The death of an SMSF member is always challenging – in many cases, the person left behind to work out what next is the grieving spouse. But there are some particular issues for accountants and advisers to get right when it comes to this tricky time.
Let’s just focus on the issues surrounding the trusteeship of the fund, rather than the deceased member’s death benefit and all the planning and advice involved there. Because one very important reason we need to know who the trustees are (or should be) is that they will have a vital job to do – get the death benefit paid. Depending on whether the deceased had a binding death benefit, reversionary pension or neither, the trustee might even have to decide who gets the money. So clearly, working out “who is in charge now” and “is that sustainable” is a pretty important issue.
These rules haven’t changed in years. And it’s common to assume the area is well understood. Interestingly, however, at one of our recent Super Intensive Days, a session on exactly this topic was the one that generated the most questions from attendees. While the rules may be pretty well understood and unchanging most of the time, they are clearly still a bit confusing around death.
So what do professionals get wrong?
Perhaps the first is the assumption that the deceased’s executor will automatically become a trustee / director of the corporate trustee on death. In fact while the super rules give the executor special permission to be a trustee / director without breaking the normal requirements about members and trustees being the same people, it doesn’t happen automatically. The executor would need to be appointed in the usual way. This might require the agreement of members or shareholders (in the corporate trustee) or other trustees / directors – each trust deed and company constitution will be different. This special permission also only lasts for a specific time – just from the time of death until the death benefit starts to be paid out. The importance of that limitation will become clear shortly.
A related but second common error is misunderstanding who is in charge “right now” immediately after death. Mostly, in a fund with 2 trustees / directors of the corporate trustee, it is the person left behind who is in charge in the immediate future. In fact when the members involved were originally a couple, the surviving spouse is often the deceased’s executor in any case. But where they are different, it’s important to realise that the “person already in the hot seat” has the immediate power and responsibility to run the fund. This is the case even if they weren’t a member of the fund (ie, the fund had a single member – the deceased – but two trustees or directors of the corporate trustee).
This is different when the fund had a corporate trustee with only one director. In that situation, most constitutions provide that the shareholders appoint a new director. If the deceased was also the sole shareholder, the executor can appoint themselves.
A third point of confusion is understanding the importance of when membership ceases under the fund’s trust deed. This is important in working out how robust the initial structure will be going forward. And trust deeds are different here. Some say membership ceases immediately on death. Others provide that it ceases when the deceased’s benefits have been fully paid out. Others define membership as ceasing when the death benefits start to be paid out.
It's worth pausing at this point to work through some examples that highlight these first three areas of confusion.
Kylie and Mike are both members and directors of the corporate trustee of their SMSF. Mike recently died and their trust deed provides that membership ends on death. The constitution for the SMSF trustee company allows a single director. Rhett is Mike’s executor.
A few key points leap out here. Firstly, in the immediate aftermath, Kylie is solely in charge. She’s the incumbent director, the constitution allows that to continue and even if the constitution allows her to be replaced by shareholders, it’s likely she owns half the shares in the corporate trustee in any case. There’s no automatic role for Rhett (our second point above) and in fact in this particular instance, he might never join the trustee board. Remember Mike’s membership ceased on death – he’s no longer a member who needs to be represented among the trustees, it’s perfectly legal for Kylie to remain the only director while she deals with his death benefit.
What if the deed was different? Instead, membership continued until death benefits started to be paid out? In that case, we’d have a 2 member fund (Kylie and the late Mike) with a single director (Kylie). That would cause problems eventually – which could be resolved by appointing Rhett as a second director.
This brings us to a fourth area – the value of the “6 month rule”. This is a rule that gives SMSFs a short grace period (6 months) during which they can get their trustee structure “wrong” without breaching the rules. It’s often used when a member / trustee dies because time is needed to get things fixed up. In Kylie and Mike’s case, for example, it would be OK to have 2 members and only 1 director for 6 months. In fact, it would even be fine to have 2 members and a single individual trustee during that time. (A challenge for the latter is a practical one. Many banks and other financial institutions only have a loose understanding of the trustee rules for SMSFs. When they see a single individual trustee they assume something needs to change immediately and stop allowing transactions on the account until it’s “fixed up”.)
Finally our fifth common mistake is not understanding the importance of reversionary pensions. Pensions that continue automatically mean at least some of the deceased’s super will start to be paid out immediately on death (to the reversionary beneficiary). This is important for two reasons. Firstly, if the trust deed says membership ceases when death benefits start to be paid out, effectively the deceased’s membership will cease on death even if they still have an accumulation account that hasn’t been dealt with. (In our example earlier, Kylie would once again have a single member fund as soon as Mike died.)
Secondly, remember the special permission SMSFs have to include an executor as a trustee / director? This only applies until death benefits start to be paid out. That time passed immediately. Of course, in this fund, Kylie could always choose to involve Rhett because she has a single member fund which is always allowed to have a second director. If the fund has individual trustees and Rhett is someone close to her (say their adult child), she might choose to do this because she needs a second trustee. But equally she could choose another child (who wasn’t Mike’s executor) – there’s nothing special about Rhett.
Our Super Intensive Day has two sessions touching on this important topic. Not only do we explore the trustee rules in depth and look at a number of case studies involving the death of a member and trustee (Session 5A – SMSF trustee rules) but we also run through a number of important steps to get right immediately when a member / trustee dies (Session 3B – Where do I start?).