A widower nominated his son and daughter to take equal shares of his superannuation benefits on his death on a basis not binding on the trustee. The daughter, who was the surviving trustee of her father’s self managed superannuation fund (SMSF) after his death, appointed her husband as the new co-trustee and excluded the son from control of the SMSF. The daughter refused to pay the son the equal share of death benefits based on the father’s non-binding death benefit nomination (DBN). The son unsuccessfully challenged the daughter’s conduct in the NSW Supreme Court: Katz v. Grossman  NSWSC 934.
Dilemma – the SMSF trustee’s control over where death benefits go
Katz v. Grossman reveals a dilemma with SMSFs: whoever survives a member as trustee of a SMSF generally has significant autonomy as to whom death benefits of a deceased member will be paid to by default unless the member:
- has taken effective steps to ensure the DBN is a valid binding DBN (BDBN) to bind the trustee to pay his or her benefits to:
- dependant/s nominated by the member; or
- the member’s estate by nominating the member’s legal personal representative (LPR); or
- the member has made his or her pension reversionary to their chosen dependant: although a reversionary pensioner generally cannot be an adult child as only death benefits dependants contemplated by section 302-195 of the Income Tax Assessment Act 1997 can receive pension, including reversionary pension, death benefits.
The challenge of directing death benefits to dependants
Member control of superannuation is all well and good but selection of dependants to receive death benefits, either by member’s DBN or by the trustee of the fund, is fraught and is just as prone to dispute between disgruntled family beneficiaries as disputes over wills (Wills) and deceased estates are.
With superannuation funds generally, and especially SMSFs, it is a challenge for a member to:
- maintain an up to date expression of where he or she wants his or her benefits to go on his or her death; and
- to effect those wishes by way of a DBN.
In many cases this will be inconsequential such as where a surviving spouse of a deceased member is the surviving trustee, or controls the trustee, and is the obvious dependant of the member to take death benefits. But where dependants are next generation, or where a member has a blended family, surviving trustee decisions to pay death benefits of the deceased may not align with the deceased member’s wishes or their DBN especially where trusteeship of the SMSF passes into unexpected and unprofessional trustee hands on their demise.
Section 17A of the Superannuation Industry (Supervision) Act 1993 (the SIS Act) limits who can be or control a trustee of a SMSF to:
- the members of the SMSF; or
- their enduring attorneys;
unless the fund is a single member fund and, in any case, trustees of a SMSF must be unremunerated in their role as trustee: paragraph 17A(2)(c) of the SIS Act. Member controlled superannuation by a SMSF can be a control vacuum isolated from professional trustee expertise following the death of a SMSF member unless a professional is involved in the limited ways possible under sections 17A and 17B.
Does a SMSF member need to control where their death benefits go?
Is it desirable that the member controls where he or she wants his or her benefits to go in any case? Superannuation is explicitly to provide for a member’s dependants when the member dies. The SIS Act defines a dependant:
“dependant”, in relation to a person, includes the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship.Section 10 of the SIS Act
A deceased member may nominate a dependant by a DBN that is not the dependant of the member most truly dependent or most in need of the member’s death benefits. That is why it is doubly desirable to have a competent and trustworthy person succeed the member as trustee who will genuinely assess these needs. It is on the assumption that such a trustee will survive the member as SMSF trustee that superannuation fund governing rules (SFGRs) generally give the surviving trustee an open discretion to select the dependant of the deceased member to take the member’s benefits unless one of the Exceptions applies.
So even with the guidance of a non-binding DBN (NDBN), which expresses a deceased’s wishes as to whom his or her benefits are to be paid, SFGRs, the SIS Act and trust law typically give a superannuation trustee a power to pay benefits to dependants the trustee chooses in the trustee’s discretion contrary to and despite a NDBN as occurred in Katz v. Grossman.
The binding death benefit nomination
To immunise a DBN from a wrong choice of trustee, who may select a dependant in their discretion at odds with the member’s wishes, a member can use a BDBN. A widow or widower in circumstances similar to Katz v. Grossman can prevent override of their wishes as to who is to be their superannuation dependant to take their death benefits by force of a BDBN to bind the trustee to pay to that dependant.
