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By Peter Hogan, Head of Education and Technical, SMSF Association
Death of a member and large lumpy direct property assets
The death of a member of an SMSF can be a difficult time for many reasons. In most cases, the deceased member is the spouse of the surviving member of the SMSF. As well as the emotional stress of losing a spouse, the surviving spouse also has SMSF trustee responsibilities to attend to. To simplify the road ahead for the remaining spouse consideration for investing into a property unit trust over a large lumpy direct property asset should be made up front.
Death benefit - lump sum or pension?
The superannuation law requires that on the death of a member, the surviving spouse in their capacity as trustee, must pay a death benefit as soon as possible, without unreasonable delay. This can be in the form of a death benefit lump sum or death benefit pension.
Delays can be caused by many circumstances, but one of the most common causes is the fact that the dominant asset of the SMSF is a single, direct property investment. This usually represents a substantial proportion of the market value of the fund’s assets. Whether the property needs to be sold or retained for use in a related family business, or whether a partial interest in the property can be transferred as a benefit payment to appropriate superannuation dependents of the deceased member, these can all be difficult questions for the surviving spouse, as trustee of the SMSF, to answer.
Another question which the surviving spouse may need to seek specialist advice in relation to is whether a death benefit lump sum or death benefit pension is able to be paid. Ultimately the decision may have been resolved by the deceased member executing a binding death benefit nomination, directing whether a pension or lump sum is to be paid to nominated dependents of the deceased. It should be acknowledged that the ability of the surviving spouse to deliver on those wishes may be made difficult by the circumstances of a large lumpy direct property asset in the fund.
Where a death benefit pension is to be paid, the trustee must determine if the direct property investment as the dominant asset of the SMSF is generating sufficient cashflow to meet the pension payment obligations, while leaving sufficient cash to meet other expenses of the SMSF. If not, then a reorganisation of the fund’s assets which may well involve sale of the direct property, could be facing the surviving spouse as trustee.
Having to become a trustee of the SMSF
The surviving spouse should also be aware that if the intended recipient of a death benefit pension is someone other than themselves, then the receipt of the pension from the fund requires that the pension recipient must become a member of the SMSF. In turn, this means that they must also be a trustee of the SMSF.
Such a turn of events may come as a shock to the surviving spouse who must now share their SMSF with someone else, even though that person is most likely to be a relative, such as an adult child. Shared decision-making responsibilities in relation to all administration and investment issues may not be a welcome development for the surviving spouse, especially if the new member and trustee has a very different view as to how the fund should be invested and how the fund assets should be used to maintain and preserve the direct property asset.
Paying a death benefit lump sum instead of a pension may avoid the above events unfolding for the surviving spouse. However, in order to achieve this, the surviving spouse may find themselves with two equally unacceptable options.
Firstly, they may need to sell the direct property outright in order to pay a cash death benefit lump sum to the nominated dependent. Sale of the direct property may not be a preferred option.
Secondly and alternatively, they may be required to transfer an interest in the property to the value of the death benefit lump sum payable to the nominated dependent of the deceased member. Shared ownership of the direct property by the SMSF and the nominated dependent of the deceased member in their own right would be an equally unsatisfactory outcome for the surviving spouse.
What should be considered to increase flexible and liquidity?
The problems outlined above are caused by the SMSF achieving exposure to property by owning a large lumpy direct property asset which represents a substantial proportion of the SMSF assets.
Far more flexible exposure to property can be achieved by investing in property unit trusts, providing a far more liquid and divisible investment. The issues highlighted above are less likely to arise in these circumstances. The surviving spouse is left in a position of control, without being forced into having to make difficult decisions about the best way to deal with a direct property asset, while at the same time being able to more readily meet their trustee obligations in relation to death benefit payments.