SUPERANNUATION IS a complex and chronically under-addressed part of the estate planning process. While the rate of SMSF establishment is steadily increasing, the number of SMSF members organising their estate planning effectively is not.
“The population, in particular the baby boomer population, is very materially underprepared for their mortality,” says Peter Townsend, principal at Townsends Business and Corporate Lawyers.
“We try to get people to think more carefully about their estate planning at the time they set up their [SMSF], with not much luck.”
Adequate estate planning is also imperative for Generation Y, which will be the first generation to have experienced compulsory super for a majority of their working lives.
“The fact that people are building up substantial super balances at a relatively young age means estate planning is an issue even for the young,” says Heffron’s technical specialist Meg Heffron.
“If they don’t handle their estate planning appropriately, we have a ticking time bomb on our hands.”
Significant estate planning mishaps, including non-tax effective or incorrect transferring of assets, often stem from basic misunderstandings.
A common, almost universal, misunderstanding related to super is that from an estate planning perspective, super normally does not form part of a trustee’s estate, meaning it cannot necessarily be dealt with through a will.
“The biggest single issue from the point of view of the member [or] trustee is that they don’t appreciate that super fund assets can’t be dealt with through their will,” says Mr Townsend.
“If you ask a member [or] trustee how they deal with their super assets, 99.5 per cent would say ‘Do it through your will’, but that’s not quite right.
“That’s not to say you can’t deal with those proceeds through the will; you can, but only after you get those proceeds into the will in the first place,” he adds.
Speaking more broadly, Jocelyn Furlan, chairperson of the Superannuation Complaints Tribunal, says education regarding the purpose of superannuation would help prevent disputes after someone has passed away.
“It’s quite deliberate that superannuation doesn’t form part of a person’s estate,” she says.
“That’s because often, when people die prior to retirement, the benefit they get is actually more death cover than it is their account balance.”
The elephant in the SMSF room
Planning for incapacity is a significant and often overlooked part of the estate planning process for SMSF trustees. However, if trustee incapacity is not dealt with appropriately, it can result in their SMSF becoming non-compliant.
Bryce Figot, director at DBA Lawyers, says it is likely only a minority of trustees have planned for incapacity, describing trustee incapacity as the “elephant in the SMSF room”.
“[Except] unlike the elephant in the room where everyone is aware of it but they’re not talking about it, I think there’s a good chunk of people who just haven’t even turned their mind to it,” Mr Figot says.
Having an enduring power of attorney in place for when a trustee becomes unable to act on their own behalf is a fundamental step in the planning process, says Mr Figot.
“There absolutely has to be an enduring power of attorney in place. That’s just not negotiable,” he says. “[Trustees] have to do that, or else they’ll definitely leave their loved ones in a bind during a very difficult state of their life.”
If a fund does not have an enduring power of attorney in place and a trustee loses capacity, the fund may struggle to meet the definition of an SMSF, which could in turn result in the loss of complying status.
“Having enduring powers of attorney in place goes a long way to ensuring that upon loss of capacity, the fund continues to be an SMSF, and thus continues to be a complying superannuation fund and retain its tax concessions,” says Mr Figot.
“Sadly, anecdotal evidence suggests that only a minority of SMSF members actually have enduring powers of attorney.”
Individual versus corporate trustee
A majority of SMSFs have chosen the individual trustee option, which is notably cheaper than appointing a corporate trustee. However, the corporate trustee option is strongly favoured by professionals from an estate planning perspective.
“One of the risks people run, or one of the ways people make life harder, is by having individual rather than corporate trustees,” says Ms Heffron.
“One of the risks with Generation Y is they’re naturally focused on setting up a fund with the least possible cost … that demographic in particular is probably the reason we’re seeing an increasing trend towards individual trustees, and that’s actually the wrong way to go for estate planning,” she adds.
There are several estate planning advantages to having a corporate trustee, including administrative ease. There’s also less opportunity for error with a corporate trustee because while individuals die, companies do not.
“There is almost never any need to change the trustee of the fund. Accordingly, there is no need for change of trustee documentation and therefore no chance to incorrectly draft change of trustee documentation,” Mr Figot says.
