What follows are some of the essential planning strategies that members should undertake in order to achieve a smooth succession, and the legal framework surrounding the death of an SMSF member.
Corporate versus 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.
Alternatively, an SMSF can 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. Upon death, there would also be the task of contacting investment managers, banks and other stakeholders regarding the change of trustee, whereas 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, 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 an SMSF. 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 which play an important role in succession planning 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 the member’s death. The deed will also contain provisions that 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. Some 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.
We note 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, 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.
Benefit nominations
A binding death benefit nomination (BDBN) is a direction (or “nomination”) made by a superannuation fund member to the trustee of the fund. The nomination directs the trustee to pay death benefits to a particular individual. If validly made, the direction should be binding on the trustee. Effectively, it is a will for a superannuation fund.
A member is allowed to make a BDBN only 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 is an alternative sort of nomination. This is a pension set up with a specific nomination that provides that on the death of the pensioner, the pension continues to be paid (ie, it reverts) to another person who is usually their spouse or a child under 25 years of age.
Of the two forms of nomination, there has been some recent debate as to which of these will prevail.
Which nomination prevails?
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 binding only if it is to the trustee’s 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 regard to 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
An alternative to a BDBN is to have the SMSF deed ‘hard-wired’ so that the deed itself binds the trustee to pay death benefits in a certain way (sometimes called a ‘death benefit rule’). This can provide an SMSF member with greater certainty as to whom their death benefits are to be paid after their death.
For example, a husband could set up an SMSF to provide for his second spouse and incorporate into the actual trust deed that death benefits (such as a pension) are payable to that spouse upon his death.
Also, 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.
Tying it all together
SMSF succession planning involves a clear nomination as to whom death benefits of the member shall be paid. This should be supported with documentation such as 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 TR2011/D3. It also involves appropriate succession as to who will control the trustee of the SMSF. A corporate trustee will make this process a lot smoother.
It should be noted, however, that 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.
