Planning for the future

It is critical for SMSF trustees to put measures in place to deal with their death or loss of mental capacity. In this multi-part series, DBA Lawyers senior associate William Fettes and director Daniel Butler detail the options available to ensure optimal outcomes when these circumstances eventuate.

This article is the first in a series on SMSF succession planning. Here, we examine the key characteristics of a sound SMSF succession plan, including in relation to planning for control of the fund to pass into trusted hands in the event of a member’s death or loss of capacity.

Introduction

For many Australians, superannuation is a significant asset, especially if an SMSF is involved. Despite this, many do not plan ahead for what happens to their retirement savings upon their loss of capacity or death.

We recommend every SMSF member develops a succession plan, consistent with the other strategies of this nature they have in place, to ensure there is a well-considered and documented process present to govern control of their fund in the future.

Failing to plan ahead can result in considerable uncertainty with respect to the control of an SMSF and the ultimate fate of the member’s superannuation benefits. For instance, inadequate attention to succession planning could result in super death benefits being paid otherwise than intended and unnecessary costs and stresses arising for the family.

Elements of good succession planning

SMSF succession planning broadly aims to accomplish the following outcomes:

• having the right people gain control of the SMSF to ensure superannuation benefits are paid as intended,

• having the right people receive the intended proportion of SMSF money and assets, and

• ensuring outcomes are provided in a timely and legally effective manner, with minimal uncertainty and in as tax-efficient a manner as possible.

SMSFs are subject to some complex rules and are strictly regulated by the ATO, with sizeable penalties available to be imposed for most breaches. Thus, expert advice should be considered when undertaking this type of strategy, especially seeing not all SMSFs will have governing rules covering the right succession strategies.

Accordingly, there is no easy one-size-fitsall solution for SMSF succession. However, all plans should, at least:

• determine the person(s) who will occupy the office of trustee/director upon loss of capacity or death,

• ensure the SMSF can continue to meet the definition of an SMSF under section 17A of the Superannuation Industry (Supervision) (SIS) Act 1993,

• determine what each member’s wishes are for their superannuation benefits,

• determine to what extent each member’s wishes should be locked in through the use of a reversionary pension and/ or a binding death benefit nomination (BDBN), and

• determine the tax profile of anticipated benefits payments.

Succession on loss of capacity

With the passage of time there is a significant risk some SMSF members may lose the capacity to administer their own affairs. In the absence of prior planning, this could result in major uncertainty and risk arising in relation to control of the SMSF. Having an enduring power of attorney (EPOA) in place can help overcome this problem as such an appointment is ‘enduring’, enabling a trusted person, that is, the member’s attorney under an EPOA, to continue to run the SMSF as their legal personal representative (LPR) in the event of loss of capacity.

It is strongly recommended every SMSF member implement an EPOA as a part of their personal SMSF succession plan. It would not be an exaggeration to say being an SMSF member without having an EPOA is a significant risk exposure.

Naturally, given the important responsibilities placed on an attorney, a member must trust their attorney to do the right thing by them. Only a trusted person should be nominated and insofar as the member retains capacity, the EPOA should be subject to ongoing review to ensure its ongoing appropriateness.

Consideration should also be given as to whether the scope of the appointment should be general in nature, that is, a general financial power, or limited to the SMSF or to the fund trustee. For example, if the member wishes to preclude their attorney from exercising certain rights in relation to their member entitlements or making or revoking their BDBN, this should be expressly covered in their EPOA.

It should be noted that having an EPOA in place does not generally give effect to an intended appointment of the attorney as an SMSF trustee or director of a body corporate that is trustee. An EPOA merely permits the member’s attorney to occupy the office of trustee or director of the corporate trustee to help satisfy the trustee-member rules set out in section 17A of the SIS Act. Thus the attorney must still be appointed at the trustee level at the appropriate time.