The BDBN obstacle course
A SMSF member seeking to impose a BDBN to control his or her superannuation needs to be sure it will take effect. There are numerous contingencies. Consider these:
- is the capability in SFGRs allowing BDBNs effective and does it have integrity? Does the member appreciate that BDBN forms and arrangements differ from trust deed to trust deed? Not all BDBN arrangements in trust deeds are rigorous;
- will the BDBN be validly completed? (Wareham v. Marsella discussed below is an instance of invalid completion of a BDBN);
- if the BDBN is stated to be non-lapsing will it take effect as non-lapsing? That is: will the BDBN continue to bind the trustee more than three years after it is made? In the recent case Re SB; Ex parte AC  QSC 139 a non-lapsing BDBN was accepted by the Supreme Court of Queensland. Non-lapsing BDBNs are understood to be feasible for SMSFs following:
- Donovan v. Donovan  QSC 26; and
- Self Managed Superannuation Funds Determination SMSFD 2008/3 Self Managed Superannuation Funds: is there any restriction in the Superannuation Industry (Supervision) legislation on a self managed superannuation fund trustee accepting from a member a binding nomination of the recipients of any benefits payable in the event of the member’s death?
- what if the member marries, divorces or commences a reversionary pension after making a BDBN?
- will the BDBN have a fraud risk? Who needs to witness completion of a BDBN form by a member under the SFGRs? Depending on arrangements and the regime in the SFGRs for safe custody and verification of a BDBN, is there a risk that a BDBN may be altered by a dishonest successor trustee or a trustee in a conflict of interest with other dependants or “lost” so the BDBN won’t take effect as intended by the member? and
- what if the SFGRs are subsequently amended so that a BDBN made under former SFGRs of a SMSF no longer comply with the later SFGRs?
So a member looking to rely on a BDBN to direct who will take their superannuation faces a veritable obstacle course turning on:
- the SFGRs in the trust deed of the fund;
- the member’s domestic circumstances; and
- the security integrity of the BDBN arrangements;
in his or her quest to have a BDBN complied with by the trustee of the SMSF when the member is no longer around.
Better for a BDBN to be in a member’s Will?
Although a payment of death benefits is not a testamentary disposition: McFadden v Public Trustee for Victoria  1 NSWLR 15, it is desirable that a BDBN should be set out in, or, in the least, kept with, the Will of a SMSF member to avoid some of the above contingencies.
Generally speaking Wills are:
- subject to strict witnessing and other evidentiary requirements under state laws which reduce the prospect of fraud. By inclusion of a BDBN in a Will the BDBN can attract the same protections; and
- revoked on marriage and, depending on state laws, altered by divorce. A dependant nominated in a BDBN may pre-decease the member. On any of these events BDBNs are ideally revisited and, in that context, a non-lapsing BDBN is especially fraught after a situation where a long-dated BDBN should have been updated to reflect changes in a member’s domestic situation. If a BDBN is in a Will there is a greater likelihood that desirable update of a BDBN will not be overlooked.
There is also the advantage of consolidated consideration and expression of the member’s wishes for his or her property and financial resources substantially in a single document. Superannuation death benefits of deceased superannuation members now frequently exceed deceased estate property governed by their Wills in value.
To include a BDBN in a Will there needs to be a basis or regime for making a BDBN in a member’s Will in the SFGRs (in the trust deed) of a SMSF. Ordinarily SFGRs/SMSF trust deeds do not provide for BDBNs to be set out in a Will and instead require the BDBN to be in a discrete BDBN form.
When there is no BDBN
- a BDBN fails;
- there is a NDBN but no BDBN; or
- no DBN at all;
what assurance does a member have that a trustee will act in the interests of and fairly to the prospective dependants of the member?
There is initially the issue with the first and third cases that there is no satisfactory expression of what the member wishes. This situation arose in the recent Victorian Supreme Court Appeal decision in Wareham v. Marsella  VSCA 92.
Wareham v. Marsella
In Wareham v. Marsella the dependants of the deceased member of a SMSF included:
- the deceased’s daughter from her earlier marriage, Mrs. Wareham; and
- her husband of 32 years up to her death, Mr Marsella.
The deceased had made a BDBN in favour of her grandchildren at the inception of the SMSF but her grandchildren were not her superannuation dependants (see the definition in section 10 of the SIS Act above) so the BDBN was invalid.
Mrs. Wareham was the deceased member’s surviving trustee. Relations between her and the husband, Mr. Marsella, were strained. Mrs. Wareham appointed her husband Mr. Wareham as co-trustee. The trustees paid all of the deceased’s SMSF death benefits to Mrs. Wareham wholly excluding Mr. Marsella.
At first instance McMillan J. held that Mr and Mrs Wareham had exercised their discretion as trustees without giving real and genuine consideration to the interests of the dependants of the SMSF and:
- set aside the exercise of their trustees’ discretion to favour themselves; and
- removed Mr and Mrs Wareham as trustees of the SMSF.
