Superannuation Death Benefits and Bankruptcy - Important Points for Will Drafting
If a person dies and leaves their estate to a bankrupt beneficiary, the estate may be lost to the beneficiary's creditors unless alternate arrangements are prescribed in the Will.
Whilst section 116(2)(d)(iii) and (iv) of the Bankruptcy Act 1966 generally exempts superannuation interests and payments from property divisible amongst creditors, it has not always been clear whether the exemption extends to a beneficiary's interests in a deceased person's superannuation either under a death benefit nomination or traced through the deceased person's Will.
Two recent cases have addressed this question and provide guidance to succession lawyers seeking to draft Wills with asset protection objectives in mind.
In Morris v Morris  FCA 846, the trustees of a deceased man's superannuation fund determined to distribute his death benefits directly to his widow. She had been made bankrupt about 3 months after his death. When she received the funds she claimed they were exempt from property divisible amongst her creditors. Her trustees in bankruptcy argued otherwise. The Court held that when the superannuation fund trustees made their determination to distribute to her, an interest in his superannuation fund was created and the funds became exempt.
In Cunningham v Gapes  FCA 787, death benefits were paid to the legal personal representative of the deceased person's estate and distributed to the residuary beneficiaries under her Will. One of those beneficiaries was a bankrupt and claimed his share of the death benefits were exempt under section 116. The trustees in bankruptcy disputed this. The Court held that he only derived the death benefits because he had an interest in the deceased's Will, not because he had an interest the deceased's superannuation fund. Accordingly, the benefits were not exempt and could be claimed by the trustee in bankruptcy.
Both of the cases indicate that a person only has an “interest in a superannuation fund” for the purposes of section 116 if the interest derives from the fund deed under trust law. Such an interest may arise by the trustee determining to distribute the benefits to the person as the named beneficiary of the death benefits or by the trustee being required to distribute the benefits to the named beneficiary in compliance with a binding nomination (thus making the person presently entitled to the benefits under the fund deed for trust law purposes).
It will not arise, however, by “tracing” the ultimate beneficiary of death benefits through a Will. So, in cases where the superannuation fund trustee determines to distribute to a legal personal representative (whether by the exercise of discretion or compliance with a binding nomination), the benefit will not be protected under section 116 because the legal personal representative will be presently entitled to the funds under the fund deed rather than a named beneficiary. It does not appear to matter if the Will specifically gifts the death benefits to a named beneficiary – in such case, the beneficiary’s entitlement will derive from the Will, not the superannuation fund deed.
Accordingly, any protection of superannuation death benefits paid to a deceased person's estate from the interests of a bankrupt beneficiary in the estate must be addressed in the Will another way. The will-maker may consider:
- vesting those assets in a trustee of a non-fixed trust (such as a superannuation proceeds trust or testamentary discretionary trust, where the bankrupt beneficiary will be a mere discretionary object), or
- making any gift of death benefits to a beneficiary under the Will wholly contingent upon the beneficiary not being a bankrupt.
In the first case, the recent decision of Fordyce v Ryan & Anor; Fordyce v Quinn & Anor  QSC 307 affirms that (subject to the terms of the trust) a bankrupt’s interest under a purely discretionary trust is not an interest in any assets of the trust and is not property that passes to a trustee in bankruptcy under section 116, even where the beneficiary controls the trustee. In that case, a bankrupt discretionary beneficiary was also the sole director and shareholder of the corporate trustee. The trustee in bankruptcy argued that the trust assets should be included in the beneficiary’s estate because it was “as good as certain” that the beneficiary would benefit from the trust if he were not a bankrupt. The Court disagreed and held that control did not alter his interests in the trust and accordingly the trust assets were excluded from the property divisible among the beneficiary’s creditors.
The case indicates that superannuation death benefits paid to a beneficiary controlled testamentary discretionary trust are unlikely to form part of the beneficiary’s estate under section 116. To ensure the trustee in bankruptcy cannot assume control of the trust, the Will should also disqualify the beneficiary from acting as trustee whilst he or she is a bankrupt.
In the second case, where a gift to a beneficiary is wholly contingent upon the beneficiary not being a bankrupt, succession lawyers need to consider if section 302B of the Bankruptcy Act applies. Section 302B(1)(a) provides that a provision of a trust deed is void to the extent it has the effect of cancelling, reducing or qualifying a beneficiary’s interest under the trust if the beneficiary becomes a bankrupt. It is currently unclear whether this section extends to gifting provisions, or trust provisions, in a Will, because a Will is not (or at least is not generally considered to be) a “trust deed”. For this reason, succession lawyers need to exercise caution before relying upon a bankruptcy contingency provision to achieve the asset protection objectives of a will maker.
It is generally preferable to use appropriately drafted testamentary discretionary trusts to protect family assets bequeathed under a Will from the risks and uncertainties of future generations. This also applies where those assets include superannuation death benefits paid to the estate. If a will maker, who is concerned about a financially unstable beneficiary, does not want to include a testamentary discretionary trust in their Will, serious consideration needs to be given to whether superannuation death benefits ought to be distributed to the beneficiary directly from the superannuation fund and whether by doing so section 116 will apply.
Special Counsel │ Private Advisory