In recent months, we have seen a significant increase in succession planning queries and assignments where we have been asked to provide advice and/or documents, including binding death benefit nominations (‘BDBNs’), reversionary pensions, planning for control of an SMSF and implementing timely member exit strategies for those who may be left with a limited time to live.
Indeed, it is not surprising that many SMSF trustees/members and advisers are proactively reexamining their succession planning arrangements in view of the current global coronavirus (COVID-19) pandemic.
This article examines some of the key considerations that should be borne in mind in formulating and implementing a successful SMSF succession plan.
What is succession planning?
Succession planning is a critically important aspect of successfully operating an SMSF, though it is often overlooked. Every SMSF member should develop a personal succession plan to ensure there is a smooth process in place to govern succession to control of the fund that fits in with their other estate and succession planning arrangements. Indeed, in times of uncertainty and heightened risk of illness, this is even more critical than ever.
SMSF succession planning broadly aims to accomplish the following outcomes:
- that the right people receive the intended proportion of SMSF money and assets; and
- that the right people gain control of the SMSF to ensure that superannuation benefits are paid as intended
An optimal SMSF succession plan should achieve these goals in a timely and legally effective manner, with minimal uncertainty and in as tax efficient manner as possible. However, it should also be recognised that trade-offs may need to be considered, as it would usually be considered preferable that the ‘right’ people receive a benefit and pay tax, rather than the ‘wrong’ people receive a benefit in a tax efficient manner.
Accordingly, there is no easy ‘one size fits all solution’ for SMSF succession. However, a well thought out SMSF succession plan should address the following matters:
- determine the person(s) or corporate entity who will occupy the office of trustee upon loss of capacity or death;
- in relation to a corporate trustee, determine who the directors of the SMSF trustee company will be (ie, who will have control of the company) upon loss of capacity or death of directors/members;
- ensure that the SMSF can continue to meet the definition of an SMSF under s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’);
- determine what each member’s wishes are for their superannuation benefits;
- determine to what extent each member’s wishes should be ‘nailed down’ through the use of an automatically reversionary pension and/or a BDBNs; and
- determine the tax profile of anticipated benefits payments.
Many people have no succession plans in place for their SMSF which may result in considerable uncertainty arising in the future with respect to the control of the fund and the ultimate fate of their member benefit.
Succession on loss of capacity — the role of an enduring power of attorney (‘EPoA’)
With the passage of time, there is a significant risk that 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 EPoA in place can help overcome this problem, as an EPoA appointment is ‘enduring’, enabling a trusted person (ie, 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 that every SMSF member implement an EPoA as a part of their personal SMSF succession plan. It would not be an exaggeration to say that 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 scope of the appointment should be general in nature (ie, a general financial power) or limited to the SMSF or to the SMSF trustee. For example, if the member wishes to preclude their attorney from exercising certain rights in relation to, say, their member entitlements or making or revoking their BDBN, this should be expressly precluded in their EPoA.
It should be noted that, by itself, an EPoA is not a mechanism by which an attorney can actually step into the role of an SMSF trustee or director of an SMSF corporate trustee. An EPoA merely permits the member’s attorney to occupy the office of trustee or director of the corporate trustee to help ensure that the SMSF can continue to operate in a fashion consistent with the member’s wishes. This is because a member’s attorney appointed under an EPoA is expressly recognised in s 17A of the SISA for the purposes of the trustee-member rules. However, the attorney must still be appointed in the first place. The appointment mechanism which facilitates the LPR to step into the role of SMSF trustee or director of the corporate trustee is contained in the SMSF deed and the company’s constitution. For example, in the context of a corporate trustee, 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 role of the executor as LPR
The death of a member is another case where succession to control of an SMSF should be carefully considered.
Section 17A(3) of the SISA provides an exception to the trustee–member rules where a member has died. The exception in s 17A(3) 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 (eg, an executor of a deceased person’s estate) to be an individual trustee or a director of a corporate trustee in place of a deceased member until the member’s death benefits commence to be payable.
However, it is important to understand that this provision does not require or create this state of affairs. For example, for s 17A(3) to apply, an LPR must actually be appointed as either:
- a director of the corporate trustee of the fund pursuant to the constitution of the company; or
- an individual trustee of the fund pursuant to the governing rules of the fund.
The operation of the provision in this way has been confirmed in numerous cases, particularly in 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 s 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. Section 17A(4) provides a period of grace – that is to say it allows a fund six months to organise its affairs so it can remain a SMSF. So in the case of a fund which has two members and which would qualify under s 17A(1), on the death of one of the members it remains a SMSF for six months. If the remaining member has not taken some steps during that period to bring the fund within the terms of s 17A(2) then it will cease to be a SMSF…
[Emphasis added]
These cases underscore the fact that a deceased person’s LPR (ie, their executor) does not automatically step into the role of an SMSF trustee or director upon a member’s death. Broadly, it depends on the provisions of the SMSF deed (most SMSF deeds do not have a mechanism for this to occur) and whether there are other appropriate legal documents in place to ensure this occurs.
Successor directors
By ensuring that the company constitution of the SMSF trustee contains successor director provisions, it is possible to plan for succession to the role of a director in advance.
Making a successor director nomination allows a director (ie, the principal director making a nomination in accordance with an appropriately drafted constitution prepared by DBA Lawyers) to nominate a person to automatically step into the shoes of the principal’s directorship role immediately upon 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 will to be automtically 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.
