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Most SMSF trustees understand the concept of estate planning and its importance in ensuring your assets are distributed to the right people following your death.
Unfortunately, not all trustees consider the importance of planning a smooth transition for their fund and their super benefits when they pass away.
In a small business a good succession plan removes the risk of the business failing if the key person dies, but few SMSFs have a similar plan in place, despite the significant assets many funds hold. So, what should an SMSF succession plan include?
Succession vs estate planning
While both an estate plan and a succession plan play an essential role in determining what happens to your financial assets after your death, they cover two separate activities:
This is the process of deciding and planning who gets your assets when you die and in what form they are received (such as cash or shares). With your super death benefits, this could be a lump sum, reversionary pension or a mix of both.
For an SMSF, estate planning is a subset of the broader succession planning process for your fund and your super death benefits. If you want to ensure your wishes in relation to your super benefits are carried out after your death, it’s essential to develop a detailed SMSF succession plan well in advance.
This is the process of planning who will control your SMSF after you die or lose mental capacity. Good succession plans ensure a smooth transition in control of your SMSF and safeguard your instructions in relation to the distribution of your death benefits.
Having a succession plan also helps avoids administrative and compliance problems with the SMSF following your death. It can reduce the prospect of reporting and compliance obligations (such as transfer balance account reporting) being overlooked.
Good succession planning also provides benefit payment certainty and increases the ability to make these payments in a tax effective manner.
Why a succession plan is essential
Simply having a detailed Will or death benefit nomination in place is not enough to ensure your super assets will be distributed the way you want.
When it comes to your super assets, the trust deed of your SMSF always takes precedence over your Will as super funds operate under trust law, rather than the rules relating to estate law.
This means the remaining or newly appointed trustees of your SMSF have a say in what happens to your death benefits. Instructions in your Will have no power over a trustee’s decisions.
Court cases such as Katz v Grossman (2005) and Wooster v Morris (2013) have highlighted that the person in control of an SMSF after a member dies (or loses mental capacity) is critical in determining the subsequent distribution of their super benefits.
In the Katz v Grossman case, the deceased’s Will provided that his estate assets, including around $1 million in his SMSF, were to pass equally to his son and daughter. However, following his death the SMSF was in the control of his daughter who paid the entire super death benefit to herself. The son took legal action, but the Court found his sister was legally within her rights.
If control of your SMSF passes to the wrong person – or someone who fails to follow your death benefit nomination – your plans for distribution of your death benefits may not be respected. This can occur even if you have a binding death benefit nomination (BDBN) in place.
What can go wrong
A detailed succession plan can help avoid many of the potential problems that could arise with your SMSF and super benefits following your death.
Without a succession plan, the SMSF may find it’s unable to appoint a replacement trustee – such the executor of your Will – to act in your place. If there is no ability to replace the trustee, normally the fund will need to be wound up.
The Superannuation Industry (Supervision) Act 1993 only provides a six-month grace period to restructure the trusteeship of an SMSF, with this time period commencing with the first payment of a death benefit. If there is no succession plan and the fund cannot be restructured before the deadline, its compliance may be called into question.
Binding nominations aren’t always a solution
Problems can also arise with your SMSF when it comes time to distribute your super death benefit.
Although having a BDBN in place is a normal part of an estate plan, it’s a common misconception that this type of nomination ensures your wishes will be followed or will be followed in a timely manner.
The case of Wooster v Morris showed the problems that can occur even with a valid BDBN. The deceased’s BDBN provided that his SMSF death benefit of almost $1 million be paid equally to his two daughters from a previous marriage. However, his second wife was left with control of his fund. The daughters were forced to spend years engaged in an expensive legal battle with the fund trustee before obtaining their inheritance.
In reality, the person who takes over as trustee and gains control of your SMSF is the most critical element in determining whether or not your estate plan is followed. It’s the replacement trustee who has control of the fund’s purse strings, so they are responsible for ensuring your super death benefit is distributed according to your nomination.
Without careful succession planning, the fund trustee may not want to – or be able to – follow your benefit nomination. In these situations, estate plans can go astray, with beneficiaries ending up in court or waiting years for their money.
Get your trust deed right
Under super law, an SMSF’s trust deed governs what the fund can do and how it can distribute a member’s death benefits. If the deed does not contain the necessary powers, the remaining trustees will be unable to execute your wishes, even if you have a valid BDBN in place.
SMSF succession plans should ensure the fund’s trust deed provides all the required powers to distribute your death benefits as intended. These normally include:
- Permitting an executor or LPR to be appointed in the place of a deceased trustee
- Identifying who has the power to appoint a new trustee when a member dies
- Permitting payment of a reversionary pension.
Reversionary pensions can be a useful tool in succession planning, as they provide trustees with considerable flexibility and can be used to stream pension money to several beneficiaries. Terms and nominated beneficiaries for a reversionary pension can also be ‘hard-wired’ into the SMSF’s trust deed to provide greater payment certainty.
Consider a corporate trustee
For many SMSFs, it’s sensible to consider introducing a sole purpose corporate trustee rather than individual trustees – particularly if the fund is multigenerational or intends to introduce additional members under the six-member rule.
Ensuring succession control is much easier if an SMSF has a corporate trustee, as a company does not die, but all trustee directors eventually pass away.
A corporate trustee also makes it easier to keep the SMSF functioning and fully compliant when trustee transitions occur. This structure can also remove uncertainty in relation to payment of death benefits as it is not a potential beneficiary and is more likely to promptly pay benefit nominations.
The decision-making rules for a corporate trustee are normally set out in the company’s constitution, removing some of the ambiguities arising about control of the SMSF. These rules can cover issues such as whether a majority or other voting threshold is required to a make decision, whether the threshold is based on member balance and whether an LPR has the casting vote.
10 tips for successful SMSF estate and succession planning
- Select the person you want to become your successor director and fully document their responsibilities.
- Ensure both your Will and enduring power of attorney (EPOA) nominate the person you want to take over. The EPOA should specifically cover your super benefits and SMSF.
- Ensure you have a valid non-lapsing BDBN in place so the fund trustee is required to pay your death benefits to your nominated beneficiary.
- Ensure your SMSF’s trust deed and other documentation place the right people in control of your fund and authorise your EPOA nominee to act.
- Provide your EPOA with the power to deal with potential conflicts or problems (such as making a new BDBN).
- Consider moving your SMSF to a corporate trustee structure to avoid control problems with family members, but check if remaining members will have the power to remove the corporate trustee after your death.
- Check the constitution of your corporate trustee to ensure its decision-making process is appropriate for your SMSF’s situation and membership.
- Discuss details of your succession plan with your intended trustee successor to ensure they are aware of your wishes in relation to your death benefits.
- Consider listing specific assets – rather than a percentage of your death benefit – in your BDBN or reversionary pension if you intend for an asset to pass to a particular beneficiary.
- Bring together all the relevant professional advisers and family members when drawing up a succession plan to ensure everyone understands your wishes and is prepared to act on them.