We need to talk about the step kids

Author: Richard Webb, Policy advisor - Financial planning and superannuation, CPA Australia

Estate planning is important and many superannuation fund members carefully nominate one or more beneficiaries in the event of their death. For some members, this could include a step-child. But what happens when death benefit dependents are not who members think they are?

Some of the most complex situations involving the payment of death benefits involve marital or de facto relationships where there are children from previous relationships. The situation is even more complicated when the parties are also the trustees of an SMSF.

In recent years, the concept of ‘family unit’ has been broadened in the Superannuation Industry (Supervision) Act 1993 (SIS Act) to include married or de facto couples, including opposite sex and same sex couples. This has generally made death benefit planning simpler. Yet, the situation with stepchildren is fraught with issues that don’t arise in the case of biological or adopted children.

The payment of superannuation death benefits to biological or adopted children is relatively straightforward. They are considered dependents and therefore eligible to receive a death benefit. Children under 18 (or 25 if still financially dependant or interdependant) may receive this as an income stream. Benefits are taxable if children are not financially dependant (or interdependant).

Ex-nuptial children (those born during but outside of the relationship) are not defined in the SIS Act but are generally regarded as subset of biological children. They are treated similarly to those residing within the member’s family unit. It is the inclusion of these children from outside the family which makes the situation involving stepchildren somewhat counterintuitive.

The SIS Act specifies that a stepchild is as much a child of the deceased as biological or adopted children are. However, exactly who are considered stepchildren is unclear. The term “stepchild” is not defined in either the SIS Act or its associated regulations.

Stepchildren, as most people understand the term, occur in a variety of ways. Ordinarily, the biological children of one partner, but who are not biologically related to the other partner, are considered to be step-children of the other partner. This can occur even if the stepchild resides outside the family unit.

Yet, inconsistencies arise in certain circumstances. For example, if the marriage of the child's natural parent to the deceased has ended (whether due to divorce or death), ATO Interpretive Decision ID 2011/77 states that the child's term as the deceased's stepchild ends.

Applying the ATO’s interpretation, if Partner A brought children of a previous relationship into a new relationship with Partner B, those children will cease to be Partner B’s stepchildren when the couple separates. So, those children would no longer be able to be considered stepchildren of Partner B for superannuation purposes and would no longer be valid dependents, even if a binding nomination had previously been made in their favour.

Building on the previous example, consider the situation and resulting inequity if Partner A dies and Partner B is now the only person left to parent the children. For superannuation purposes, this could lead to a scenario where the stepchildren would not be regarded as Partner B’s dependents notwithstanding that they are raising them.

While it may be possible for former stepchildren to prove that are financially dependant or interdependant on the deceased, this takes time. It could also be costly and may ultimately reduce the benefits for all dependents.

Most legal definitions also tend to disregard further children of former partners (whether biological, adoptive or stepchildren) after remarrying. This is so, even if such children spend large amounts of time with the member’s family unit.

Adding to this confusion, some Australian jurisdictions (such as Victoria and Queensland) have estate laws which apply outside of superannuation, and which may be different to the outcomes highlighted above.

As this shows, laws and decisions regarding who is a dependent have the potential to up-end estate planning nominations by SMSF members, particularly since binding death nominations are only valid in cases where valid dependents are nominated. This may lead to unplanned and unwanted outcomes if it is found by trustees that their planned beneficiaries are not legally their stepchildren.

Members should be able to make a binding death nomination in favour of their stepchildren without worrying that it won’t be respected. Blended families are commonplace in modern Australian society. This reality needs to be reflected in our superannuation laws, by clearly defining the stepchildren in line with community expectations.