Asset Protection within a SMSF The SMSF as an asset protection and estate planning vehicle

Speaker

Mike Fitzpatrick

Solicitor and Barrister

Clarendene Estate Planning Lawyers

Asset Protection within a

SMSF

The SMSF as an asset protection and

estate planning vehicle

Important Disclaimer

No person should rely on any part of the contents of this presentation without first obtaining advice from a qualified professional person. This presentation is given on the terms and understanding that the author is not responsible for the results of any actions taken on the basis of information in this presentation, nor for any error in or omission from this

presentation. The author hereby expressly disclaims all and any liability and responsibility to any person, whether a

purchaser, recipient or reader of this presentation or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the

Modern Estate Planning Issues

While you are alive holding wealth securely

and tax effectively and on your death the

transfer of wealth

Tax effectively

So that it “stays within the family”

Protected from legal claims from spouses

and creditors

Sensitively to the needs and welfare of the

beneficiaries and their descendants and

Why the worry about Asset Protection

Society more prone to litigation

HIH and Insurance Company Failures

New Bankruptcy Law plug loopholes

Tax complexities - Service Trusts

Fragility of Relationships

Severe Laws impose personal liabilities on

directors, managers advisers etc

Sophisticated investments structures more

Seminar Overview

Asset Protection Basics

Review of New Bankruptcy Provisions

SMSF as a wealth creation vehicle

SMSF as a wealth protection vehicle

SMSF as an estate planning vehicle

The 5 Super Estate Planning Issues

Asset Protection under the New Laws

Rules

1.

“You can’t get blood out of a stone” is still the

basic principle

2.

The best time to implement asset protection

is when it is not needed

3.

Any strategy where the obvious primary

focus is ‘asset protection’ could be at risk of

failure

4.

Be careful with your written advice

5.

Avoid unnecessary directorships

Director’s Risk

* Company structure (or trust with company trustee) provides measure of limited liability

* Does not protect directors (executive or non-executive) and financial controllers against:

* Personal borrowings & guarantees, eg to

bank/suppliers

* Losses incurred while company was insolvent * Statutory liabilities, eg PAYG, injuries to

employees/members of the public

* Failure to properly satisfy themselves of company

Partner’s Risk

The liability of partners is

joint and

several

New Laws ‘overhaul’ Bankruptcy Act



Bankruptcy and Family Law Legislation

Amendment (Anti Avoidance) Act 2005

(‘BFLLAA’) – March 2005



Bankruptcy Legislation Amendment (Anti

Avoidance) Act 2006 (‘BLAAAA’) May

2006



Bankruptcy Legislation Amendment

(Superannuation Contributions) Act 2007

April 2007

Asset Protection - Issues

S120 Bankruptcy – 5 year clawback

for undervalue transaction

S121 Bankruptcy – unlimited

clawback where main purpose is to

defeat claims of creditors

Super Contribution Clawback

Cummins Case

Bankruptcy Act – Key provisions



s116(1) “Divisible” property (must be capable of assignment)



s116(2) Excluded assets (see Reg 6.03 for household items)



s116(5) RBL limit – abolished from 1 July 2007



s118(2) Exclusion of maintenance payments



s120 Undervalued transactions within 4 (or 5) years of earliest “act of bankruptcy”



s121 and s121A General anti avoidance provisions

Bankruptcy Act – Key provisions



s139A-139H Transactions involving related entities/persons



s139L “Divisible” income



s252 Possible personal liability of legal personal representative, eg if not acting in good faith



s263 Concealment of assets – 1st of the offences provisions



s270 Adequate business records to be kept for 5 years

Assets at Risk - s 116(1)



Personally owned assets – unless subject

to constructive trust – Parianos v Melluish



Assets can be made subject to mortgage,

guarantee or indemnity



Unpaid present or future entitlements, eg

trust allocations, remainder interests



Retained profits in (and loans from) trading

(or even beneficiary owned) companies



Unsecured loans, eg to trusts & companies

Excluded Assets – s116(2)