In addition, with a corporate trustee, there is never usually a need to change investments when a member passes away.
“For example, if mum and dad are individual trustees, then the investments will be in the name of mum and dad. When mum [or] dad die, they will need to change the name of those investments ... if they have a corporate trustee all the way through, those things will not need to change,” says Peter Hewish, head of estate planning at Australian Executor Trustees.
Tax: Getting it right
From an estate planning perspective, SMSFs can be a tax-effective vehicle if handled correctly. However, strategies that can be put in place to maximise the tax-free component of a member’s balance are often overlooked.
For example, within an SMSF there are opportunities to pay a tax-free pension to a surviving spouse upon the death of a member, says Tony Greco, senior tax adviser at the Institute of Public Accountants (IPA).
In addition, re-contribution strategies can be highly effective and can potentially save a member or their beneficiaries “many thousands of dollars”, according to the SMSF Academy’s Aaron Dunn.
The strategy involves withdrawing benefits from a member’s superannuation account and then making a non-concessional contribution of the same money back into the fund, Mr Dunn explains. The purpose of this process is to convert all or part of a member’s taxable component into a tax-free component.
However, Mr Dunn indicates the member must have met a condition of release to withdraw benefits and still be eligible to contribute to superannuation.
There are various benefits to this strategy, including improving the tax effectiveness of a superannuation income stream paid up to age 60 and reducing the tax impost on death benefits paid to non-dependant beneficiaries, Mr Dunn says.
Factoring in LRBA risks
Limited recourse borrowing arrangements (LRBAs) have become increasingly popular in the SMSF space, and are often used to buy property. It’s imperative these borrowing arrangements are factored into a trustee’s estate plan to protect their estate and its beneficiaries.
“The problem with LRBAs is that there’s a liquidity issue there. There’s a piece of property that takes a while to sell,” says Mr Townsend. “So not only have we got the problems associated with how long it’s going to take to sell the property, there’s also issues about what the market is like and whether it’s a good time to sell at all,” he adds.
“The lender is likely to want their money back pretty quickly and will want to be pushing for the sale to occur regardless.”
Mr Burgess indicates the fund must be in a position to meet its loan repayments or pay off its debts, and that practitioners and trustees should be considering the use of appropriate insurance when setting up an LRBA.
“There can be problems if the major contributor of the fund dies and then the funds cash flow dries up and they’ve still got to service that borrowing somehow,” Mr Burgess says.
“It may be more important in those situations to have life insurance in place to make sure the fund is in a position to keep servicing that debt, or perhaps even retire the debt on the death of a major contributor.”
Although SMSFs are largely self-directed, when it comes to do-it-yourself (DIY) estate planning, Equity Trustees’ Anna Hacker says clients should be warned to “run as fast as you can”.
“DIY wills with SMSFs are an absolute no no,” Ms Hacker says. “It always surprises me to see people who have done everything they can throughout their lives to develop strategies to protect their wealth and minimise their tax liabilities, then decide to save money by using a DIY will.”
One of the most common reasons for wills to be challenged and overturned is that the person who put the will together didn’t seek appropriate professional advice or guidance, Ms Hacker says.
“People considering a will should consider having it professionally prepared by a legal practitioner as insurance for the proper administration of the estate in the manner in which it was intended,” she says.
Ms Hacker adds that when writing a will, careful consideration must be made to all aspects of asset ownership and family relationships, ensuring a “complete picture” of a trustee’s finances and personal goals is established to determine the best legal structure to accomplish objectives.
“A will that has been incorrectly written, improperly witnessed or that is ambiguous or out of date can result in lengthy court proceedings, which delay payments and emotionally drain potential beneficiaries who are frustrated that wishes are not being followed,” she says.
“If a will is successfully challenged, the legal cost of the challenge is usually paid for out of the estate, thus reducing the amount for distribution to beneficiaries.”
The result of using do-it-yourself wills can sometimes cost the estate far more to “fix” than having a will prepared by a professional in the first instance.
Ms Hacker adds that ultimately, advice from a range of professionals is the key to an effective estate planning strategy.
“A will itself, the document, is not as important as the advice that goes with it.”