Planning for a ‘legal disability’

Recommendation 7–3               The relevant operating standards for self-managed superannuation funds in cl 4.09 of the Superannuation Industry (Supervision) Regulations 1994 (Cth),should be amended to add an additional standard that would require the trustee to consider the suitability of the investment plan where an individual trustee or director of the corporate trustee becomes ‘under a legal disability’.

7.141  Trustees of SMSFs must ensure that the fund complies with prescribed operating standards.[137] The relevant operating standards are set out in cl 4.09(2) of the SIS Regulations:

The trustee of the entity must formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following:

(a)     the risk involved in making, holding and realising, and the likely return from, the entity’s investments, having regard to its objectives and expected cash flow requirements;

(b)     the composition of the entity’s investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification;

(c)     the liquidity of the entity’s investments, having regard to its expected cash flow requirements;

(d)     the ability of the entity to discharge its existing and prospective liabilities;

(e)     whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.[138]

7.142  Recommendation 7–3 recognises that planning for a legal disability, as a central protective strategy against elder abuse, needs to look beyond the legal structures for succession and consider the investments in the SMSF, and how they may be best managed in the event of a trustee suffering a legal disability.

7.143  This recommendation was suggested by the SMSFA:

Our proposed amendment is similar to the recent addition of SIS regulation 4.09(2)(e) that requires trustees to consider whether their fund should hold insurance. This has had great success in putting insurance to the front of every trustees mind and will have the same effect with estate and succession planning. Furthermore, it then becomes a legal requirement that trustees consider estate planning and then this becomes part of the audit standards that SMSF auditors must see evidence of when auditing the SMSF financials each year.[139]

7.144  A similar reform was suggested by Dixon Advisory:

the annual reporting requirements to the Auditor or ATO could contain a declaration stating that the trustee has considered succession planning for each of the Trustees. The annual declaration could include considerations like: the benefits of corporate trustees, the importance of appointing an appropriate enduring power of attorney and executor as well as educating the trustee appropriately on their preferences.[140]

7.145  A key part of this proposed operating standard is requiring trustees to consider whether the asset mix of the SMSF is consistent with proposed succession plans. That is, are the assets fungible on a trustee suffering a legal disability or will the assets require long term management by the trustee’s enduring attorney. This brings ‘front of mind’ important questions as to the suitability of the chosen enduring attorney to manage the SMSF. Dixon Advisory noted that

SMSFs often have tailored strategic approaches and unique investments that require individualised management strategies. Noting our increasing life and retirement phase expectancy, it is entirely appropriate for SMSF trustees to hold investments that have a long term focus. SMSF trustees may also hold business and residential property, unlisted assets and other sophisticated investments which can, at times, be less liquid. A prescribed event, such as rolling a member out of the SMSF within a set period of time, may cause significant losses for the members and beneficiaries in these situations.[141]

7.146  As the requirement to review the SMSF’s investment strategy for consistency with succession planning for loss of legal capacity would be an operating standard of SMSFs, trustees would be required to demonstrate to the SMSF’s auditors that they have considered their investment strategy in light of the potential for loss of capacity by a director/trustee. Regular reviews through the audit process should encourage consideration of appropriate succession planning and focus on the need to keep the plan up to date. This addresses a key risk for older people in relation to SMSFs: that many members do not understand, or have not considered, how lack of planning for the possibility of a legal disability may make them susceptible to elder abuse.

7.147  Recommendation 7–3 only requires trustees to ‘consider a plan’, not to have a plan, or a plan of a particular type. This retains ultimate control with the trustee—consistent with the regulatory approach for SMSFs. It is also consistent with the view expressed by submitters that a ‘one size fits all’ approach to succession on loss of capacity would be problematic given the diversity and complexity of SMSFs in terms of both their assets and structure.[142]

7.148  The ALRC recognises that the regulation was amended in 2012 to require trustees to consider whether their fund should hold insurance. There is no data on the uptake of insurance following the implementation of this requirement. Recommendation 7–3 would add only a limited regulatory burden as it would not require SMSFs to do any more than consider planning for the loss of capacity by trustees/directors as part of the fund’s investment strategy.