Daniel Butler and William Fettes explain the reasons why SMSF succession planning is critical and the steps that can enable a sound exit strategy.
Succession planning is a critically important aspect of successfully operating an SMSF, although 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 and other succession arrangements appropriate for their individual circumstances.
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 have control of the SMSF to ensure superannuation benefits are paid as intended.
An optimal SMSF succession plan should achieve these goals in a timely fashion, with minimal uncertainty and in as tax-efficient a manner as possible. However, it should also be recognised trade-offs may need to be contemplated 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 that 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 (that is, who will have control of the company) upon loss of capacity or death of directors/members,
- ensure the SMSF can continue to meet the definition of an SMSF under section 17A of the Superannuation Industry (Supervision) (SIS) Act 1993,
- 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 binding death benefit nomination (BDBN), 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
With the passage of time there is a significant risk 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 enduring power of attorney (EPOA) in place can help overcome this problem as an EPOA appointment is enduring, enabling a trusted person (that is, 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 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 a member of an SMSF without an EPOA is courting disaster.
Naturally, given the important responsibilities of the position, the member must trust their nominated 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 to whether the scope of the appointment should be general in nature (that is, a general financial power) or limited to the SMSF or to the trustee of the SMSF. 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 from 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 trustee or director of the 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 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 the SIS Act for the purposes of the trustee-member rules in section 17A. However, the attorney must still be appointed in the first place.
The appointment mechanism that 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 the 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.
The recent case of Ioppolo v Conti  WASCA 45 illustrates the point that the control of an SMSF upon death should not be left to chance.
Mrs Francesca Conti and Mr Augusto Conti were individual trustees and members of an SMSF. Francesca had a number of children, including two daughters who were named as executors in her will.
The SMSF deed provided that unless a BDBN was made, death benefits were to be paid at the trustee’s absolute discretion.
Francesca died without a valid BDBN and Augusto was left as the sole trustee. Augusto appointed his sole director/shareholder company as the new trustee. As director of the trustee, he then resolved to pay all of Francesca’s benefits to himself.
As executors of her estate, Francesca’s two daughters commenced legal action, losing both at the West Australian Supreme Court at first instance and in the Court of Appeal.
In both cases (see also Ioppolo v Conti  WASC 389) the two daughters argued that Francesca’s LPR must be appointed as trustee of the fund in compliance with section 17A of the SIS Act.
However, this argument failed. Chief Justice Wayne Martin noted the definition of an SMSF in section 17A of the SIS Act would have allowed the appointment of the LPRs, however, it did not require it.
Ioppolo v Conti highlights the fact that a deceased trustee’s LPR (that is, executor) does not automatically step into the role of trustee of an SMSF member on their 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.
By ensuring 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 appointment allows a director to nominate a successor to automatically step into their role as director immediately upon their loss of capacity or death.
The successor director strategy is designed to work in conjunction with a member’s overall estate plan to enable an attorney appointed under an EPOA or an executor of a deceased member to be 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.
Tax considerations on death
The tax profile of death benefits is also a relevant consideration in succession planning.
Where a death benefit is paid to a tax dependant (that is, a death benefit dependant under section 302-195 of the Income Tax Assessment Act 1997), the dependant will receive the benefit tax-free. A death benefit dependant means any of the following:
- the deceased person’s spouse or former spouse,
- the deceased person’s child, aged under 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 they died.
Note, this limb of the definition imports the common law meaning of dependent, which is accepted to include financial dependency.
Accordingly, adult independent children do not generally qualify as death benefit dependants. Thus, any death benefit payment they receive (usually when there is no surviving spouse) will be subject to a tax rate of 15 per cent plus applicable levies to the extent that the benefit comprises the taxable component.
When you consider the average SMSF holds over $1 million in assets, the tax exposure of benefit payments made to adult independent children is likely to be significant.
Planning an exit strategy
Given the impact of this effective death tax, one option is to withdraw member benefits prior to death, assuming a relevant condition of release has been met. However, relying on the usual method of lump sum benefit payment to effect this withdrawal may be a precarious strategy, given none of us can foresee the exact hour or minute of our death. After all, it must be borne in mind a premature withdrawal would entail benefits being exposed to the normal tax environment outside of superannuation, and it may not be possible to implement a timely lump sum withdrawal due to loss of capacity or rapidly deteriorating health.
We are aware that in practice some people have relied on a spouse or close family member, trusted friend or adviser to withdraw their member benefit pursuant to an EPOA. This approach has been adopted because it has been widely considered an attorney is empowered to withdraw a person’s super while they are still alive.
However, this thinking is flawed for a variety of reasons:
- the legislation governing EPOAs differs between each state and territory and generally does not empower an attorney to deal with a person’s interest under an SMSF, which is a special form of trust,
- without an SMSF deed expressly authorising an attorney under an EPOA to act for a member, the EPOA might not be effective, and
- an attorney withdrawing a member’s benefit may not be acting in the donor/principal’s best interests if others benefit from the withdrawal.
For these reasons it is important to implement a deed that expressly authorises the appointment of a representative who is specifically empowered to implement a withdrawal of member benefits when the member is close to death, if this is deemed to be necessary and appropriate in the circumstances.
This solution avoids the problems identified above in respect of EPOAs. Thus, a member can appoint a representative to act on their behalf and withdraw their member benefit while they are still alive, but do not have long to live, including in the event of the member’s loss of capacity.