Control of an SMSF on a member's incapacity or death

2 Mar 2020

Lyn Formica

Head of SMSF Technical & Education Services

My client has chosen her spouse as her attorney in the event that she loses mental capacity but her adult children will be the executors of her estate on her death. Could this arrangement cause complexities for her SMSF on her incapacity or death?

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An SMSF member’s legal personal representative (LPR) can play an important role in the operation of the SMSF should they lose mental capacity or die.
 
For example:
 
If an SMSF member becomes legally disabled, they will no longer be fit and capable of acting as an individual trustee or a director of the fund’s corporate trustee. To allow for the smooth running of the fund, they should immediately be removed from that position. Note that their removal should be done in accordance with the governing rules (in the case of an individual trustee) or the constitution of the corporate trustee (in the case of a director of the corporate trustee). 
 
However, such an individual can still be a member of the SMSF provided their LPR (in this case their attorney under an Enduring Power of Attorney) is an individual trustee/director of the corporate trustee in their place [SIS s.10(1) def’n of “legal personal representative”, SIS s.17A(3)(b)(ii)]. 
 
Similarly, if an SMSF member dies, the fund will not fail the SMSF definition if the member’s LPR (in this case their executor or administrator of their estate) is an individual trustee/director of the corporate trustee in place of the member in the period from date of death until the death benefit starts to be paid out of the fund [SIS s.10(1) def’n of “legal personal representative”, SIS s.17A(3)(a)].
 
There is generally a six month “grace period” in which the fund could technically fail the SMSF definition following the cessation of the individual’s trusteeship or directorship due to their death, or their removal due to incapacity, but the failure will be disregarded [SIS s.17A(4)].
 

Importantly, this does not mean that a member’s LPR will automatically become an individual trustee/director of the corporate trustee on the member’s death/incapacity, nor is the SMSF required to restructure its trusteeship/directorship to do this (unless required under the governing rules/constitution). 

It just means that if an LPR is appointed as an individual trustee/director of the corporate trustee in place of the deceased/incapacitated member, doing so will not cause the SMSF to fail the SMSF definition.
 
Note that, once appointed, the LPR is a trustee/director of the corporate trustee in their own right with legal powers and responsibilities and they will remain in the role until such time as they resign or are removed (in accordance with the governing rules/constitution).
 
Depending on a family’s dynamics, complexities can arise when a member’s attorney and executor are not the same. Consider the following example:

  • Shirley and her spouse George are the sole members of an SMSF. They are also the directors of the fund’s corporate trustee.
  • Shirley has appointed her spouse George as her attorney under an EPOA but her adult children, Tony and Lena, will be her executors under her will. 
  • Shirley loses mental capacity. Following the constitution of the corporate trustee, Shirley is removed as a director and George remains as the sole director representing both himself and Shirley (eg he’s “wearing two hats”). 
  • Shirley dies. Whilst her death terminates the EPOA and George is no longer Shirley’s LPR, he will remain a director unless removed in accordance with the constitution of the corporate trustee.
  • Along the same vein, Shirley’s death does not automatically mean that Tony and Lena (her LPRs upon her death) become directors of the corporate trustee. They must be appointed in accordance with the constitution of the corporate trustee.
  • The fact that Tony and/or Lena may need to be appointed as a director of the corporate trustee in order for the fund to comply with the SMSF definition does not mean that it happens automatically.
  • Depending on who has the power to appoint directors under the constitution/appoint a trustee under the governing rules, George may be able to effectively block Tony and Lena's appointment.

To ensure their wishes are followed, SMSF members in a similar situation may need to consider putting in place a binding death benefit nomination and/or reconsider their choice of LPR. At the very least, SMSF members should be aware that if their LPR is appointed as an individual trustee/director of the corporate trustee, the LPR’s appointment in this position does not automatically end when their role as LPR ends.