Tips for dealing with loss of capacity with SMSF clients

Tips for dealing with loss of capacity with SMSF clients

There are key steps practitioners should be recommending their clients take to ensure their funds continue despite a member’s diminished capacity.

At some point, one or more members of an SMSF may become temporarily or permanently incapacitated due to illness, ageing or an accident and as a result, incapable of managing their role as trustee.

Preparing for this eventuality well in advance will enable membership to continue, regardless of capacity.

Step 1: Appoint an Enduring Power of Attorney

All SMSF members should appoint a Legal Personal Representative (LPR) under an Enduring Power of Attorney (EPoA), regardless of whether their fund has individual trustees or a corporate trustee.

Should a member (the EPoA ‘donor’) lose capacity and be unable to fulfil their role as director or trustee, their LPR may be able to step into this role, ensuring ongoing operation of the fund.

Ideally an LPR should be a relative, friend or adviser who understands the requirements of taking the place of an SMSF trustee and has sufficient time to devote to the task. Although the LPR would be 'standing in' for the trustee/director, they would assume full responsibilities as a trustee or director of a corporate trustee.

Step 2: Update the SMSF trust deed

Ideally, the SMSF trust deed should be flexible enough to allow for the appointment of an LPR as a replacement director (or trustee, if an individual-trustee fund) should a member become incapacitated.

However, if the deed requires that, at all times, members be trustees/directors and vice versa (with no allowance for the appointment of others, such as an LPR, under the exceptions to the standard trustee/member rules) it is vital the deed be updated.

Should this not occur and a member becomes incapacitated, their benefits may no longer be able to remain in the SMSF and will have to be transferred to a public offer fund.

Step 3: Implement the best structure to enable LPR appointment

The third step in preparing for incapacity is to ensure the trustee structure allows for an LPR to smoothly and quickly replace the member. A corporate trustee structure (compared with an individual trustee structure) significantly simplifies this process.

 

LPR Appointed

No LPR Appointed

Individual Trustee

Structure

Subject to the trust deed permitting, when replacing the trustee with the LPR:

  • The member is removed as trustee by other members,
  • LPR appointed as trustee in place of the incapacitated trustee,
  • Fund assets re-registered in the names of all trustees.

After a member has lost capacity, it is too late to appoint an LPR.

Remaining members may have the power to remove the trustee, but not appoint a replacement.

Member benefits may need to be transferred to a public offer fund, subject to power in trust deed.

Fund assets need to be re-registered in the names of all trustees.

Corporate Trustee

Structure

LPR will usually:

  • Be appointed as director, and
  • Resign ‘donor’ as a director.

No need to re-register fund assets, as the company will remain trustee.

Once a member has lost capacity, it is too late to appoint an LPR.

Directors may be able to remove incapacitated director.

Remaining directors must ensure the SMSF meets trustee/member rules. Must decide action regarding member’s benefits in SMSF.

No need to re-register fund assets, as company will remain trustee.

The greatest difficulties emerge for individual trustee funds where an LPR has not been appointed.

Conversely, a corporate trustee where an LPR has been appointed allows for the easiest possible transition:

• Easy appointment and removal of directors. The LPR completes the resignation on behalf of the incapacitated donor,

• Ensures no requirement for re-registration of fund investments into the names of the individual trustees with each change of trustee (whether or not as a result of incapacity).

Every individual’s circumstances are different and, thankfully, not all SMSF members will find themselves with diminished capacity.

However, attending to the steps above will pave the way for a smoother transition, whatever the individual circumstances.

Michael Harkin, national manager, training and advice, Topdocs

Tips for dealing with loss of capacity with SMSF clients
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