The appointment mechanism that facilitates an attorney, or other LPR, to step into the role of trustee/director must be contained in the SMSF trust deed and the company’s constitution. For example, in the context of a corporate trustee and in the absence of other appointment provisions in the constitution, generally a majority of the company’s shareholders must exercise their voting rights to appoint a director.

Succession on death

The death of a member is the other key succession planning risk needing to be carefully considered.

Section 17A(3) of the SIS Act provides an exception to the trustee/member rules where a member has died. The exception in this section provides that a fund does not fail to satisfy the basic conditions of the trustee/ member rules by reason only that:

a. a member of the fund has died and the [LPR] of the member is a trustee of the fund or a director of a body corporate that is the trustee of the fund, in place of the member, during the period:

i. beginning when the member of the fund died, and

ii. ending when death benefits commence to be payable in respect of the member of the fund.

This exception permits an LPR of a deceased member, such as an executor of a deceased person’s estate, to be a trustee or director in place of a deceased member until that member’s death benefits commence to be payable.

However, this provision does not result in an LPR becoming a trustee or director. This means, for section 17A(3) of the SIS Act to apply, an LPR must actually be appointed as either:

• a director of the corporate trustee pursuant to the constitution of the company, or

• an individual trustee pursuant to the governing rules of the fund.

This has been confirmed in numerous cases, including Ioppolo v Conti [2013] WASC 389, Ioppolo v Conti [2015] WASCA 45 and implicitly in Wooster v Morris [2013] VSC 594. In Ioppolo v Conti [2013] WASC 389, Master Sanderson described the operation of section 17A(3) as follows ([20]):

“…The mechanism of the section is tolerably clear. Section 17A(3) allows for the appointment of an executor as a trustee of the fund but does not in its terms require such an appointment…”

These cases broadly confirm a deceased person’s LPR, that is, their executor, will not generally step into the role of an SMSF trustee or director automatically upon a member’s death. Broadly, it depends on the provisions of the fund’s trust deed and the company constitution (most SMSF deeds and constitutions do not have a mechanism for this to occur) and whether there are other legal documents in place to ensure this occurs.

The role of the Corporations Act 2001

Section 201F of the Corporations Act 2001 empowers the personal representatives of a sole director and sole shareholder in a private company to appoint new directors for the company on the death or loss of mental capacity of the principal, that is, the sole director/shareholder.

Thus, if an SMSF was a sole member who is also the sole director/shareholder of the corporate trustee, section 201F can assist in relation to the member’s LPR exercising powers to take control of the SMSF trustee after their death or loss of legal capacity.

However, it is important to understand the limitation of this provision. For instance, section 201F cannot assist where a fund member has died and the SMSF trustee company has more than one director or shareholder, or where the shareholder is a person other than the sole director who has died.

Accordingly, relying on section 201F is not a sound strategy in many cases.

Successor directors

By ensuring the fund’s corporate trustee has an appropriate company constitution containing successor director provisions, it is possible to plan for smooth succession to the role of a director in advance, while also overcoming limitations that apply in respect of:

• appointing a new director via the usual rules in the corporate trustee’s constitution, for example, by majority shareholder vote, or

• the limited flexibility in section 201F of the Corporations Act 2001.

Making a successor director nomination allows a director, that is, the principal director making a nomination in accordance with an appropriately drafted constitution, to nominate a person to automatically step into their shoes immediately upon their loss of capacity, death or a specified event occurring.

The successor director strategy is designed to work in conjunction with a member’s overall estate and succession plan to enable an attorney appointed under an EPOA or an executor of a deceased member’s estate to be automatically appointed as a director without any further steps involved.

Naturally, a successor director strategy relies on the right paperwork being in place, including the right constitution and related successor director nomination form.

Conclusion

Forward planning supported by the right documents is required for smooth and effective SMSF succession planning.

Please note, expert advice should be sought in relation to formulating and implementing an appropriate SMSF succession plan.

Part 2 in this multi-part series on SMSF succession planning will cover the role of BDBNs.