Self-managed superannuation funds (SMSFs) are a major asset for Australians, and disputes over death benefits have been on the rise for the last 10 years. Trustees of SMSFs face a high burden when navigating the payment of a death benefit.
A number of complex issues arise:
- when considering the validity of any death benefit nominations;
- the exercise of the trustee’s discretion in choosing how to pay the death benefit; and
- the conflicts of interest because the Trustee will almost certainly also be an interested beneficiary.
Is there a valid and binding beneficiary nomination?
On the death of a member, the Trustee must first determine whether there are any beneficiary nominations in place, and whether or not those nominations are valid and bind the Trustee to the payment of the death benefit (hence removing the Trustee’s discretion).
The validity of a beneficiary nomination can often result in a dispute between the parties because strict compliance with the terms of the trust deed is required. The courts have taken a form over substance approach to interpreting the validity of binding nominations. This places a high burden on Trustee’s when assessing whether they must follow a beneficiary nomination.
Common mistakes include failing to review the fund rules, using incorrect forms, nominating ineligible beneficiaries, and not obtaining trustee acknowledgment. Anyone of these faults will typically result in the nomination being invalid.
In these circumstances it is important for a Trustee to seek specialist legal advice. A Trustee may face personal liability if they pay a death benefit in accordance with a nomination which is later held to be invalid. In some cases it may be necessary for a Trustee to seek directions from the court before proceeding with a payment from the SMSF.
Risks to trustees for improper exercise of discretion
If there is no valid binding death benefit nomination, the Trustee will be left with a discretion as to who to pay the death benefit to. This discretion must be exercised with care, honesty, and genuine consideration. A Trustee’s failure to properly exercise their discretion can result in their decision being reversed, and the Trustee may face personal liability for any loss incurred as a result of their actions.
Importantly where the Trustee declines to provide reasons for the decision, provided the decision has not been made in bad faith or with ulterior purpose, the court is not able to review the trustee’s decision.
However, the court will review a trustee’s decision if:
- there was a failure of the trustee to act honestly and in good faith;
- the trustee failed to give genuine consideration to the decision;
- the discretion was not exercised with due consideration for its proper purpose; and
- the trustee’s reasons (if given) were not sound.
As a result, the Trustee must be able to provide evidence of proper enquiries and consideration of all relevant factors, including:
- intention of the deceased (looking at any previous binding and non-binding death benefit nominations, or other documentation);
- relationship between the deceased and eligible beneficiaries;
- financial circumstances and needs of each of the eligible beneficiaries;
- the tax implications of the payment;
- the purpose of superannuation generally; and
- if the estate is an eligible beneficiary:
- who will receive the superannuation under the Will;
- is there a risk of dispute.
Conflicts of interest
Conflicts of interest for trustees of SMSFs is a particular risk because they will often have multiple interests in the decision:
- an eligible beneficiary and the trustee of the SMSF;
- the trustee of the SMSF and the executor of the estate; and
- a combination of the above.
Because of the potential for a conflict of interest, it is extremely important for trustees to seek specialist legal advice about their role and obligations in making a decision about the death benefit payment.
When should a trustee seek directions from the court?
While there is no legal obligation for the trustee to seek judicial advice, there will be a number of scenarios in which it will be prudent for a trustee do so. These include:
- dispute between the interested parties as to whether a beneficiary nomination is binding;
- a risk a disappointed beneficiary will challenge the trustee’s exercise of discretion;
- before bringing or defending proceedings in a dispute.
Importantly, if a trustee fails to seek judicial advice, they may be deprived of their entitlement to be indemnified out of the trust assets for the costs, leaving the trustee personally liable.
Conclusion
Trustees must remain vigilant. Seeking specialist legal advice early on will have a material impact on how any dispute may develop. Our estates team regularly advises trustee on their obligations in relation to the payment of superannuation death benefits.