Making sure the wishes of a deceased SMSF member are followed can be complicated. Daniel Butler details some strategies to make the process more painless.
There are many strategies put forward on how to provide smooth and effective succession for an SMSF.
Fortunately, while there is no one-size-fits-all solution, there are a number of simple and cost-effective strategies that can substantially bolster your position to set the foundations for SMSF succession.
It is important to obtain documents and advice from suppliers who have the appropriate expertise as the most appropriate strategy must have regard to the background circumstances of each client.
Your personal estate planning must also be consistent with your SMSF succession plans. Obtaining expert advice and implementing a tailored succession plan is the best way forward for smooth and effective succession, especially with the increased emphasis on technological development and commoditisation of the SMSF industry.
Sole purpose corporate trustee
We strongly recommend an SMSF has a sole purpose corporate trustee rather than individuals as this greatly enhances succession. The upfront cost of establishing the company generally results in long-term benefits that far outweigh the upfront cost. These are conveniently summarised in Annexure A on page 52.
Despite the numerous compelling reasons, outlined in Annexure A, around 74 per cent of SMSFs still have individual trustees. This is surprising considering the many long-term advantages from having a corporate trustee.
The introduction of the new administrative penalty regime in mid-2014 can now result in fines ranging from $850 to $10,200 for each offence. Importantly here, the penalties are imposed on a per head basis for individual trustees.
By contrast, the directors of a company are only jointly liable to one penalty per offence. Thus, if an SMSF loan is made to a member or related party, and there are two individual trustees, the minimum penalty is $20,400 compared to $10,200 for an SMSF with a corporate trustee.
Loans to members/related parties are consistently noted year after year by the Australian Taxation Office (ATO) as one of the main contraventions in the 15,000 to 18,000 auditor contravention reports lodged each year, meaning for many SMSFs it is not so much a question of not being subject to one of these penalties, but merely one of when.
Moreover, when you consider recent legal cases the merits of having a corporate trustee become very clear. In Katz v Grossman  NSWSC 934 a family relationship between two children (Linda and Daniel) was jeopardised as a result of Linda being admitted as a co-trustee on her mother’s (Evelin Katz) death to satisfy the trustee-member rules.
Linda used this power on her father’s (Ervin Katz) subsequent death to pay herself his around $1.2 million death benefit.
Ervin and Evelin were the original trustees/members of their SMSF. After Evelin’s death, Ervin appointed his daughter, Linda, as the other co-trustee.
Shortly after Ervin’s death, Linda appointed her husband (Peter Grossman) as co-trustee and refused to follow her late father’s non-binding nomination that entailed an equal sharing between her and her brother, Daniel.
This case could have easily been avoided if a corporate trustee had been appointed, with Ervin gifting an equal number of shares in the corporate trustee to each child via his will. In addition, Ervin could have left a binding death benefit nomination (BDBN) paying his death benefit to his deceased estate, that is, his executor as a legal personal representative (LPR).
With so many SMSFs with individual trustees currently managed by mums and dads with children who are waiting in line for succession, Katz v Grossman is a great war story to encourage families to commence their SMSF succession planning.
So in summary, a corporate trustee is an essential step in the process of SMSF succession planning.
Why is succession to control so important?
Many lawyers like the old saying that possession is nine-tenths of the law. This general expression reflects the fact that even if you do have legal rights, you may have to enforce these at great expense, time delay and uncertainty. In many legal battles, many give up soon after receiving a number of invoices from their lawyers unless they are seeing some tangible progress. Entering a Supreme Court typically involves a substantial outlay.
The recent decision of Wooster v Morris  VSC 594 is the most important decision ever regarding SMSF succession planning. Namely, what really matters is the identity of who controls the fund on loss of capacity or death.
Mr Morris (the deceased) had two adult daughters from a previous marriage (Mrs Wooster and Mrs Smoel, being the plaintiffs). He also had a second wife, Mrs Morris. The deceased and Mrs Morris were the members and trustees of the SMSF. The deceased made a BDBN in favour of his two daughters.
After his death, Mrs Morris appointed herself as the sole director/shareholder of a corporate trustee. She decided the BDBN (in favour of Mr Morris’s two daughters) was not binding and, as sole director of the corporate trustee, decided to pay herself the $924,509 death benefit.
The plaintiffs issued court proceedings seeking declarations that the BDBN was binding. A special referee found in favour of the plaintiffs, holding the BDBN binding and that the plaintiffs were entitled to be paid the death benefit plus interest. The parties agreed to be bound by the referee’s findings with the main lessons from this case being:
Lesson 1 – LPR does not automatically become a trustee
Wooster v Morris clearly dispels the myth that when a person dies their executors (LPRs) automatically become a trustee in the deceased’s place. Here the plaintiffs were the deceased’s executors, but they did not become trustees.
The identity of trustee upon death is determined by the SMSF deed. Unfortunately, there are very few SMSF deeds that appropriately distribute the power to appoint a trustee upon death or loss of capacity.
Lesson 2 – BDBNs are only a partial solution at best
There is a misconception that SMSF succession planning is handled by purely putting a BDBN in place, but Wooster v Morris clearly dispels this myth. In this case the deceased had made a BDBN, but the plaintiffs still had to spend years in legal battles to obtain any money.
While a BDBN can be important, it will not necessarily be complied with. However, there is a much greater opportunity for a BDBN to be effective if a successor can, in essence, ‘stand in the shoes’ of the deceased to ensure the control of the fund is not simply left to the surviving member(s).
