Auditing the death of a member in an SMSF

An area about which we commonly receive questions from our clients is the subject of death benefits

Whilst no two cases of the death of a SMSF member are the same, and individual advice should be sought for each specific circumstance, there are a number of key requirements which apply generally to all funds.

Whilst this article will focus on how we approach our audit and the issues we encounter, we would like to highlight that, as with all compliance matters, it's always preferable to avoid issues by effectively planning ahead of time, rather than having to rectify historical breaches.  Therefore, if trustees have any doubts about the actions they are taking, they need to pause and seek formal advice before proceeding. It is a dangerous strategy to simply forge ahead and wait to see what the SMSF auditor may say about the transactions, as by that time, the death benefits will have already been paid and may be complicated and costly to unwind.

Our audit approach

Part B of our audit report includes an opinion on the trustees' compliance with regulation 6.17 of the Superannuation Industry (Supervision) Regulations (SISR).  Compliance with that regulation requires the trustee to observe regulation 6.21 which states a member's benefit must be cashed as soon as practicable after the member dies. It is therefore this which is our focus.

It should be noted that we are not providing an opinion on whether all potential beneficiaries have been considered; nor are we providing an opinion on the impact on the transfer balance account of the beneficiaries.

Specific matters we'll consider

Who is making the decisions

Potentially the most important issue following the death of a member of an SMSF becomes who controls the fund. The member's legal personal representative is able to act as a trustee (or director of the corporate trustee) of the fund up until the death benefit commences to be paid. However, the fund has to ensure any necessary changes are made within 6 months to ensure compliance with section 17A of the Superannuation Industry (Supervision) Act 1993 (SISA). We will review compliance with this section and ensure that any changes are documented in a signed amendment deed or an equivalent document. An ATO Trustees’ Declaration should also be signed by any new trustee/director within 21 days of their appointment (section 104A of SISA).

To whom has the death benefit been paid

The obligation is on the trustees to identify the potential beneficiaries and distribute benefits accordingly. As noted above, the death benefit must be cashed as soon as practicable after the member dies. The industry rule of thumb is that the payment of death benefits should ideally be made within 6 months of the date of death however, in our experience, between 6 and 18 months is more typical. We believe a delay beyond 6 months is acceptable provided there is a sufficient explanation (e.g. a delay with probate in the courts or in obtaining all necessary valuations).

We will look to see that the trustees have observed a valid binding death benefit nomination or an existing reversionary pension. Naturally, the documentation is of utmost importance. If neither exists, the trustees have ultimate discretion as to whom and how the death benefits will be paid.

Only SIS dependants and the estate can directly receive a death benefit; all other beneficiaries must be paid via the estate. SIS dependants include spouses, anyone in an interdependency relationship with the member, children (regardless of age) and anyone financially reliant on the member.

It will be up to the trustees to provide us with evidence to confirm an individual's status as a SIS dependant.

Whether a death benefit has been 'cashed'

In the absence of a reversionary pension, death benefits can be paid as either a lump sum or pension, subject to any restrictions in the fund’s trust deed. In making the decision on how to pay death benefits, trustees should recall that all pension payments must be paid in cash. In contrast, a lump sum can be either paid in cash or in-specie. A single asset transfer (non-cash) can consist of multiple benefit payments coming from different member accounts.

Further, trustees should note that the ATO has confirmed in ATO ID 2015/23 that mere journal entries are insufficient for a lump sum benefit to be considered as 'cashed' and that regulation 6.21 of the SISR strictly states that no more than two lump sums (cash or non-cash) are permitted when paying a death benefit out of the fund.

Again, these are all considerations that will be reviewed during our audit.

Tax considerations

Death benefits will only be tax-free in the hands of the beneficiary if they are paid to tax dependants. Tax dependants include a spouse; former spouse; anyone in an interdependency relationship with the member; minor children and adult disabled children. Financially independent adult children are generally not included. However, a parent and adult child may be in an interdependency relationship if the necessary conditions are satisfied. For this relationship to exist there must be a close personal relationship, both parties living together, one or both parties providing financial support to the other and one or both parties providing domestic support/personal care to the other. Such a relationship has been found to exist in recent private rulings from the ATO (Authorisation Numbers: 1051560119930 & 1051770106043).

Where the death benefit beneficiary is likely to be subject to tax on the benefit they receive, the fund needs to consider its withholding tax obligations.

Where a member dies whilst not in pension phase, capital gains tax on the disposal of investments necessary to pay death benefits needs to be considered.  However, where the member was in receipt of a complying income stream at the time of their death, the fund is considered to be in pension phase until the death benefit is cashed despite a non-reversionary pension ceasing upon the death of the member.  Therefore, the fund will still be entitled to exempt current pension income in relation to any assets sold to facilitate the payment of the benefit.

We will consider the tax implications when assessing the fund's taxation liabilities as part of our financial statement audit.

Checklist of documentation required for audit purposes upon the death of a member

• Death certificate
• Documentation to confirm the deceased member's legal personal representative
• Signed change of trustee/director documents, including the signed ATO trustee declaration (if applicable)
• Most recent ASIC statement for the corporate trustee (if applicable), confirming the change in the directorship (as applicable).
• Signed binding death benefit or non-binding death benefit nominations (if applicable)
• Signed pension commencement documents confirming any reversionary pension (if not already provided)
• Signed minutes from the trustees/directors outlining the form in which the death benefits will be paid and to whom (beneficiaries)

We hope this article has provided some useful guidance on what we are generally looking for as auditors in this complex area. As always, all our client managers are available to discuss specific funds with you whenever complex issues arise so contact the Baumgartner Super team on 1300 047 673 for assistance.

Please note that our office will close from 25 December 2020 and will reopen on 4 January 2021. Wishing you a Merry Christmas and a Happy New Year!