Property held in trust for another

person

Certain household items, eg television,

bedding

Certain property of sentimental nature

Certain property needed by bankrupt to

earn income ie tools etc

Excluded Assets – s116(2) cont

Superannuation and life insurance

policies not affected by S128 clawback

Certain family law payment splits

Any right to recover damages or

compensation for personal injuries

Payments under a Rural Support

Scheme

Assets required to be paid to a spouse

Bankruptcy Act – Major Anti-Avoidance

Provisions

S120 –

clawback

of assets transferred

S121 – Part IVA style

“main” purpose

provision

Bankruptcy Act amendments – trustee can



Intervene in family law proceedings



Access bankrupt’s income prior to its receipt



Seek Court approval to override pre or mid

relationship “binding” financial agreements



Treat entering into such agreements an act

of bankruptcy

Section 139DA Assets of Natural Persons

Assets of natural persons attackable where,

during the examinable period:



Person acquired asset as a result of the

direct or indirect result of financial

contributions by bankrupt



Bankrupt derived benefit from the property



Person still has interest

Order cannot exceed the amount by which the

value of the increase as a result of the financial

contributions (section 139EA).

“Clawbacks” of Asset Transfers – s120

Definition of

transfer

includes



Gifts and forgiveness of debts



Guarantees and mortgages



Preference dealings

Clawback periods



None - arm’s length terms/fully commercial



4 years - gifts with no immediate “cloud”

S 121 – General Anti-Avoidance Provision

Provision similar to Part IVA in ITAA 1936

Transfers are void against bankruptcy trustee

if

main purpose

is to defeat creditors

ITAA Part IVA (sole or dominant purpose) and

s121 (main purpose) mutually exclusive

Some exceptions to divisible assets or

income specifically made subject to s121,

eg s123(6)

S121A applies where consideration is given

to 3

rd

party

Cummins Case

[2006] HCA 6

The Trustees of the property of John

Daniel Cummins – v – Cummins [2006]

HCA 6

7 March 2006

Summary Asset Protection

Life and critical illness insurance also offers significant asset protection The protection offered by any of these vehicles is not absolute

Ownership Choices

for “Risk” Individual

High Gearing Capital

Reserved Trust Superannuation Domestic

Partner

SMSF as a Wealth Creation Vehicle

Modern SMSF with good Trust deed

Can invest widely

Attract low income tax and CGT tax rates

Provides access for incapacity/disability

Allows zero tax in pension phase

Provides excellent protection from

Creditors

SMSF as a Wealth Creation Vehicle

Disadvantages

Compliance

Some limits on investments

Limitations of access prior to

retirement – need to satisfy a

condition of release

What the ATO thinks

“The removal of age-based deduction limits, reasonable benefit limits (RBLs) and tax on superannuation benefits from taxed funds for

people 60 and over will increase the concessions provided to superannuation. These changes, in conjunction with the continuing tax exemption provided for income from superannuation assets supporting a pension, will make superannuation an attractive vehicle for retaining assets to minimise tax. There will be an incentive for people to transfer income producing assets currently held outside

SMSF as a Wealth Creation Vehicle

VERDICT

When compared to other tax and asset

structures

SMSF as a Wealth Protection Vehicle

BANKRUPTCY ACT 1966 - SECT 116(2) (d) property NOT divisible amongst the creditors of the bankrupt.