All new company establishment documents prepared by DBA Lawyers include successor director provisions in the constitution, as well as a free value-added appointment template. Further, successor directors can also be implemented for an existing private company with a constitution update.
To place an order to update a company’s constitution to DBA Lawyers’ constitution (ie, to implement successor directors and obtain may other advantages) click here.
For further reading on successor directors click here.
Tax considerations on death
The tax profile of death benefits is also a relevant consideration in succession planning.
Where a death benefit lump sum is paid to a tax dependant (ie, a death benefits dependant under s 302-195 of Income Tax Assessment Act 1997 (Cth)), the dependant will receive the benefit tax free (ie, as non-assessable non-exempt income). A dependant for tax purposes means any of the following (s 302-195):
- the deceased person’s spouse or former spouse;
- the deceased person’s child, aged less than 18 at the time of death;
- any person with whom the person has an interdependency relationship; or
- any other person who was a dependant of the deceased person just before he or she died.*
* NB — this limb of the definition imports the common law meaning of dependant, which is accepted to include financial dependency.
Accordingly, adult independent children do not generally qualify as death benefits dependants. Thus, any death benefit payment they receive (usually when there is no surviving spouse) will be subject to a tax rate of 15% plus applicable levies to the extent that the benefit comprises the taxable component.
When you consider that the average SMSF holds over $1.27 million in assets, the tax exposure of death benefit payments made to adult independent children by an SMSF is likely to be significant.
Planning an exit strategy in light of the ‘death tax’
Given the impact of the effective ‘death tax’ where the likely recipient(s) of the death benefits will not be tax dependants, one tax effective option is for the member to withdraw the bulk of their superannuation benefits during their lifetime (ie, assuming that the member is over age 60 and a relevant condition of release has been met).
Naturally, this is an option that should not be contemplated lightly as the member’s entitlements will leave the super environment and there are likely to be very limited opportunities for the member to make further contributions into superannuation. Additionally, it should be borne in mind that such a withdrawal will mean the relevant money and/or assets will be exposed to the normal tax environment outside of superannuation and it is possible that the member may go on to live a healthy life for many years after the withdrawal.
However, if the option is being seriously contemplated, SMSF members/trustee and advisers will need to carefully consider how to best achieve the intended outcome in relation to implementing the withdrawal by paying:
- ordinary pension payments for any pensions that may be in place; and/or
- lump sum payments for the member’s accumulation entitlements and amounts arising on commutation of a pension.
While superannuation benefits can be withdrawn by drawing down on a pension account (ie, assuming the pension is an account-based pension with no payment restrictions in place), pension payments can only be paid in cash. Thus, generally this approach will require additional time to realise fund assets which can be problematic in an economic downturn and where the fund has illiquid investments. Additionally, pension payments will not address any accumulation account balance that the member has in the fund. (For completeness, it should also be noted that this will have negative transfer balance cap consequences in relation to there being no debit available to a member’s transfer balance account for withdrawals by pension payment, eg, if the member wished to preserve their ability to commence retirement phase pensions in the future.)
Thus, to speed up the withdrawal process, an SMSF member looking for a timely exit strategy may wish to arrange for fund assets to be transferred out of the fund, ie, by way of a lump sum payment.
Lump sum payments in specie
In view of the above, transferring legal title to relevant fund assets from the SMSF trustee to the member (is, as part of a lump sum payment in kind) is generally considered the most conventional way to achieve a speedy withdrawal of non-cash assets from an SMSF.
However, the process of transferring legal title can still take days, weeks or even longer in certain cases, especially if the assets include:
- real estate;
- assets that cannot be readily realised or transferred for various reasons; or
- securities (eg, shares or units) where disposal of the securities may be subject to specific requirements or formalities in the applicable constitution or governing rules of the trust or company; or
What if time is of the essence?
As noted just above, ample time needs to exist to arrange for an effective transfer of legal title especially as you ‘never know the hour, nor the minute’.
If the member dies and the relevant assets remain with the SMSF trustee, the mere existence of a request to cash the relevant fund assets as a lump sum will generally not be accepted by the ATO as proper basis for treating the benefits as having been paid to the member (ie, for legal, tax and accounting purposes).
Thus, if time is of the essence in relation to implementing a timely withdrawal of benefits, we recommend that you obtain expert advice. DBA Lawyers can assist in relation to providing advice and documentation to ensure that the best legal position possible is established to achieve a legally effective and timely withdrawal of benefits based on sound legal principles.
As there is some complexity and risk associated with this process and implementing the requisite documents, SMSF trustees/members and advisers who are interested in this exit planning option should contact one of our senior lawyers to discuss the steps and documents that are most appropriate to the particular circumstances.
Related articles
For more information on succession planning, click on the articles listed below:
- Planning your exit: a guide to SMSF succession planning – Part 1
- SMSF Succession Diagnostic Service
- SMSF succession planning – who receives the benefits and who gains control? (podcast)
- SMSF Succession Planning – webinar recording
- Advantages of a DBA Lawyers company
- Preserve the intended control of a company using successor directors
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400.
By William Fettes, Senior Associate ([email protected]) and Daniel Butler, Director ([email protected]) DBA Lawyers
27 March 2020