Accordingly, while a BDBN can be an important tool in SMSF succession planning, the control of the fund is more crucial.
Lesson 3 – what really matters is who controls the fund
Wooster v Morris demonstrates that far more important than a BDBN is the identity of who controls the fund upon a member’s death or loss of capacity.
As stated above, this depends to a very large degree on what is contained in the SMSF deed. In Wooster v Morris, the trustee’s legal fees in defending the claim were $302,699 in one year as reflected in the fund’s 2013 accounts.
Thus, it is crucial SMSF members plan succession to their role to cover loss of capacity and death.
How to plan for control of an SMSF
A key planning element for covering risks on loss of capacity and death is to have a trusted person stand in your shoes as your successor director. This requires planning in advance to ensure the smooth transition.
To ensure this occurs, among other things, the following needs to be undertaken:
- Select the person who is to become your successor director. Ensure they are willing to act and there are sufficient instructions/wishes documented for them on what needs to be done.
- Make sure the person’s will and enduring power of attorney (EPOA) nominate the appropriate person they wish to stand in their shoes. Basically an attorney under an EPOA while a person is alive and the executor of a deceased person’s will is their LPR who can act for them in legal and financial matters.
- Check the SMSF deed and the constitution to the corporate trustee to see what steps and documents need completing to appoint that person. Typically, in addition to that person consenting in writing, they may need to satisfy some other hurdles, and better to discover these now otherwise it may be too late.
- It is important to note if someone has more than one LPR, and they wish to nominate more than one, that the voting and decision provisions of the relevant SMSF deed and constitution should be carefully examined.
- This is because unless there are special provisions to equalise voting, each attorney/executor may have an equal control. However, the LPR who is standing in for the incapacitated/deceased member should only assume this (one) person’s voting capacity. Thus, if there are two attorneys/executors nominated to act jointly, the joint LPRs should only have the equivalent of one vote.
- Note that in the case of a corporate trustee the decision-making depends in the first instance on what’s in the constitution and not what is in the SMSF deed even though many deeds seek to cover this. In most constitutions, directors usually have an equal vote regardless of the number of shares they hold or their account balance in the fund.
- The casting or deciding vote is generally given to the chairperson of the meeting. In a mum-and-dad company this is generally inappropriate and such constitutions should be avoided.
- Given that most mum-and-dad companies do not comply with formalities, there is generally no practical mechanism to work through potential deadlocks. One solution could be, for instance, if there is a deadlock the person with the most voting shares can have a casting vote. Again, the shares on issue or the constitution could be tailored to provide such a mechanism.
- In so checking the deed/constitution, it is important to check what voting mechanism applies. This is important as the constitution and/or the SMSF deed may need amending if it is not appropriate.
- For example, if the relevant member has the lion’s share of the fund, and voting is based on the number of directors, then this could give rise to an imbalance if the member with the greater fund balance wants control over the company’s decisions.
- One mechanism to work through this type of deadlock would be to give members with the greater fund balance the majority of voting shares and ensuring the constitution reflects this voting power in director and shareholder decisions. If the constitution is not appropriate, then it should be tailored accordingly.
- There are numerous advantages to using a corporate trustee compared to individuals as trustees. However, ultimately a well-designed SMSF deed is also required. In many SMSF deeds, the majority of members hire and fire the trustee. Under this type of deed, the company could be removed by a majority of members, which does not reflect any member’s account balance in the fund.
- Thus it is crucial to check the mechanism for changing a trustee to ensure a smooth and planned succession occurs.
- It is also important to consider who will be the successor shareholder as the shareholders generally hire and fire the directors of a company. Thus, as you can readily see from the above analysis, SMSF succession involves a review of both the SMSF deed and the constitution, and these two need to be consistent in design and the implementation of the succession strategy to overcome any conflicts between them arising.
On the death of a member, the trustee is responsible for administering the fund, including where there is a BDBN, the decision as to how the death benefit will be paid out.
If the deceased member did not make a BDBN, this decision is generally left to the trustee’s discretion. Accordingly, where a second spouse is left running the fund, they will have discretion as to how to manage the fund and pay out any death benefit.
Annexure A: Corporate versus individual trustees
Estate planning flexibility
A company offers greater flexibility for estate planning, as the trustee does not change as a result of the death of a member.
The administrative penalty regime that commences from
1 July 2014 typically only applies to a company once for each contravention.
Sole member SMSF
You can have an SMSF where one individual is both the sole member and the sole director.
On the admission or cessation of membership, that person becomes or ceases to be a director of the company. Thus, the title to all assets remains in the company’s name.
A company has an indefinite lifespan; in other words, it cannot die. A company makes succession to control more certain on death or incapacity.
Greater asset protection
As companies have limited liability, they provide greater protection where a party sues the trustee for damages.
Extra administration and costs
The death of a member gives rise to considerable administrative work and costs at an inopportune time.
A penalty can be imposed from 1 July 2014 on each individual trustee for each contravention. Thus, having two individual trustees can double the administrative penalty that would otherwise apply to a corporate trustee.
Sole member SMSF
A sole member SMSF must have two individual trustees.
Extra and costly paperwork
The admission or cessation of a member requires that person to become or cease to be an individual trustee. As trust assets must be held in all trustees’ names, the title to all assets to be transferred to the new trustees.
Ceases upon death
Timely action must be taken on death to ensure the trustee/member rules are satisfied. (SMSF rules do not allow a sole individual trustee/member SMSF.)
Less asset protection
If an individual trustee suffers any liability, the trustee’s personal assets are also exposed.