SMSF testamentary trust power

The use of an SMSF testamentary trust can provide significant estate planning benefits. LightYear Docs director and founder Grant Abbott details how effective an asset protection mechanism they can be.

When it comes to SMSF estate planning, binding death benefit nominations (BDBN) have long been viewed as a standard tool for trustees despite the huge number of cases where they have been litigated. And with more than $400 billion to be transferred out of SMSFs through the death of members in the next 20 years, expect a lot of litigation on the horizon.

This means accountants and specialist SMSF advisers preparing SMSF estate planning documentation may find themselves unwittingly in the firing line if something goes wrong courtesy of section 54C of the Superannuation Industry (Supervision) (SIS) Act and the strict damages provisions of section 55(3). It beggars belief BDBNs are being done without any protection or providing secondary choices in the event that the primary dependent beneficiary is no longer on the scene, is bankrupt or in the midst of litigation.

BDBNs can be dangerous

At Abbott and Mourly Lawyers, like many specialist SMSF legal firms, we review a lot of BDBNs and the first problem we see is many of them are invalid because either:

1. The governing rules require the trustee to establish an approved form for a BDBN that has not been done, placing any purported BDBN ineffective at law, and

2. An approved BDBN must be used, as stipulated by the trust deed, but instead a standard one from an online document provider has been implemented, again rendering the purported BDBN invalid.

For a specialist lawyer these are dangerous rookie mistakes, but it is the next level that is worse. Nearsightedness in drafting a BDBN is an affliction. The standard BDBN that has all one spouse’s super going to the other and vice versa, but does not countenance what happens if they both die together is an accident waiting to happen. Only recently a financial planner said to me it was crazy to cover this scenario, which was highly unlikely to happen. I asked did they know not only a couple, but a mother and daughter were killed in the recent wedding bus crash in the Hunter Valley? Plus, I also reminded him of his duties as a planner to cover all contingencies. The golden rule then must be to always prepare for the worst because if the worst happens, you have done your duty and the client’s family is covered.

Are standard BDBNs sufficient in the face of evolving legal and financial landscapes?

No. There can be no doubt SMSF advisers must be vigilant, proactive and more importantly protective when it comes to securing a member’s superannuation benefits for their dependants or nondependants as the stakes are simply too high.

Section 62 of the SIS Act states the sole purpose test provides that the trustee of an SMSF can pay death benefits to a dependant, which includes a spouse and children, even if they’re adults. However, a lump sum or commutation of a pension payment may be simple, but on a protection scale only rates a one out of 10. The truth is, it places your assets at risk, whether from the clutches of family law disputes, creditor claims, ATO claims or family provisions litigation, if the dependant passes away.

Case study 1: The perils of direct payment

Consider the case of John Smith, a successful businessman who, unfortunately, passed away, leaving his superannuation benefits to his adult son, Alex. Within two years of John’s passing, Alex found himself entangled in a messy divorce and so John’s hard-earned super was now in play as a divisible asset.

On the other hand, what if super is paid directly to the deceased’s estate? It would seem like a logical choice, wouldn’t it? But here, timing and litigation loom large. Probate can be a lengthy process, and with nearly 50 per cent of all wills now being contested through family provisions claims, it’s like playing Russian roulette with a client’s super.

Case study 2: Family provision claims

Sarah was a diligent SMSF member who nominated her estate as the beneficiary of her super. When she passed away, her will was contested by a long-estranged daughter. The super she had intended for her other children was now part of a protracted legal dispute and was eventually eroded by the costs of litigation and settlement.

Are advisers negligent for not advising on family provisions claims?

A BDBN solution to transfer all of the deceased member’s superannuation death benefits to their estate can be dangerous, courtesy of family provisions claims. If the member’s death benefits are to be paid to the deceased member’s estate and it is subsequently wrapped up in a family provisions claim, is there a duty of care to warn of any possible family provisions action? Not advising on a potential family provisions claim has been increasingly litigated, notwithstanding the High Court decision in Robert Badenach & ANOR v Roger Wayne Calvert [2016] HCA 18. The big questions being firstly, is preparing a BDBN considered legal work and secondly, whether it is or not, does the duty of care to advise a client of a potential family provisions claims extend to SMSF advisers and accountants who recommend death benefits be paid to an estate when a proper review of potential family provisions claims by eligible persons is not undertaken?

A BDBN or SMSF will with a testamentary trust

In the face of these dangers, it’s time to turn to the rare gem of estate planning, the SMSF testamentary trust (TT). This is not a regular TT; it’s a purpose-built vehicle designed to shield a member’s super from the trials and tribulations of life, death and litigation. It can be optional, such as the CBUS industry super fund TT option, or mandatory in that the BDBN requires the trustee to create and settle an SMSF TT on death.

An SMSF TT is a special purpose testamentary trust that must meet the conditions of section 102AG(2) of the Income Tax Assessment Act 1936 (ITAA) This provision ensures any income a minor beneficiary derives from the trust due to a super death benefit is taxed at adult rates, providing a substantial tax benefit. It is not only the tax benefits making an SMSF TT attractive, but also the ability to offer adult beneficiaries asset protection.

SMSF TT protective benefits

1. Asset protection: One of the primary benefits of an SMSF TT is the protective barrier it forms around the assets from family law and creditor claims. The structure ensures the assets within the trust are not held directly by the beneficiaries, thereby shielding them from potential legal disputes or insolvency proceedings. With family law the important positions of trustee and appointor need to be carefully considered and we advise seeking a legal firm with a specialisation in protective estate planning and SMSFs be used as a sounding board.

2. Family provisions claim protection: An SMSF TT also offers a safeguard against family provisions claims on the estate. By circumventing the estate and directing super benefits into a TT, the exposure to litigation is minimised, ensuring the assets reach the intended beneficiaries.

3.Flexibility: SMSF TTs provide great flexibility, allowing for a wide range of beneficiaries, including bloodline only. This means the trustee has the discretion to distribute the income and capital of the trust to any of the specified beneficiaries, based on their needs and circumstances.

4. Bankruptcy protection: If a beneficiary is declared bankrupt, the assets within an SMSF TT are protected from trustee-inbankruptcy claims. This ensures the family wealth is preserved and isn’t eroded by unfortunate financial circumstances.

5. Control: The control of the trust can be passed down through generations, thereby ensuring the family wealth is managed in accordance with your wishes, even after your demise.

6. Longevity: A testamentary trust has the potential to last 80 years, providing long-term benefits to your descendants. Interestingly, if established under South Australian law, the trust can continue indefinitely, ensuring the perpetuation of your legacy.

7. Minors taxed as adults: Lastly, under section 102AG(2) of the ITAA, any income derived by a minor from the trust due to a super death benefit is taxed at adult rates. This provision can result in significant tax savings, especially when compared to the hefty tax rates applicable to unearned income of minors.

Providing the opportunity of an SMSF BDBN with an in-built testamentary trust is important advising and legal work. It’s crucial to engage experienced professionals to ensure an SMSF estate planning strategy is sound, protective, compliant and, most importantly, aligns with the client’s intentions because when it comes to protecting your clients and their family’s wealth, it pays to be at the top of your SMSF advising game and not playing in the thirds.