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Self Managed Super Fund (SMSF) Article
Bankruptcy and Superannuation
By Tony Negline.
This article may be out of date.
16th September 2009
A common question is, “How can I protect my assets if I were made bankrupt?”
The bankruptcy laws in relation to superannuation assets have changed over the last five or six years principally because of the High Court's Cook v Benson decision.
Under the bankruptcy laws which have applied principally since July 2006, only superannuation contributions and not super fund benefits can be attacked.
These rules apply for all regulated super funds even those ineligible for tax concessions because of super law compliance breaches.
If the super contributions cannot be attacked under these specific provisions then they will be safe from creditors under the Bankruptcy laws. The might be attacked under other laws but we will not review these rules here.
There is no time limitation for the superannuation contribution claw back provisions. This is different to some of the other bankruptcy rules which exclude transactions which occurred more than 5 years before bankruptcy.
There is one set of contribution claw back provisions that apply to member contributions and another to contributions made by others.
These member contribution provisions also potentially apply to contributions made for a spouse and some third party contributions (for example, super contributions made for a child). The claw back rules apply to all contributions (that is, Concessional and Non-Concessional Contributions).
Under the Bankruptcy Act, a Bankruptcy Trustee needs to establish that a super fund member made super contributions either to prevent the transfer of their property to creditors or to hinder or delay making property available for division amongst creditors.
A bankruptcy trustee will either seek to demonstrate that if the super contributions had not been made then those contributions would probably have been property of the super fund member or will seek to show that the super fund member was having difficulty paying debts or selectively paying some debts but not others or was subject to impending and overwhelming debts that the debtor did not have the capacity to pay.
If a Bankruptcy Trustee succeeds here they then need to show that a super contribution was "out of character" which means that before it is made a pattern of super contributions has been developed and a particular contribution doesn't fit the pattern.
Once a contribution is deemed to be out of character, all of it can be clawed back not just the out of character portion unless the super fund member can explain the contribution and show that the purpose of the contribution was neither to prevent the transfer of property nor hinder or delay making property available to creditors.
If a person is self-employed or running a small corporation the contribution variance might easily be explained as merely reflecting their trading environment.
Third party contributions, such as contributions by an unrelated employer, may be clawed back using the same rules and an additional rule. The contribution must have been made at the direction, request or understanding of the super fund member.
It is not clear if this means that the super fund member only has to decide that super contributions are to be made for the member as well as deciding which fund will receive the contributions.
In many cases, employees will ask their employer to contribute a bonus to a super fund. Will these contributions be caught?
It appears that a contribution will be caught under this rule if the member directs or significantly influences the decision to make the super contributions.
Compulsory employer super contributions will not be covered by this recovery rule. Voluntary employer contributions might be covered if the employee has the ability to directly or significantly influence whether the contributions are made.
How can a super fund member protect themselves?
Assuming that a contribution is vulnerable what options are available to super fund members to protect themselves and place contributions beyond the reach of a Bankruptcy Trustee?
- Rollover or Transfer – this is unlikely to work. A Bankruptcy Trustee could simply ask the official receiver to issue a statutory recovery notice to the receiving super fund's trustee. A Bankruptcy Trustee issues "tracing orders" to follow super fund contributions from one fund to another
- Commencing a pension benefit – this will also not work because a statutory recovery notice could be issued that forced the super fund to commute the pension. Alternatively some of the actual income payments could be claimed to pay creditors
- Debiting amounts to the contribution – a Bankruptcy Trustee can only recover the actual out of character contributions less any specific expenses such as tax and administration expenses. Earnings on those amounts are excluded from the amount that can be claimed
- Spouse contribution splitting – this may be an option. The contribution would have to be split immediately after the contribution was made. This strategy will only work if the bankrupt takes all their benefit out of the fund where the splitting took place. If they intend to claim some of their personal contributions as a tax deduction then they would need to tell the super fund's trustee before they leave that fund. Only contributions claimed as a tax deduction can be split.
When contributions are paid to the official receiver, the amount withdrawn from a super fund is not deemed to be a benefit. This means that the super fund member's taxable and tax-free components are not changed if the member is receiving a pension. If a lump sum is paid out then it will first impact the taxable component and then if necessary the tax-free component.
If a bankrupt owns shares in a company which is the trustee of a Self Managed Super Fund then the Bankruptcy Trustee could gain control of that company.
This means the Bankruptcy Trustee could exercise voting rights that attach to the shares which vested in the Bankruptcy Trustee. The Bankruptcy Trustee could remove the bankrupt member's directorship and appoint another person as director (there are time limits for this to be done).
That new trustee is bound by normal trust law to act in the best interests of the beneficiaries.An option for a bankrupt in this situation is to seek to make their fund a Small APRA Fund.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.