This result was upheld on appeal to the Court of Appeal.
The court confirmed the wide autonomy the trustees of the SMSF had to select a dependant to take death benefits:
Apart from cases where trustees disclose their reasons, the exercise of an absolute and unfettered discretion is examinable only as to good faith, real and genuine consideration and absence of ulterior purpose, and not as to the method and manner of its exercise.from Karger v Paul  VicRP 13
Mr and Mrs Wareham did not give reasons for their decision to distribute all of the death benefits to Mrs. Wareham which meant that Mr. Marsella needed to establish:
- bad faith;
- lack of real and genuine consideration by; and/or
- an ulterior purpose of
the trustees in making the decision (the Challengeable Grounds). These are all matters that are challenging to prove before a court particularly where there are no expressed reasons of the trustees for making the decision. However in this exceptional case the Supreme Court could focus on:
- the erroneous response by the trustees’ lawyers in correspondence with Mr. Marsella over his claim to participate as a dependant. From that it could be shown that the trustees misconceived their obligation to give Mr. Marsella’s claim a real and genuine consideration. For instance, the trustees’ lawyers had asserted in the correspondence that “Mr. Marsella was not a beneficiary or dependant and had no interest in the fund”; and
- the bad faith of the trustees. The court observed that “the decision to pay no part of the death benefit to the deceased’s husband of more than 30 years was, at least, remarkable” and the “grotesquely unreasonable” nature of the decision to exclude him was enough to establish bad faith. As there was actual conflict between Mrs. Wareham, a trustee, and Mr. Marsella the court observed that it may remove a trustee in its discretion.
Balanced against that was:
- the trustees’ resolution to pay Mrs. Wareham which did not reveal errors that establish any of Challengeable Grounds;
- the power of the trustees to pay death benefits to a dependant who is a trustee despite the conflict of interest; and
- the trustees did not give evidence and so where not examined about their consideration of Mr. Marsella’s claims as a dependant;
An exceptional case
So even though Mr. Marsella was successful the case was appealed and hard fought. The trustees’ lawyer’s unlikely lapses in the correspondence and the extreme outcome and treatment of a husband of more than 30 years were vital to the result especially where SFGRs expressly permit a trustee to favour themselves in death benefits discretionary decisions despite their conflict of interest with other potential dependants that could receive those death benefits.
Where a trustee is more cautious and opaque in the course of:
- their decision to pay death benefits to their own benefit, despite their conflict of interest; and
- in related correspondence;
the trustee will reveal little which will give a disgruntled dependant Challengeable Grounds to challenge the trustee’s exercise of discretion.
In that respect Katz v. Grossman more likely reflects the reality facing most disgruntled family members who miss out on death benefits, especially those who are not a spouse or in an interdependency relationship. In Katz v. Grossman Mr. Katz may not have been in a position to establish the Challengeable Grounds even though:
- his father had nominated him on a non-binding basis to take an equal share of his death benefits; and
- his sister and her husband as trustees of the SMSF instead distributed all of the death benefits of the father to his sister.
It follows that the authority of Wareham v. Marsella may only assist a spouse or interdependency dependant highly deserving of death benefits as dependants in compelling cases where:
- a SMSF’s trustee makes identifiable error in the process of discretionary decision-making to pay death benefits to himself or herself despite their conflict of interest with the deceased’s spouse or interdependency dependant; and
- where that spouse or interdependency dependant can endure legal action to challenge the decision based on the Challengeable Grounds.
Otherwise SMSF members need to ensure the right person or people are their successor trustee of their SMSF if a Katz v. Grossman or other situation where a dependant favoured by the member misses out on death benefits is to be avoided. A valid or current expression of wishes either in a NDBN or better:
- in a BDBN, rigorously backed by SFGRs, included in or with the Will of the member to ensure its integrity, reducing the likelihood that a payment of death benefits will be made to the exclusion of a desired or deserving family member especially where, due to the confines of the SIS Act, the member can’t be confident that their successor SMSF trustee won’t use the opportunity to favour their own benefit; or
- where a member foresees that their dependants will be in potential conflict, in next generation or blended family circumstances, by taking steps in accordance with the SFGRs to remove trustee autonomy to make the death benefits payment decision and to instead mandate that death benefits are to be paid to the LPR of the member in compliance with core purposes of superannuation which allow payment of death benefits to the LPR under section 62 of the SIS Act. In that case the member can set out how death benefits are to be left in his or her Will.