SMSF succession is about who will receive which of your SMSF assets how and when once you are no more. It is an important part of any SMSF lifecyle.
How does SMSF succession work? In this episode Daniel Butler of DBA Lawyers in Melbourne gives a helpful overview and shares quite a few war stories. Here is what we learned.
Right Assets to the Right Person at the Right Time
For SMSF succession to work according to plan you need the right assets to go to the right person at the right time.
There is an old saying that possession is 9/10ths of the law. This is still true. Even if you have the legal rights, you still have to enforce these. And that costs time and money and comes with uncertainties.
People often give up after receiving a couple of invoices from their lawyers unless they can see some tangible progress. Going all the way to the Supreme Court involves a substantial outlay.
Wooster v Morris
Wooster v Morris is one of the most important decisions around SMSF succession planning. It shows that what really matters is who controls the fund on loss of capacity or death.
Mr Morris had two adult daughters from a previous marriage. They are Mrs Wooster and Mrs Smoel and they were the plaintiffs in this case.
He also had a second wife, Mrs Morris. And they together – Mr and Mrs Morris – had an SMSF with a corporate trustee.
Mr Morris made a binding death benefit nomination (BDBN) in favour of his two daughters and made his daughters the executors of his will And this is where the trouble starts because when Mr Morris died, Mrs Morries held the purse strings to the SMSF but was to receive nothing. She obviously didn’t like that.
And so after Mr Morris’ death, Mrs Morris appointed herself as the sole director/shareholder of the corporate trustee. She declared the BDBN (in favour of Mr Morris’ two daughters) as not binding and, as sole director of the corporate trustee, paid herself the $924,509 death benefit.
Even though the daughters were the executors of Mr Morris’ will, they had no direct control of the SMSF. Mrs Morris did.
But the daughters fought back. They issued court proceedings seeking declarations that the BDBN was binding. And won in a ‘special referee’ mediation process that all parties agreed to be bound by.
So the daughters now had an established legal right to the death benefit. But Mrs Morris still wasn’t forthcoming with the cash. The daughters had to fight for every penny and in the end received very little. The trustee’s legal fees for 2013 alone were $302,699, all charged to the fund.
There are three lessons to learn from this case.
Lesson # 1
It is the trustee of your SMSF who controls your SMSF assets upon your death. Not your LPR.
When you die, somebody will step into your shoes and act as your legal personal representative (LPR). They become the trustee of your estate.
But your estate does not include your SMSF. The SMSF is separate to your estate and lives in a world of its own. So your legal personal representative – your executor if you have a will – has no control over your SMSF. Only your SMSF’s trustee does. And it is the SMSF deed that determines the SMSF trustee. Not the will.
Wooster v Morris made this painstakingly clear. Ioppolo & Hesford v Conti was another case. The deceased member’s two executor children were unsuccessful in their case against their mother’s second spouse to be appointed as SMSF trustees following their mother’s death.
Unfortunately, these two cases are not the exception. There are very few SMSF deeds out there that appropriately distribute power to appoint a trustee on death or loss of capacity. And many cases involve a second spouse and children from a previous marriage, but not always.
Lesson # 2
A binding death benefit nomination is only part of the solution, if at all.
A BDBN can be an important tool in SMSF succession planning. But control of the fund is more important. A BDBN might be effective but if the person in control of the SMSF funds chooses not to comply, the plaintiffs will spend years in legal battles trying to actually obtain the money. And by that stage most of it is probably gone.
Issues usually arise when the beneficiaries of a BDBN are not the ones left in control of the fund after a member dies. If the BDBN is in favour of the surviving spouse and the surviving spouse is the only other member of the fund, then all is usually well.
A BDBN is most effective if the beneficiaries of the BDBN have some form of control of the fund and the fund is not simply left to the surviving member. Unless of course the surviving member is a beneficiary of the BDBN.
When the BDBN favours other parties that are not part of the SMSF, all depends on the goodwill of the surviving member in the SMSF. And that goodwill is often not there to honour the BDBN. Wooster v Morris is just one sad example.
Lesson # 3
Control of the fund is all that matters.
Who controls the fund on a member’s death or loss of capacity is far more important than a BDBN. And who controls the fund depends to a very large degree on the SMSF deed.
A successful succession requires planning. For your wishes to be followed, you need a trusted person “stand in your shoes” as your successor director. And that requires planning. For this to happen you need to do 10 things.
Select the person who is to become your successor director. Ensure that they are willing to act on your behalf. And that there are sufficient instructions so they know what to do.
Ensure that your will and enduring power of attorney (EPoA) nominate the appropriate person that you wish to stand in your shoes. The difference between power of attorney and enduring power of attorney is that the EPoA still applies even if you lose mental capacity.
Make sure that the EPoA has express power to deal with superannuation. And includes the power to make a new BDBN or revise an existing BDBN that they are able to benefit from.
Review the SMSF deed and corporate trustee’s constitution to understand what is required to appoint a successor director. The person usually needs to consent in writing. But they may need to satisfy some additional condition. It is better to discover these now. Otherwise, it may be too late.
SMSFR 2010/2 confirms that a member can nominate more than one LPR to stand in their shoes as a director. If you wish to nominate more than one LPR, you must carefully examine the voting and decision provisions of the relevant SMSF deed and constitution. This is important because, unless there are special provisions to equalise voting, each LPR may have equal control.
In the case of a corporate trustee, the decision-making depends in the first instance on what is in the constitution nd not what is in the SMSF deed despite many deeds seeking to cover this. So don’t forget the constitution in all this.
Will the number of directors, member account balances, the number of shares held in the corporate trustee, or some other method determine voting power? It is important that the corporate trustee’s constitution spells this out to avoid future disputes.
In many SMSF deeds, a majority of members can hire or fire a trustee. And this majority often doesn’t reflect any member’s account balance in the fund. So it is crucial that you check the mechanism for changing a trustee to ensure that a smooth and planned succession occurs. If you neglect this point, your nominated successor director could be voted out through a ‘majority’ vote.
Consider who the successor shareholder will be. The shareholders generally hire and fire the directors of a company.
If there is more than one LPR, your nomination should specify who has first go or whether they are to act jointly or jointly and severally.
Binding Death Benefit Nomination
On the death of a member, the trustee is responsible for administering the fund. Where there is a BDBN, this responsibility includes paying out the death benefit accordingly. If the deceased member did not make a BDBN, this decision is generally left to the trustee’s discretion. Accordingly, in the case of as second spouse who is left running the fund, they will have discretion as to how to manage the fund and pay out any death benefit.
So your will doesn’t cover your SMSF succession. A binding death benefit nominations is definitely not all it takes. And a piece meal solution will not work well.
SMSF succession requires a holistic approach where the will, power of attorney, trust deed, BDBNs and reversionary pensions all need to work hand in hand.
All this is just our brief take on the issue, but please listen to the episode above. Daniel Butler explains all this in a much better way than we ever could.
Disclaimer: Tax Talks does not provide financial or tax advice. This applies to these show notes as well as the actual podcast interview. All information on Tax Talks is provided for entertainment purposes only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 22 May 2019