Overview
Succession planning in an SMSF should be an important consideration for all SMSF members. With the right planning, a smooth succession can be achieved with administrative ease, minimal compliance hassles, tax effectiveness and certainty upon the death of a member.
But what is succession planning? How does it differ from estate planning?
Succession planning is about control and estate planning is about distribution. Good succession planning is the right assets to the right person at the right time.
Estate planning is a sub-set of succession planning.
Succession planning is concerned with who replaces you in the driver’s seat, when you cannot drive anymore.
Estate planning is concerned with who gets the assets, and how they get them.
The super laws have changed markedly over the last 18 years or so, with Simpler Super in 2007 and the more recent changes effective 2017 have made super more about the current member than a wealth transfer vehicle.
Sadly, the Division 296 Tax prevarication will make things even more complex, but that is a discussion for another day.
But this also makes succession planning more important than ever, to ensure administrative ease, certainty, compliance with the rules (such as Transfer Balance Account reporting obligations) and importantly all this occurring in the most tax effective manner possible.
Trustee of the fund after death
The first things to note is when a member dies, they also cease to be a trustee (individual or director of a corporate trustee).
This may mean the fund fails to satisfy the definition of an SMSF.
But the super laws – the SIS Act – gives us 6 months to restructure the fund, so it again satisfies the definition of an SMSF.
With a simple fund with 2 members, the surviving spouse may look to appoint the Legal Personal Representative (LPR) – the executor of the deceased – as trustee in their stead.
This may be themselves, or often it may be adult children to assist with the running of the fund.
Does this mean the fund will again satisfy the definition of an SMSF? Mum continuing as trustee in her own right, and, say, Mum and her two adult children as LPR for Dad?
Yes. The fund will satisfy the definition of an SMSF if Mum and the executors of Dad’s estate are trustees of the fund, but only for a period of 6 months after Dad’s benefit commences to be paid.
After that time, the trusteeship will need to be permanently restructured.
Super is not an estate asset
Remember, however, super is not an estate asset, so the LPR being appointed as trustee in place of the deceased member is not an automatic appointment.
Super exists in its own world. Your Executor is only appointed trustee if the fund’s governing rules – the trust deed – allows for it.
In many cases there may not be an issue with this, but in blended family situations, it can be a major issue. There is much case law regarding control of SMSFs, such as Ioppolo & Hesford v Conti & Anor [2013] WASC 389, where the 4 daughters from the first marriage challenged the payment of a death benefit and wanted to be appointed co-trustee of the fund as executors of the deceased (unfortunately for them the fund’s trust deed did not expressly allow for this).
The importance of the fund’s trust deed
And one cannot underestimate the importance of the fund’s trust deed. It is this document that tells us what your fund can and cannot do.
The fund’s trust deed will not just tell us if the executor can be appointed in the stead of a deceased trustee/member; it also tells us who has the power to appoint a new trustee upon a member’s death.
This last point is important, as single member funds with individual trustees involve a little more thought than funds with corporate trustees.
Why is that?
One issue is the requirement for asset to be registered in the names of the individual trustees. This can be a time-consuming process, so you only want to do it once!
And of equal importance to choosing who will be individual co-trustee after one has passed away is clarity around whether a majority or other voting threshold is required for member decisions.
What if the LPR and the existing trustee disagree on who is going to be appointed as new trustee and/or member?
This becomes even more crucial as we now have 6 member funds – if another generation comes into the fund – who has control?
Is control determined by member balance? So, if the LPR represents a deceased member, who had the larger balance in the fund, does that mean the LPR has more decision-making power than the continuing member or members?
Does the LPR have a casting vote?
Notwithstanding that fact, we would always advocate for a corporate trustee, even if it involves a restructure while you are both alive.
Administration, especially when it comes to succession planning, is so much easier and cleaner with a company as trustee.
On this core, one needs to be careful with shares in the trustee company. On the death of a director/shareholder, who inherits the shares? Shareholders can remove directors, so the deceased’s Will could say the LPR inherits the deceased member’s shareholding in the corporate trustee.
But one needs to be careful as to how this is structured.
Example – LPR becomes director
Andrea and Mark are directors of their SMSF corporate trustee, with 3 shares each. They have 2 children, Molly, and Jess, who are their LPR.
The trust deed appoints the LPR as director of the corporate trustee on death of the member.
The Company Constitution appoints the LPR as Director in place of the deceased.
But Andrea’s Will says all her shares in the company are to go to Mark.
On Andrea’s death, Mark is then the sole shareholder, with Molly and Jess as co-directors.
In this scenario, Mark would have greater control over the fund than Molly and Jess, which may be appropriate if he has the majority member benefit.
Succession planning is about who controls the fund.
Binding Death Benefit Nominations
A Binding Death Benefit Nomination (BDBN) is a direction from member to trustee to pay their benefit a certain way on death.
It is absolute – the trustee must follow the member’s direction. However, it must be valid – otherwise it is invalid.
Most large super funds only provide 3-year lapsing BDBNs. However, an SMSF can have a non-lapsing BDBN if the Trust Deed allows.
SMSFs can have a cascading BDBN, which directs the trustee to pay the benefit to a subsequent beneficiary if the primary beneficiary passes away.
But again, the governing rules must allow for this.
