SMSF trustees are likely to have to deal with their own incapacity to run their own retirement savings fund. Zoe Paterson examines the issue and explores some measures that might be deployed to mitigate these circumstances.
Ageing is inevitable. Unfortunately, the older we get, the higher the risk we will lose the capacity to manage our financial affairs.
Research by aged-care provider Benetas found 6 per cent of Australian community members aged over 65 who live in their own home are frail, while a further 38 per cent are considered ‘pre-frail’, or at risk of soon becoming frail.
Added to that, almost one in 10 people aged over 65 has dementia, rising to three in 10 people aged over 85, according to Dementia Australia.
These figures highlight how important it is to be financially prepared for a range of future possibilities. The stakes are high, especially for people who have an SMSF.
ATO statistics show 35.5 per cent of SMSF members are aged 65 and over. A further 26.9 per cent are aged 55 to 65.
Over the coming decades many trustees may find running an SMSF becomes too much of a burden to continue.
What to do
Aged Care Steps director Louise Biti says SMSF trustees should have plans in place right from the outset to address what will happen if a member loses their capacity to run the fund.
Biti recommends getting family members together to discuss their preferred outcomes.
“It gives the person the opportunity to express their wishes, thoughts and fears, and it gives other family members that opportunity as well,” she says.
Unfortunately, many people put off taking action until it’s too late.
“The problem is that with frailty no one wants to think about it. They don’t want to talk to family about it or prepare for it,” she says.
“People need to acknowledge that frailty is a normal part of getting older and as they do age they won’t be able to make all the financial or life decisions that they used to make.”
“People need to acknowledge that frailty is a normal part of getting older and as they do age they won’t be able to make all the financial or life decisions that they used to make.” Louise Biti,
Aged Care Steps
Even before people become infirm, they may begin to feel they are no longer making the best financial decisions. Unexpected accidents and medical issues that prevent a person from being able to run their fund can strike at any age.
Risks of not having a plan
Regulations require each SMSF member to be a trustee of the fund or director of the corporate trustee, depending on the fund’s structure. Each person must have the mental capacity and ability to perform the role.
“If you can’t, it’s absolutely critical that someone else can take that on,” Biti says.
An SMSF has six months to appoint a successor after a trustee has lost capacity before it is considered non-complying, which brings serious tax consequences. If one of the trustees is unable to make decisions, the fund may become locked up, meaning it is unable to pay benefits or sell assets.
Colonial First State executive manager Craig Day warns without appropriate plans in place, the remaining trustees may have to go through a lengthy process involving state government tribunals, or the courts, to get a decision about who will control the fund.
“A little bit of pre-planning goes an awfully long way in this area,” Day says.
Trustees should consider their wishes for the fund in the event they can no longer make decisions.
“Would you want the fund to continue? Would you want it to be wound up? If it is to continue, who would you want to control the fund?” Day says.
The majority of SMSFs are run by married or de facto couples and the most logical solution is usually for the surviving spouse to continue to control the fund. But trustees should have a back-up plan.
Whoever is to take over must be both trustworthy and capable themselves of taking on the role.
Adult children may be suitable candidates, but what if they lack the skills and inclination to run an SMSF? What if they are currently bankrupt or have previously been disqualified from acting as a trustee?
“What we’re asking someone to do is come in and take legal responsibility for this fund in terms of complying with the legal and regulatory obligations, as well as actually making decisions about the fund’s investments and the payment of benefits out of the fund,” Day says.
He emphasises it’s a big job to ask someone to take on and to ensure the process runs as smoothly as possible, trustees need to have the right documents in place.
Enduring power of attorney
DBA Lawyers director Daniel Butler recommends the appointment of an enduring power of attorney (EPOA) is one of the first steps an SMSF trustee should take. An EPOA acts on behalf of the trustee if that person loses the capacity to make financial decisions and run their fund.
The EPOA must be appointed before the trustee loses capacity. The arrangement can be written to begin immediately or to start only after a certain trigger event.
But having an EPOA alone is not sufficient for people running an SMSF.
“The enduring power of attorney itself is quite ineffective in respect of the super fund,” Butler says.
“It does not give them [the agent appointed by the EPOA] the right over the trust assets. It’s the trust deed that guides who has the say.”
In an SMSF with an individual trustee structure, the trust deed must be carefully worded to allow an incapacitated trustee to be removed and replaced with a representative acting under an EPOA.
There are ways to do this, but Butler says it’s easier if the SMSF has a corporate trustee structure instead.
In funds with a corporate trustee structure, the company constitution can be written to allow a director of the SMSF trustee company to be automatically removed upon satisfying the definition of an incapacity.
“The other option in there is that the shareholders can potentially vote to remove that person,” Butler explains.
“Where you have a two-member fund with mum and dad owning one share each, if dad holds an enduring power of attorney in respect of his spouse, then he could exercise the shareholding vote to remove her as a director of the company.”
