended family, instructions that can’t be adjusted at all after you’ve died can be problematic. We’ve covered a few issues in our article here.
But if you don’t have a BDBN, is that like dying without a Will? We’re often told dying without a Will is irresponsible and creates difficulties for your family after you die. Having an SMSF without a BDBN isn’t the same.
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This article was first published by Meg Heffron of Heffron Consulting.
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