Automatically reversionary pensions versus BDBNs

After the ATO finalised its views on automatically reversionary pensions (ARPs) in TR 2013/5, there has been considerable debate on whether an ARP or binding death benefit nomination (BDBN) wins out.

The way the law applies to these types of situations can be demonstrated through a case study.

Facts

We will assume the following facts exist in relation to Rob and Mary:

• They are in their second marriage and have one child each from their prior relationships.
• They share an SMSF together and are both directors and equal shareholders of the SMSF corporate trustee.
• Both Rob and Mary are drawing account-based pensions (‘ABPs’) and their pensions are automatically reversionary to the survivor on death.
• They both have a BDBN that broadly requires the SMSF trustee to pay their death benefit in the fund to their legal personal representative (‘LPR’ – i.e. their estate).

Question?

What would happen to the super moneys if both Rob and Mary both died in the same accident and we assume Mary was slightly younger than Rob?

Legal analysis

Does Rob’s pension automatically revert to Mary since she was younger?

Generally, in circumstances where two people die together, the younger person is deemed to survive the elder person. We are also dealing with state law and we will rely on Victorian law for this analysis. (Naturally, if the law of another jurisdiction applies, you would need to obtain confirmation on whether equivalent state or territory provisions apply.)

Section 184 of the Victorian Property Law Act 1958  (‘PLA’) provides that in cases where two or more persons have died in circumstances rendering it uncertain which of them survived the other or others, such deaths shall (subject to any order of the Court), for all purposes affecting the title to property, be presumed to have occurred in order of seniority, and accordingly the younger shall be deemed to have survived the elder.

Property is broadly defined in s.222 of the PLA to include real and personal property, things in action and rights with respect to property. (It is noted that s.184 is subject to the order of deaths being uncertain. Therefore, evidence may exist to rebut the presumption that the younger survived the elder.)

Thus, there is the prospect of Rob’s ABP ‘immediately’ having reverted to Mary on Rob’s death based on the presumption in s.184 of the PLA. However, this is on the basis that Rob’s pension satisfied the test of what is an ARP. This, in turn, depends on the particular documents in question.

What is an ARP?

SMSF deeds and pension documents differ considerably from supplier to supplier. These differences are substantial in respect of the wording and effectiveness of the documents. Indeed, many SMSF documents do not provide legally effective ARPs or succession planning provisions. Thus, subject to this qualification, many SMSF deeds do have the following general ‘traits’ in common:

• A provision allowing a trustee’s discretionary power to be fettered by a BDBN; and
• A provision providing the trustee a discretion to determine the terms of a pension. Indeed, one reason why a trustee should retain discretion in regards to whether a pension should be reversionary is where the couple had separated as not many would want the trustee ‘locked into’ paying their former spouse a pension.

Accordingly, many SMSF deeds typically oust the prohibition on fettering in respect of BDBNs. However, for the above and other reasons, they typically fail to oust the prohibition in respect of ARPs. Therefore, most ARPs would typically not bind an SMSF trustee. A validly executed BDBN, however, is more likely to bind an SMSF trustee. Surprisingly, however, we find that many BDBNs are not binding anyway.

Can an SMSF trustee fetter its discretion?

An SMSF is a trust. So the starting point here is the law that applies to trustees of trusts. While the general proposition is that a trustee’s discretionary powers cannot generally be fettered, where the deed expressly provides for a fetter or limitation – for example, a BDBN provision – then this can be effective.

Justice Finkelstein summarised the position succinctly in Fitzwood Pty Ltd v Unique Goal Pty Ltd (in liquidation) [2001] FCA 1628 (para 121):

Speaking generally, a trustee is not entitled to fetter the exercise of discretionary power (for example, a power of sale) in advance: Thacker v Key (1869) LR 8 Eq 408; In Re Vestey’s Settlement (1951) ChD 209. If the trustee makes a resolution to that effect, it will be unenforceable, and if the trustee enters into an agreement to that effect, the agreement will not be enforced (Moore v Clench (1875) 1 ChD 447), though the trustee may be liable in damages for breach of contract.

Accordingly, on its face, neither BDBNs nor ARPs are ever possible. This is because both would be a fetter of a trustee’s discretion. However, general law rules can be excluded by express provision in the fund’s trust deed. See Muir v Inland Revenue Commissioners [1966] 1 WLR 1269 and Dagenmont Pty Ltd v Lugton [2007] QSC 272.