While there is some reporting to do, replacing a director is administratively easier than replacing a trustee, according to Butler.
Additionally, replacing a director has no effect on the fund’s assets. In contrast, the ATO usually requires SMSFs with an individual trustee structure to list each trustee as an owner of the assets in the fund and this must be updated if trustees are changed.
“Let’s say you’ve got an SMSF with a property and a portfolio of 30 shares. You are going to have to go through the process of removing the previous trustee and adding in the new trustee to the title deeds for the share registry ownership and that can be quite burdensome in time and cost,” Butler notes.
ATO figures show 57 per cent of SMSFs overall have a corporate trustee. Further, the data indicates this type of structure is the most popular with recently established SMSFs with 80 per cent of SMSFs set up since 2015 having a corporate trustee.
Do it right
Basic EPOA documents and SMSF trust deeds are available online, but Butler advises trustees to seek specialist legal advice.
Each document – the EPOA, the SMSF trust deed and the SMSF constitution – must be carefully worded to ensure they all line up in assigning power and access to the appointed person when the time comes.
There are many details that must be documented, such as whether the EPOA would be appointed as a replacement or alternative director under the constitution.
Documentation needs to create a clear line of control and not have conflicting clauses that lead to uncertainty or mean they are not operational.
“These are very technical documents that could be of little effect and could, in fact, be dangerous if prepared incorrectly,” Butler says.
Financial advisers who do this work jeopardise their professional indemnity cover as they are doing legal work for which they are unqualified, and if the documents are challenged, they undermine their clients’ best interests, he stresses.
“The risk for advisers is very high. We see advisers going into it without an experienced lawyer. From an individual trustee member perspective, they should be guarded with that. These people who are a one-stop shop and do everything may not do it properly.”
Armed with a professionally prepared EPOA that aligns with the SMSF trust deed and company constitution, the appointed person could continue to operate the fund on behalf of the trustee they represent.
This option offers the greatest flexibility, but it is not always considered the most appropriate course of action.
If the financial affairs in the SMSF are relatively straightforward, the EPOA might consider winding up the fund and either rolling the money into a public offer fund or removing it from superannuation.
“For a lot of people in pension phase, moving to a retail product is likely to be the simplest and easiest thing to do,” Australian Executor Trustees (AET) senior technical services manager Julie Steed says.
However, money can only be withdrawn from the fund if the member has reached preservation age. Moving into a retail or industry fund may not be appropriate if the SMSF is still in accumulation phase or holds unusual assets that the members want to retain.
“If you have incapacity of someone who is under preservation age and has not moved into pension phase, moving to a retail fund is a capital gains tax (CGT) event,” Steed points out.
“That can be a significant tax event if there are gains, and if you’ve got losses, you can’t move them forward into a retail fund.”
Even SMSFs that have recently moved into pension phase may get caught as the fund has to have made several pension payments before it qualifies as being in pension phase and no longer has to pay CGT.
Appoint a professional trustee
In a some cases a small Australian Prudential Regulation Authority (APRA)-regulated fund may be a suitable alternative for people who wish to relinquish their SMSF duties but retain a private fund.
Steed says some SMSF members in their mid-70s who have seen friends and family members dealing with dementia are proactively seeking out small APRA funds (SAF).
“We are seeing it more and more. Usually the trigger event is a family member or friend who is losing capacity,” she says.
SAFs suit investors with large account balances and assets that would not be accepted by a retail fund.
“At over $2.5 million, small APRA funds get very cost-effective,” Steed says, adding low-balance funds are actively discouraged by the fee structures.
There are restrictions on the types of assets that can be held in an SAF compared with an SMSF, making it a less flexible solution, but it does allow a wider range of assets than a retail or industry fund would, such as commercial property leased back to a family business.
Process to transfer
To convert an SMSF into an SAF, the trustees would have to retire from their positions and appoint a professional in their place, Steed explains.
In theory, all that involves is filling in a four-page document. “In practice, it’s never that simple. It usually takes months, not weeks or days, to move. For a lot of people who have lost capacity, even if they have got an enduring power in place, often it’s the last thing that gets dealt with. It’s the day-to-day things that take priority,” Steed notes.
According to Steed, preparing for the transfer can be time-consuming. Accounts and financial returns have to be brought up to date, but often when a key member of the fund has lost capacity, more than a year’s worth are outstanding.
If the SMSF has good administration systems, pension payments will have continued automatically, but sometimes the pension payments have been forgotten so there can be some unexpected income tax to pay.
Unravelling these issues can become complicated and expensive and AET has a forensic accounting team to deal with these tasks.
Steed notes the same complexities will arise even if the SMSF is being wound up.
This underscores the importance of making an early plan for who will take over and putting the right paperwork in place to allow them to do the job properly as soon as they need to.