“(d) subject to sections 128B, 128C and 139ZU:

(i) policies of life assurance or endowment assurance in respect of the life of the bankrupt or the spouse of the bankrupt;

(ii) the proceeds of such policies received on or after the date of bankruptcy;

(iii) the interest of the bankrupt in:

(A) a regulated superannuation fund; or (B) an approved deposit fund; or

(C) an exempt public sector superannuation scheme; (iv) a payment to the bankrupt from such a fund received on

SMSF as a Wealth Protection Vehicle

BANKRUPTCY ACT 1966 - SECT 128B(1)

Superannuation contributions made to defeat creditors

contributor later becomes a bankrupt - Transfers that are void:

(1) A transfer of property by a person who later becomes a bankrupt is void if:

(a) the transfer is a contribution to an eligible superannuation plan; and

(b) the property would probably have become part of the

transferor's estate or would probably have been available to creditors if the property had not been transferred; and (c) the transferor's main purpose in making the transfer

was:

(i) to prevent the transferred property from becoming divisible among the transferor's creditors; or

(ii) to hinder or delay the process of making property

available for division among the transferor's creditors; and

SMSF as a Wealth Protection Vehicle

BANKRUPTCY ACT 1966 - SECT 128B (2)&(3)

Showing the transferor's main purpose in making a transfer (2) The transferor's main purpose in making the transfer is

taken to be the purpose described in paragraph (1)(c) if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent.

(3) In determining whether the transferor's main purpose in making the transfer was the purpose described in

paragraph (1)(c), regard must be had to:

(a) whether, during any period ending before the transfer, the transferor had established a pattern of making

contributions to one or more eligible superannuation plans; and

SMSF as a Wealth Protection Vehicle

VERDICT

When compared to other tax and asset

structures

EXCELLENT

Main advantage – no S120

SMSF as an Estate Planning Vehicle

PROBLEMS

Limits to beneficiaries

Limits to multigenerational application

Compulsory cashing on members

death

Limits to who can receive a pension

Taxation issues

SMSF as an Estate Planning Vehicle

SIS REGULATIONS 1994 – REG 6.21

Compulsory cashing of benefits on Death

(1) ... a member's benefits …must be cashed as soon as practicable after the member dies.

(2) ... benefits may be cashed under this regulation is any one or more of the following forms:

(i) a single lump sum; or

(ii) an interim lump sum and a final lump sum Can be paid as

(i) 1 or more pensions;

SMSF as an Estate Planning Vehicle

SIS REGULATIONS 1994 - REG 6.21

(2A) If a member dies on or after 1 July 2007, a pension

can only be paid to a recipient who is: (a) a dependant of the member; and

(b) in the case of a child of the member: (i) less than 18 years of age; or

(ii) being 18 or more years of age:

(A) is financially dependent on the member and less than 25 years of age; or

SMSF as an Estate Planning Vehicle

SIS REGULATIONS 1994 - REG 6.21

(2B) If benefits in relation to a deceased member are being paid to a child of the deceased member in

the form of a pension or an annuity, the benefits must be cashed as a lump sum on the earlier of:

(a) the day on which the annuity or pension is commuted, or the term of the annuity or pension expires (unless the benefit is rolled over to

commence a new annuity or pension); and

(b) the day on which the child attains age 25; unless the child has a disability of the kind

described in s8 of the Disability Services Act 1986. (3) … it is sufficient if, instead of being cashed, the

benefits are rolled over as soon as practicable for immediate cashing.

SMSF as an Estate Planning Vehicle

DISABILITY SERVICES ACT 1986 - SECT 8 (1) …persons with a disability that:

(a) is attributable to an intellectual, psychiatric, sensory or physical impairment or a combination of such impairments;

(b) is permanent or likely to be permanent; and (c) results in:

(i) a substantially reduced capacity of the person for communication, learning or mobility; and

SMSF as an Estate Planning Vehicle

SIS REGULATIONS 1994 - REG 6.22

Limitation on cashing of benefits in favour of persons other than members or their legal personal

representatives

(1) … a member's benefits must not be cashed in favour of a person other than the member or the member's legal personal representative (LPR):

(2) If the member has died the conditions of this

sub-regulation are satisfied if the benefits are cashed in favour of either or both of the following:

(a) the member's LPR;

SMSF as an Estate Planning Vehicle

SIS ACT 1993 - S10

"dependant", in relation to a person, includes the spouse of the person, any child of the person and any person with whom the person has an

SMSF as an Estate Planning Vehicle

SIS ACT 1993 - SECT 10A

Interdependency relationship

(1) …, 2 persons (whether or not related by family) have an interdependency relationship if:

(a) they have a close personal relationship; and (b) they live together; and

(c) one or each of them provides the other with financial support; and

(d) one or each of them provides the other with domestic support & personal care.

