SMSF Technical Education & Strategies

SMSF Succession Planning

By Daniel Butler (dbutler@dbalawyers.com.au), Director, DBA Lawyers and Nathan Papson (npapson@dbalawyers.com.au), Lawyer, DBA Lawyers

Succession planning in an SMSF should be an important consideration for all SMSF members. With the right planning, a smooth succession can be achieved with minimal costs and administrative hassles upon the death of an SMSF member.

Conversely, where planning is not undertaken before death, there may be uncertainty as to whom death benefits will be paid to, as well as a range of unexpected attendances for the remaining trustees (or directors of the corporate trustee).

 

This article will outline some of essential planning strategies that members should undertake in order to achieve a smooth succession. It will also outline the legal framework surrounding the death of an SMSF member.

 

 

Corporate vs Individual Trustee

A corporate trustee of an SMSF can facilitate better succession planning for the SMSF. Where a corporate trustee has multiple directors, upon the death of a member a successor director can step into the place of the deceased member. Where an SMSF has a corporate trustee with a sole director, the shares in that company can be gifted via the deceased’s will to ensure that control of the trustee is still maintained after death.

 

There are a number of documents that affect the strategies above, such as the company’s constitution, deed of succession and estate planning documents (such as a member’s will). Having these documents in place during the member’s lifetime will save on costs and administration after death.

 

An SMSF can alternatively have individual trustees. In comparison, costly paperwork may be required to change individual trustees upon the death of an individual trustee. This is on top of the considerable paperwork that is usually associated with administering a person’s estate and obtaining probate of their will, etc. Another attendance upon death would be the task of contacting investment managers, banks and other stakeholders regarding the change of trustee. A corporate trustee entity would continue as trustee after the death of a member.

 

 

Control of trustee after death

A member ceases to be an individual trustee or director of a corporate trustee upon their death. As a result, the SMSF will not be a ‘self managed superannuation fund’ for the purposes of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’), see ss 17A(1) and (2). However, the SISA gives a six month window from when the fund ceases to satisfy the usual member trustee rules to rectify its trusteeship (see SISA, s 17A(4)).

 

A legal personal representative (eg, an executor) can be appointed as a trustee (or director of a corporate trustee) in place of a deceased member for the purposes of continuing to meet the definition of ‘self managed superannuation fund’. This means that the six month window will be in addition to the period that the deceased member’s legal personal representative may hold office in place of the member. The legal personal representative should usually cease as a trustee or director when the death benefit commences to be payable.

 

A few important source documents are outlined below.

 

SMSF Deed

The SMSF’s deed governs when a member ceases to be a fund member. A common time for this is upon the death of a member. The deed will also contain provisions which govern who (if anyone) will have the power to appoint a new trustee upon the member’s death. This is a particularly important mechanism if there is a single member fund with two individual trustees.

The deed should provide that a deceased member’s legal personal representative can vote for them. This ensures that the deceased member’s interests are taken into account. Many do provide the members with the right to hire and fire the trustee but most SMSF deeds do not cover this important point. Thus, a deceased member may have no say unless the deed protects their interests. Further, one mechanism for working through a deadlock between individual trustees is to give the member with the majority account balance a casting vote.

 

It should be noted that an SMSF deed will be more important for succession planning where there are individual trustees and this should provide clarity on whether a majority or other voting threshold is required for member decisions. If there is a corporate trustee, these steps will usually be set out in the company’s constitution.

 

Company constitution

A company’s constitution can contain a number of mechanisms to provide for smoother succession planning. The voting mechanism in the constitution is an important aspect. In practice, many constitutions may not have a sufficient mechanism for dealing with a deadlock and many provide the chair with the casting vote. Naturally, this is not appropriate for most mum and dad SMSFs.

 

One clearer mechanism for working through a deadlock between directors is to give the director with the majority of voting shares a casting vote. This is a lot clearer than simply leaving it up to the chair as most mum and dad trustee companies do not follow formalities in respect of their trustee meetings.

 

The constitution should also outline how a director can be appointed and removed. Further, the constitution should provide a mechanism for a director to nominate a successor trustee to fill their shoes if they lose their legal capacity or die. These formalities should be followed to ensure an appropriate document trail for the SMSF.

 

 

Death benefits

The focus of this article so far has been on the mechanics of who controls the office of SMSF trustee upon the death of a member. The importance of this control is that trustees will continue to make decisions on behalf of members. This includes the discretion as to whom a member’s death benefits are paid to, subject to restrictions in the legislation (eg, death benefits must be paid to the member’s dependants or legal personal representative) and whether there are any documents that would bind the trustee in relation to this determination.

 

Auto reversionary pension v binding death benefit nomination (‘BDBN’)

A BDBN refers to a direction (or ‘nomination’) made by a superannuation fund member to the trustee of the fund. The direction directs the trustee whom to pay death benefits to. If validly made, the direction should be binding on the trustee. Effectively, it is a will for a superannuation fund.