BDBNs are a part of the succession planning solution, but who controls the fund is of critical importance!
Why is control of critical importance?
Once again, case law shows us what can go wrong. In Wooster v Morris [2013] VSC 594, the deceased completed a BDBN in favour of 2 daughters from first marriage. The surviving individual trustee (second Wife) disregarded the BDBN, which a court later found to be valid.
But the plaintiffs had to wait 3 ½ years to get their money!
A well-constructed BDBN, along with a corporate trustee, trust deed and other documentation that ensures the right people are in control of the fund, are cornerstones of effective succession planning.
Reversionary pensions
This is another piece of the puzzle. A reversionary pension is one where documentation shows the income stream is to ‘revert’ to a subsequent beneficiary (or beneficiaries) on the demise of the primary pensioner.
This means the pension does not cease on the death of the primary pensioner – it continues seamlessly and can be paid to multiple beneficiaries, such as minor children.
The ability of the fund to pay a reversionary pension can be ‘hard-wired’ into the Trust Deed, which may be beneficial on several levels, such as making a non-reversionary pension reversionary without having to stop and restart (which may impact Centrelink or other grandfathering provisions).
Reversionary pensions provide certainty as to who gets your death benefit.
Combined with a BDBN, strategies can be implemented that stream various benefits to different beneficiaries to maximise planning outcomes.
This last point is important; each pension account is a separate superannuation interest, whilst an accumulation account is only ever one superannuation interest. The combination of reversionary pension and BDBN can mean the right person receives the right benefit with minimal fuss and, importantly, minimal tax.
BDBN versus reversionary pension – which one takes precedent?
Whilst the two should be used to complement each other, we are often asked which takes precedent? If a client has a reversionary pension that stipulates a spouse is to receive the benefit, but a BDBN that states the same benefit is to go to the deceased’s estate, which one wins?
Remember a BDBN is a direction from the member to the trustee instructing how the trustee should pay the member’s benefit if they die. A BDBN is binding on the trustee of the fund.
However, a reversionary pension does not cease on death – it seamlessly continues to the reversionary pension recipient. A reversionary pension is akin to a contractual obligation.
Therefore, in most instances, a reversionary pension trumps a BDBN.
But it often depends on the fund’s trust deed and other documentation.
Bringing it all together
Below is a simple Case Study that brings the salient points together. It is by no means exhaustive but illustrates how the concepts work in unison.
Case Study
Mark, 68, has $1m in his fund. He is the only member. His benefit is in accumulation mode.
He is married to Selina. They are both individual trustees of the SMSF.
Mark has a child from a previous marriage, Neil. Neil is an independent adult working in IT.
Neil is Mark’s executor. Upon his demise Mark would like an income stream to be payable to Selina. He would also like his adult son, Neil to receive a lump sum from the fund.
How could he structure his benefit, so this is achieved?
Subject to the fund’s governing rules, Mark could commence 2 pensions worth $500,000 each. Selina could be named as the reversionary recipient of one of the pensions. The other pension could be non-reversionary.
Mark could also have a BDBN that nominates his son Neil as the recipient of his benefit.
This could encompass the non-reversionary pension, as this pension would cease on his death and form his accumulation benefit.
Therefore, the BDBN would only encompass the accumulation interest, not the pension interest.
A corporate trustee could also be established. The fund’s trust deed and Company Constitution could allow the LPR to become trustee in Mark’s place.
Therefore, both Selina and Neil could become director/shareholder. Selina would not ‘control’ the fund.
The non-reversionary pension would cease and be paid as a death benefit lump sum to Neil.
However, the reversionary pension would continue to Selina.
Once the death benefit is lump sum is paid out, Neil could resign as director. This would only involve notifying the Australian Securities and Investments Commission (ASIC) that a director has been removed (Form 484). There would be no need to re-register the assets into new names, as would be the case if there was the death of an individual trustee.
He could also cease being a shareholder, meaning Selina would then be the sole director and shareholder of the corporate trustee.
But Mark needs to ensure the pension is reversionary. The fund’s governing rules – including any pension documentation – is key in this area.
If both pensions cease on death, they will form the accumulation interest, which would then be encompassed by the BDBN.
And this says the benefit will go to Neil.
Mark also needs to ensure the control of the fund is in the right hands.
Possession is nine-tenths of the law!
Conclusion
Effective SMSF succession planning involves the following:
• A clear nomination as to whom death benefits of the member shall be paid. This should be supported with documentation such as reversionary pension documents and a BDBN. In may be beneficial to have these elements hard-wired into the SMSF’s trust deed
• Appropriate directions via the deed, Company Constitution, and other contemporaneous documentation as to who controls the trustee of the SMSF.
An SMSF only forms part of the member’s overall succession planning. It is important that Wills, Enduring Powers of Attorney, and any other estate planning documentation (such as testamentary trusts) align ensuring the right people, at the right time, receive the right benefit, paying as little tax as possible.
What does Neo Super provide?
We are an innovative end-to-end SMSF service provider specialising in:
• SMSF administration and compliance
• Documentation services, including fund establishment, borrowing arrangements and pension documentation
• White label documentation and services for Intermediaries such as accountants and financial planners
• SMSF technical support, education, and training.
Further Information
For other service requirements, please contact our office at neo@neo-super.com.au or 1300 083 428.