(2) …. for the purposes of this Act, if:

(a) 2 persons (whether or not related by family) satisfy the requirement of paragraph (1)(a); and

(b) they do not satisfy the other requirements of an

interdependency relationship under subsection (1); and (c) the reason they do not satisfy the other requirements is

that either or both of them suffer from a physical, intellectual or psychiatric disability;

SMSF as an Estate Planning Vehicle

Taxation of Lump Sum Super Death Benefits

General Principles

1.

Benefits paid to spouse or tax dependant

on death of member are paid tax free

2.

Benefits paid to non tax dependant are

taxed at either 16.5% or 31.5% (proceeds

of Insurance policies owned by Fund)

SMSF as an Estate Planning Vehicle

INCOME TAX ASSESSMENT ACT 1997 - SECT 302.195

Meaning of death benefits dependant

A death benefits dependant , of a person who has died, is:

(a) the deceased person's spouse or former spouse; or

(b) the deceased person's child, aged less than 18; or

(c) any other person with whom the deceased person had an interdependency relationship under

Sec 302-200 just before he or she died; or

(d) any other person who was a dependant of the deceased person just before he or she died.

Super and Estate Planning

General Principles –

1. Super Death benefits are a non estate asset –

you can’t leave super in a Will. Government has made it clear that it does not wish to see

Superannuation used as an “estate planning vehicle” as in the past.

2. The taxable proportion of a Super Death benefit

is not taxable only if it is paid to a spouse or tax dependant of the deceased – otherwise it is

Super –

The 5 Main Estate Planning Issues

1. What is the best way to pass control of a SMSF

on death or incapacity?

2. What can be done to reduce or eliminate super

death benefit taxes?

3. What will be the best way to pay a benefit –

pension or lump sum?

4. Can you protect a vulnerable/incapable/insolvent

beneficiary from losing/wasting a death benefit?

5. Which will be best - binding, non binding or non

SMSF as an Estate Planning Vehicle

DEFINITION OF DEPENDANT

General Principles

1.

No definition in Tax Act or SISA

2.

Common Law principles apply

3.

See Malek Case Judgement for review of

authorities – Malek -v- Comm of Taxation

[1999] AATA 678 (13 Sept 99)

4.

‘It’s not the money’ - it’s the extent of the

SMSF as an Estate Planning Vehicle

Super benefits paid to trustee of deceased estate

Sec 302.10 ITAA 1997

(2) To the extent that 1 or more beneficiaries of the estate who were death benefits dependants of the deceased have benefited, or may be expected to benefit, from the superannuation death benefit:

(a) the benefit is treated as if it had been paid to you as a person who was a death benefits dependant of the deceased; and

SMSF as an Estate Planning Vehicle

Sec 302.10 ITAA 1997

(3) To the extent that 1 or more

beneficiaries of the estate who were not

death benefits dependants of the deceased

have benefited, or may be expected to

benefit, from the superannuation death

benefit:

(a) the benefit is treated as if it had

been paid to you as a person who was not

a death benefits dependant of the

deceased; and

SMSF as an Estate Planning Vehicle

VERDICT

When compared to other tax and asset

structures on its own

Limited flexibility

Needs help from other

Passing control of a SMSF

SIS ACT 1993 – S(17A)

A superannuation fund does not fail to satisfy the conditions...by reason only that:

(a) a member of the fund has died and the legal personal representative of the member is a trustee of the fund or a director of a body corporate that is the trustee of the fund, in place of the member... :

(i) beginning when the member of the fund died; and

(ii) ending when death benefits commence to be payable in respect of the member of the fund; or

