How do I calculate the benefit to pay when my client dies?

I was recently asked about a death benefit for a member who died in May. The fund and member balances were calculated at 30 June and the benefit was paid as soon as practicable in September. What should the amount be? The value at June or September?

It sounds like a simple question with an obvious answer. The death benefit is whatever the member balance was worth at the time it was actually paid out – September in this case.

But it’s a question worth unpacking a little more.

As we know, large APRA funds pay out benefits all the time and they have to do so very quickly (if the benefit is a rollover to another fund, it’s within 3 days of being asked for the money). Given the scale and (likely) complexity of their investments, how on earth do they come up with precise figures so quickly? The short answer is that they don’t – and no-one expects them to, they run on approximations. Very good approximations but approximations nonetheless.

They also make calls that just wouldn’t happen in an SMSF.

For example, some public funds use “unit prices” to place a value on the member’s account every day. Those unit prices allow for changes in investment values, income, taxes etc. The pricing calculations are very sophisticated but can’t possibly be 100% accurate 100% of the time. Instead, the “overs and unders” are effectively reflected in subsequent adjustments to unit prices.

Even funds that look far more like SMSFs (say with specific investments notionally allocated to the member and so the daily value is far more transparent) are making approximations. If a member left the fund in the middle of the year, how would the fund accurately allow for tax when so many investments only provide tax statements on an annual basis? They take reasonable steps to provide an accurate amount but don’t expect it to be dollar perfect.

For example, some public funds don’t give their members the value of franking credits their investments have earned unless the member is still in the fund at the time the fund’s tax return is lodged. That makes sense – how could the fund pay a member a franking credit refund it hasn’t yet received without unfairly treating the remaining members?

Similarly, funds routinely subtract contributions tax from a member’s account on the day the taxable contribution arrives. They hold that tax until they’re ready to lodge the fund’s tax return – possibly 12 months or even longer after the contribution is received. The fund might earn interest on all these tax amounts and that will be shared with the members (or kept in a reserve) down the track. For the individual member who leaves before this happens, though, it means they’ve lost out.

In fact, it’s highly unlikely that the amount each public fund reports to the ATO for its members’ “total superannuation balance” at 30 June adds up precisely to the fund’s audited accounts on that date. And it doesn’t need to. The value used to start a pension or report for total superannuation balance purposes has to be the amount the fund would have given to the member if they’d left the fund that day – it’s never going to be perfect. It just has to be reasonable.

There’s nothing to stop an SMSF doing the same thing. We could use (well supported and reasonable) approximations to determine a member’s balance on 1 July for paying out my client’s death benefit (and pay it a few days later rather than in September). We could even do the same for commencing pensions, well before preparing the annual accounts. This wouldn’t be an “estimate” that we’d go back and fix up later. It would be the actual value placed on the member’s account for the purposes of starting the pension.

There are two reasons it’s less common than simply preparing the paperwork “later” once the accounts have been completed:

• There are very few members in the fund. So approximations that might be very common in a large fund (such as not paying franking credit refunds to people who leave before the tax return is done) look less fair in an SMSF – the discrepancy is simply more obvious in an SMSF, and
• Most of us use software that is (logically) more focused on helping us prepare an accurate set of financial statements and a tax return at 30 June each year than producing live updates on a member’s balance. So even if we use very reasonable approximations to determine the value of the member’s account on 1 July to start a pension, we will have a discrepancy between that amount (reported on the member’s TBAR) and the (subsequently finalised) value of their account in the financial statements. And in an SMSF there’s nowhere to hide – we will be expected to show that all the individual members’ balances add exactly to the value of the fund on the financial statements.

It often seems we confuse this desire for accuracy with backdating pensions – but they’re completely different. Backdating is all about retrospectively “deciding” to start a pension and it’s illegal. But many entirely legitimate pensions are established at a time when no-one actually knows the dollar perfect value of a member’s account balance. Doing documents with the precise numbers after the event is entirely reasonable.

In some ways, it would be easier to start pensions in August rather than 1 July. I’d wager that plenty of SMSF trustees and their accountants could come up with an entirely reasonable amount at 1 August that might well be just as “accurate” as the figures reported by a large fund. Just like a large fund, they wouldn’t be dollar perfect. But some of the concern around their accuracy would disappear simply because they’d never actually be checked against audited accounts prepared on the same day.

Pensions are one thing but wind ups present their own unique challenges. Because this is one scenario where there really is nowhere to hide. Returning to the franking credits example – in a public fund it might be fine to pay out a benefit in August without giving the member anything for their share of the fund’s franking credits. (Because the fund hasn’t lodged its tax return yet and so doesn’t actually have any cash for those franking credits.)

But that won’t be possible in an SMSF that’s winding up – eventually the tax refund will arrive and it will have to be given to “someone”. Or in reverse, transferring too much out and not leaving enough money to pay the final costs or tax doesn’t make those costs or taxes go away, the trustee needs to find the money. This is why SMSF wind ups often take a long time – the trustee needs to make sure all the final costs have been met and any remaining funds are transferred to the member’s new fund or paid out.

Wherever we land with the constant drive to make SMSFs report earlier and earlier, I hope it doesn’t take us to a place where we feel the need to move away from 1 July start dates for pensions. It would seem an odd outcome to follow on from a desire for more accuracy.

There is a wealth of information in the Heffron Super Companion about valuing member accounts, paying benefits and more. Read more about how this unique resource can help your business save time and speed up your responses to clients.