 

There is no legislative right for a fund member to be able to make a BDBN. Rather, the member is only allowed to make a BDBN if the governing rules of the fund provide for it. (SISA broadly provides an exception for a binding direction to trustees for BDBNs).

 

An auto-reversionary pension refers to a pension that was set up with a specific nomination that provides that on the death of the pensioner, the pension continues to be paid (ie ‘reverts’) to another person who is usually their spouse or a child under 25 years of age.

 

There has been some recent debate as to which of these will prevail over the other.

 

A well established principle of law is that a trustee’s discretion cannot be fettered. An exception to this is where the deed governing the SMSF ousts the prohibition on fettering. It is common for SMSF deeds to have a provision allowing a trustee’s discretion to be fettered by a BDBN. Whereas the auto-reversionary part of a pension is a clause in the pension documentation.

There are serious questions as to whether most auto-reversionary pensions would bind the trustee. In most SMSF deeds that we have reviewed, the reversionary nomination was, at best, a mere request that leaves the SMSF trustee with the final decision and discretion.

 

On the other hand, it is likely that a BDBN will actually bind a trustee and therefore would typically trump an auto-reversionary pension if there was a conflict. (However, in practice, many deeds state that the BDBN is only binding if it is to the trustee satisfaction. This is obviously not appropriate especially where the second surviving spouse does not wish to feel bound by their late spouse’s BDBN.)

 

Ultimately, the contest between a BDBN and a reversionary pension nomination depends on the express provisions of the SMSF deed and the pension documents. You should therefore ensure that you have an SMSF deed that is clear in respect of which nomination prevails (and that it is appropriately worded). Moreover, the BDBN and auto-reversionary pension nomination should be consistent with each other. The deed should clearly state which of the BDBN and auto-reversionary pension wins out on any conflict. Our recommendation is for the BDBN to override the auto-reversionary pension.

 

Hard wired deeds

‘Hard wired’ provisions in SMSF deeds (which are also referred to as a ‘death benefit rules’) can provide an SMSF member with great level of certainty as to who their death benefits are to be paid to after their death.

For example, a husband could set up an SMSF to provide for their second spouse and hard wire into the actual trust deed that death benefits (such as a pension) are payable to that spouse upon his death.

Other measures should be put into place to ensure that the hard wiring works effectively. These include contractual arrangements (such as a mutual wills agreement), wills and other estate planning documents and a restriction to varying the trust deed.

Hard wired SMSF deeds can be more costly due to the substantial tailoring that may be required. They nevertheless can be an important part of the member’s succession planning. Particularly where they wish for a separate income stream to be provided to a second spouse.

 

Application of TR 2011/D3

The ATO has recently released a draft taxation ruling (TR 2011/D3) that outlines when a superannuation income stream (e.g., a pension) will cease upon the death of a member. This draft ruling impacts all SMSF members.

Broadly, if a pension is being paid during an SMSF member’s lifetime, the same pension will continue after the death of the SMSF member if there is a reversionary beneficiary nominated (either through the pension documents, a BDBN or hard wired deed) for that pension.

 

However, where there is no ‘automatic transfer’ of an existing pension to a reversionary beneficiary as described above, the ATO’s view is that the pension will cease at the time of death of the member. The deceased’s superannuation interest may still be eligible to be paid as a pension under a general trustee discretion in the SMSF’s deed. However, if the trustee was to exercise such a power (assuming no reversionary beneficiary was nominated in advance), such a pension would be treated as a separate pension, which may result in adverse tax consequences.

 

This ruling stresses the importance of SMSF members to execute relevant documents to nominate a reversionary beneficiary for pensions. If no reversionary beneficiary is nominated, the pension paid during the SMSF member’s lifetime will cease upon their death. This requires an analysis of the SMSF deed and whether the reversionary nomination, BDBN or any other document is drafted consistently to achieve an ‘auto reversionary’ pension.

Unless the pension is auto reversionary, adverse tax consequences and additional administration may arise. In particular, any new pension may not reflect the same ‘tax free’ component, as it may have been mixed with the balance of the deceased’s accumulation interest.

 

 

Tying it all together

SMSF succession planning involves the following:

 

• A clear nomination as to whom death benefits of the member shall be paid to. This should be supported with documentation such as a pension documents, a hard wired SMSF deed and BDBN. The absence of such a nomination may result in adverse tax consequences, given the ATO’s view in TR 2011/D3.

 

• Appropriate succession as to who will control the trustee of the SMSF. A corporate trustee will make this process a lot smoother.

 

However, an SMSF may only form part of the member’s overall succession planning. It is important that their will, powers of attorney and any other estate planning documentation (such as a mutual wills agreement) align with the way they want their superannuation benefits to be paid.

 

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Daniel Butler is a director and Nathan Papson is a lawyer at leading SMSF law firm DBA Lawyers (www.dbalawyers.com.au). Daniel and Nathan can be contacted respectively at dbutler@dbalawyers.com.au and npapson@dbalawyers.com.au. This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.