(b) the legal personal representative of a member of the fund is a trustee of the fund or a director of a body corporate that is the trustee of the fund, in place of the member, during any period when:

(i) the member of the fund is under a legal disability; or

(ii) the legal personal representative has an enduring power of attorney in respect of the member of the fund; or

Passing control of a SMSF

ISSUES

Corporate Trustee best – Company

should be established as a single director

company

Avoid including others as members of the

Fund ie children

Voting rights in proportion to benefits

Necessity for sophisticated Will and

Passing control of a SMSF

Clauses often omitted from SMSF Trust

Deeds



Binding Nomination provisions including

indefinite (non lapsing) nominations.



Provision allowing/requiring LPR to act as

Trustee on death or incapacity of

member.



Provision allowing Trustee to treat

pension as a reversionary pension on

death of pensioner member.

Passing control of a SMSF

Clauses needed in Wills

 Adjustment for unequal superannuation benefits

(and any reserves), eg if only one child is a dependant at fund member’s death.

 Effective transfer of control of SMSF - Proper

linking between Will and superannuation (and family trusts?).

 Maintaining bankruptcy protection of life

insurance and superannuation death benefits.

 Streaming of taxable super to tax dependants.  Super Proceeds Trust

Strategies to deal with

Super Death Benefit Taxes

1.

Withdraw and re-contribute to maximise

non concessional.

2.

Maximise non-concessional contributions.

3.

Start pension and then contribute

non-concessional to accumulation as a way of

segregating taxable and non-taxable.

Strategies to deal with

Super Death Benefit Taxes

4.

Crystallize unrealised gains while in

pension phase.

5.

Stopping and starting pensions to deal

with CGT.

6.

Removing taxable part of Super prior to

death.

7.

Establishing and documenting

dependency or interdependency

relationships.

Pension or lump sum?

No “one answer” – The “widow’s best friend” could

be a disaster for an 18 year old drug addict



Pension/annuities (if available) are usually the better option for creating income stream



Pension great for disabled dependants



Access for trust capital for surviving parent



Pension income paid directly to child once child is 18 years – capital to child by age 25 years



Need both options – tax and superannuation laws very much subject to change

Children as Dependants

L/Sum Super Pension

Child (qualifies if any one of the categories below apply)

L/Sum – Tax Free Yes Yes Yes Under 18 Yes Yes

18-25 & financially dependent Yes

Yes

No

18-25 & interdependent Yes

Yes

No

25+ & financially dependent Yes

Yes

No

25+ & interdependent Yes

Yes

No

18+ & independent No

Yes Yes

No tax on commutation - child pension

INCOME TAX ASSESSMENT ACT 1997 - SECT 303.5 Commutation of income stream if you are under 25 etc.

(1) A superannuation lump sum that you receive from a complying

superannuation plan is not assessable income and is not exempt income if:

(a) the superannuation lump sum arises from the commutation of a superannuation income stream; and

(b) any of these conditions are satisfied:

(i) you are under 25 when you receive the super lump sum;

(ii) the commutation takes place because you turn 25; (iii) you are permanently disabled when you receive the

superannuation lump sum; and

(c) you had received one or more superannuation income stream benefits from the superannuation income stream before the commutation because of the death of a person of whom you are a death benefits dependant.

Protecting the beneficiary

Protection needed for

Family Law Claims

Business Failure/bankruptcy

Drug Addiction

Bipolar

Spendthrift

Protecting the beneficiary

Which is better –

A Special Disability Trust or

A Super Incapacitated Child pension?

Consider a SMSF Pension in every

situation where your client has a

severely incapacitated child (of any

age).

Death Benefit Nominations

-Which is best?

3 Types – Non binding – Binding – Non lapsing

Depends on the particular circumstances

Generally the more you prescribe the more care

you need to exercise

No universal answer

Choice of member’s executor often crucial

The on-going involvement of the financial

planner both before and after death is crucial to ensuring the best result.

Death Benefits – Who Decides?

