This "sole purpose" is that the fund has been established with the core expectation that it is there to save and make money for each members' retirement savings. Or, to quote the regulator of SMSFs (the ATO), the fund "needs to be maintained for the sole purpose of providing retirement benefits to members, or to their dependants if a member dies before retirement".

Newly minted SMSF trustees will likely be focused on the first part of the above statement, but it is the last few words - or their dependants if a member dies - that can take on greater importance as time goes by.

While no-one really wants to think about it, it is important that SMSF members/trustees have the facts before them from the outset - that way there'll be less surprises (and hurdles) if the unthinkable happens and a member dies.

As an example, consider Peter Podd and his wife Peta. They set up an SMSF, the Ps-in-a-Podd Super Fund (PIAPSF), which is a typical two-member fund with individual trustees. But what happens if Peter dies?

A legal personal representative (LPR) may be appointed as trustee for Peter to look after his interest in PIAPSF for a limited time (until benefits are paid to beneficiaries). This is only possible when the trust deed governing the fund allows for such an appointment (many SMSF trust deeds do).

Then Peta must make sure PIAPSF still meets the definition of an SMSF.

Technically, after the death benefit payment is made to the beneficiaries, the LPR will have to be removed and the surviving trustee/member (Peta) will have to adopt one of the following options to ensure the SMSF will remain complying:

(1) ask someone else to become the second individual trustee, or (2) set up a corporate trustee (with the single member becoming the sole director of the company).

Note it is possible to ask the LPR to join the fund as soon as the death benefit commences to be paid in which case he/she becomes the second individual trustee of the SMSF in their own capacity, not as LPR.

Another viable option would be to transfer PIAPSF's balance to another fund and wind up the SMSF.

Peter's death benefits must be dealt with as soon as possible. If the fund has limited cash available, assets may need to be sold to pay the benefits.

Death benefit nominations

SMSF members can nominate who will get their benefits when they die.

A binding death benefit nomination directs the trustee to pay the benefit to a legal personal representative or a dependant. Without a binding nomination, the remaining trustees will decide how the benefits are distributed by considering the trust deed and super laws.

The trust deed must be followed, even if it is different to the member's will.

To understand how death benefits can be paid you need to know who is a dependant. A dependant is generally a spouse, or someone in a close personal interdependent relationship. Or a child who is under 18, has a disability or is aged between 18 and 25 and is financially dependent on the deceased.

In regard to tax, any sum paid to a dependant of the deceased is tax free. It's not assessable income or exempt income. The SMSF doesn't withhold tax from the payment and the recipient doesn't include it in their income tax return.

A dependant can be paid a lump sum or an income stream. A non-dependent can only be paid a lump sum. If the death benefit is paid as an income stream, or is paid to a non-dependent or the trustee of a deceased estate, there may be tax to pay.

Lump sums can be paid in cash or non-cash form, for example, shares or property.

The trustee may need to withhold tax from a death benefit. Working this out can be complex and will depend on a number of factors. If a trustee has to withhold tax, they must register for PAYG withholding and complete some other ATO forms.

It's wise to plan ahead. If there is a dispute over the payment of death benefits which can't be resolved, it may lead to costly court action. Clear guidelines in the trust deed will help prevent problems.

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