Thus, both BDBNs and ARPs are possible provided the SMSF deed empowers them. However, under most SMSF documents (apart from DBA Lawyers), the BDBN is more likely to win out in the event of any conflict with an ARP.

Back to our analysis on what occurs in this case

Mary is deemed to have survived Rob on the basis of the PLA analysis above. However, the BDBN is more likely to win out under most documents. The analysis under most SMSF documents then is further obscured as most BDBNs are not effective.

To simplify our analysis, we will therefore assume we have a quality set of SMSF documents where the SMSF deed has been validly varied in accordance with its variation power throughout its history. We will also assume that the deed has a fetter for an ARP.

We must now enter into a determination of what wins out in the context of the legal documents – i.e. does the BDBN or the ARP win out? I suspect the BDBN may still win out and throughout my 30-plus years of practice, I have only come across one SMSF deed supplier that expressly provided an ARP would win out against an inconsistent BDBN.

DBA Lawyers' approach is to expressly provide that the BDBN would win out to the extent of an inconsistent ARP. Thus, the determination that must be made is clear under a DBA Lawyers deed.

Are there any further complications?

Since most ARPs are ineffective based on most SMSF deeds, it is likely that the pension would have ceased on death if we accept the ATO theory in ATO TR 2013/5 is correct. Thus there would be no ARP on this basis. Note that the ATO theory in ATO TR 2013/5 is focused on whether the pension exists for SISR purposes and, in turn, whether the pension exemption applies for tax purposes. Paragraph 18 of TR 2013/5 states:

18. A [pension] ceases for income tax purposes if any of the requirements of the SISR 1994 relating to the payment of the [pension] are not met in a financial year. This is the case even if a member remains entitled to receive a payment from the superannuation fund in relation to the purported [pension] under the governing rules of the superannuation fund, or under general trust law concepts.

(The SISR term ‘pension’ is substituted for the tax term ‘superannuation income stream’.)

Thus, while the pension is considered to have ceased for SISR and tax purposes, there may still be a pension for legal purposes that could result in legal ramifications. From a simplicity and practical perspective, many consider the SISR and tax position to be aligned with the legal position. However, this is not the case. Again, the quality of the legal documents impacts on the final outcome.

At this stage, we have determined that with quality documents, the BDBN has won out against the ARP. Since each of Rob and Mary have nominated their own (non-spouse) LPR, the BDBNs are effective.

What if Rob’s BDBN was in favour of Mary (and vice versa)?

First, we need to analyse the position in view of the PLA. Mary is deemed to have survived Rob and thus Rob’s death benefit must be paid to Mary on his death. Note, however, that some BDBNs may include words like ‘provided my spouse survives me by 30 clear days’ that are typically used in gifts made via a will. These words would rule out a payment to Mary if she did not survive that period. (For completeness, note that s.39(1) of the Victorian Wills Act 1997 broadly provides that a gift to a person who dies within 30 days after the death of the testator fails as the beneficiary is deemed to have predeceased the testator. There is no equivalent provision that applies in respect of a direction to pay a dependant who dies within 30 days of the member in respect of a BDBN.)

Assuming the requirement to survive for 30 clear days does not exist, then since Mary is dead at the time of payment of the death benefit, if Rob’s BDBN was in favour of Mary, it would be ineffective in relation to paying the LPR of a deceased dependant. Thus, a BDBN is ineffective to pay a deceased member’s death benefit to the LPR of the deceased dependant (spouse) despite Mary being deemed to survive Rob under the PLA. This outcome relies on the analysis in the case of Webb v Teeling [2009] FCA 1094.

The case of Webb v Teeling considered the question whether a payment that was to be paid to a dependant who was alive at the time of the member’s death but who subsequently passed away, could be paid to the LPR of that deceased dependant (being the member’s mother Olive). The court held that a death benefit could not be paid to the LPR of a deceased dependant as they were neither a dependant nor the deceased member’s LPR. Paragraph 38 of Webb v Teeling provides:

I am satisfied that although Olive Webb was Christopher’s dependant at the time of his death, the trustee did not have power to make a payment to Olive’s estate consistent with its obligations to make payments only to or for the benefit of the dependants.

The lesson from this case is to ensure the person has a BDBN in favour of their LPR where they wish to pay their death benefit to people who are not dependants.

Conclusions

The above highlights some of the complexities of dealing with death benefits and the importance of having clear and effective legal documents. If there is any uncertainty or inconsistency, costly legal battles can arise which can result in the superannuation moneys potentially ending up in the wrong hands.

Daniel Butler, director, DBA Lawyers

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