“This is important as depending on how the payment is classified, it could end up being either tax-free or subject to significant death benefits tax liabilities,” Day said.

It’s not that uncommon for members to die in between requesting a member benefit payment and that payment actually being made, he said.

“The reason is that where people are at the end of their life, they will commonly want, or their beneficiaries will want them to take steps to minimise any potential tax on the death benefit to maximise the amount that beneficiaries receive,” Day said.

“And in a lot of cases, assuming the member is over 60, the easiest way to do this is to get the money out as a tax-free lump sum before they die.”

If the death benefit is going to a tax dependant, such as the spouse, there are no issues, it is when it is distributed to non-tax dependants, such as adult children, that problems arise.

Day gave an example of a member aged over 60 years with only non-tax dependent beneficiaries.

“The spouse has maybe pre-deceased or divorced, and they've only got adult non-financially dependent kids around as potential beneficiaries. Let’s assume that a $1 million benefit made up of 100 per cent taxable component is at play here,” he said.

“If the payment is treated as a member benefit, the payment would be 100 per cent tax-free and would then form part of their estate as ordinary non-super monies and would be distributed tax-free to the beneficiaries. However, if the payment was treated as a death benefit, it's going to be subject to death benefits tax of up to 17 per cent or $170,000,” he said.

However, determining whether a payment requested before death but paid after death is a member benefit or a death benefit can be complex.

“Unfortunately, like most things SMSF, it gets a little bit complicated as the ATO has changed its position a couple of times here. Prior to about two years ago, the general ATO position was that a payment from an SMSF in these circumstances would be a death benefit and not a member benefit,” he said.

“However, the ATO then reversed its position and started issuing Private Binding Rulings which confirmed that payments made from an SMSF in these situations would be a member benefit and not a death benefit.”

He added that the ATO's reasoning for this turnaround was that in the Income Tax Assessment Act, the meaning of a death benefit states it is a payment to a person from a super fund after another person's death because the other person was a member of the fund.

“The ATO concluded that this definition didn't apply as the payment was requested prior to a member’s death, and then paid in accordance with the instructions to their bank account,” Day said.

“I can remember thinking at the time that this raised a couple of interesting death benefit questions, especially if it resulted in the member’s benefit being paid to someone else due to it ending up in their estate and being paid in accordance with the terms of the will, instead of in accordance with a valid binding death benefit nomination or the terms of the deed.”

It didn’t take long for the ATO to again change its position when it issued updated guidance in February 2023 stating that where a member requested an amount to be paid from their fund before they died, but died before they received it, the trustee must assess whether it is a member or death benefit based on the facts known at the time. This includes whether the trustee is aware the member has already died.

“In all but one PBR issued in relation to SMSFs post this updated guidance, the ATO confirmed that payments made after death should be treated as a death benefit rather than a member benefit. In these cases, the main factor the ATO seemed to home in on was the fact that the trustee knew the member had already died prior to the payment of the benefit,” he said.

“For example, in one PBR where the member had requested a payment from their SMSF around four weeks before their death but which wasn’t paid until after their death, the ATO confirmed the paramount consideration in deciding the payment was a death benefit was the fact that the trustee was aware the member had already died at the time that payment was made.”

Day said in his view, once the trustee knows the member has died, it would be prudent not to proceed with any unpaid payment requests and instead administer the member’s benefits in the fund at that time per the super and tax death benefit payment rules.

“Alternatively, if the trustees wanted to go the other way and pay it out as a member benefit, I would certainly recommend getting some specialist legal advice as the trustees could be exposing themselves to legal action and penalties if they got it wrong”, he said.