Indicative (advisory) member nominations

– Trustee must consider, but need not follow

Most externally managed super funds

– Trustee has absolute discretion to choose

between dependants and estate (subject to review by the Superannuation Complaints Tribunal)

Self managed superannuation funds

– Decision made by executor (if appointed in time) and any remaining fund members or 2nd

Control of Trustee

Katz -v- Grossman [2005] NSWSC 934

The Facts

Mr and Mrs Katz have 2 kids

Mr and Mrs Katz are each directors of Corp Trustee of

their SMSF

Mrs Katz dies and daughter is appointed director of

Corp Trustee in place of deceased mother

Mr Katz signs non binding death benefit nomination in

favour of the 2 children equally and later dies

Daughter appoints her husband as director of trustee

company and decides to pay entire super benefit to herself

Court does not interfere with that result and rejects

Lessons to learn from Katz v Grossman

This case highlights the importance of having the

right persons as trustees of an SMSF who are making the decision as to payment of the death

benefits. Clearly, in this case, Ervin's intention was for both of his children to benefit from his

superannuation as he provided for in his non-binding nomination. Among the preventative measures that can be taken are:

• The inclusion of adjustment Clauses in Wills; • Implementation of binding death benefit

nominations;

Binding Nominations – 3 Year Renewable



Member determines receipt of death benefits – s59(1A) (limited to dependants and/or legal personal

representative)



Not binding if contrary to Family Court order (s90MB Family Law Act)



No requirement for fund to offer binding nominations



Consequences must have been explained to member



Must meet every prescribed requirement –



Not automatically revoked by divorce



Lapse 3 years after signing (or last written confirmation) – SMSF can have non-lapsing nominations



Should cover contingencies, eg 1st choice dependant dies

If Deed permits, SMSF

members can make either a binding nomination that:



Potentially lasts only 3

years, but is renewable; or



Potentially lasts until death

(ie unless revoked).

Both types can only benefit dependants and/or estate and need to cover

contingencies, eg if 1st _choice

Binding nominations mean that trustees have no discretion as to payment,

but

Removes flexibility and may result in more tax

being paid.

Indefinite (Lifetime) Binding Nominations

Binding Nominations – Advantages



Certainty



Binds the trustee whoever they may

be



Can be drafted to allow cascading

nominations

Binding Nominations – Disadvantages



Inflexibility



Change of circumstances and change

of tax status of nominees can cause

“unintended consequences”



Formal requirements must be followed

“to the letter”



Need for renewal

Binding nominations

Can work well when member has

executed Will with creative and

flexible trust structures

With typical “normal” families probably

not appropriate for lack of flexibility

More appropriate when dealing with

“blended” families and where

possibility of disputes are likely

Super Death Benefits Will Trust

Pays benefits directly to trustee or deceased estate Superannuation Fund Trustee Usually can

“hire and fire” trustee

Surviving Parent Income Fund Excepted Surviving Funds established for each dependant

child Eventually receives capital, eg when surviving Capital Fund Child Superannuation Death Benefits Trust

– Capital Reserved

Trustee Settlor/

Modern Will Trust

Primary

Beneficiary

“Hires & fires” trustee & approves any

exclusion of beneficiaries

Primary

Beneficiary Charities/_Religious

Bodies Related

Spouse/

Major tax concessions for beneficiaries

Trustee

Beneficiary

Controlled

Testamentary

Trust

(“BCTT”)

Executor

Willmaker

Option in Will to utilise 1 or more trusts. Crisis

provision covers loss of capacity & bankruptcy

Remember

1. You can’t leave super in the Will.

2. Do not try to make the SMSF the main estate

planning vehicle in every case.

3. You can direct its control and reduce taxation

by applying a combination of strategies which may involve the creative use of Super

nominations and Will Trusts.

4. Do not underestimate the importance of

comprehensive and professional estate planning when dealing with your clients’ superannuation.

Questions?

Mike can be contacted at

info@clarendene.com.au