Super and Bankruptcy – Protecting the Nest Egg - Part 1

Protecting the nest egg
Neal Dallas

Neal Dallas

Principal Superannuation and Revenue, McInnes Wilson

Neal Dallas, principal at McInnes Wilson Lawyers considers the extent to which amounts in superannuation are protected when implementing a bankruptcy strategy.  

The threat of bankruptcy is something which most professionals need to consider, if a claim as part of their professional working life arises. When an event of bankruptcy occurs, the primary concern of the trustee in bankruptcy is to determine the property owned by the bankrupt with a view to satisfying the claims of creditors. The larger the pool, the more likely it is that creditors will be paid. A bankrupt’s superannuation entitlement would be an attractive resource to the trustee in bankruptcy, were it available. However, whether the so called “divisible property” includes a bankrupt’s interest in a superannuation fund is dependent upon a number of factors. And whilst generally superannuation provides a significant degree of protection against claims by the trustee in bankruptcy, it is not always absolute. In more recent times, some bankrupts have sought to argue that an asset has a sufficient superannuation character with a view to having it excluded from the divisible property. So what exactly are the rules?

In this two part series, we will consider the extent to which amounts in superannuation are protected. In this Part 1 we will look at how amounts in superannuation funds are protected. In Part 2 we will look at how superannuation contributions might be clawed back out of a superannuation fund following bankruptcy.

Exclusions to Divisible Property

Under the Bankruptcy Act 1966 (Act), where a debtor becomes bankrupt, their property vests in their bankruptcy trustee. The Act treats the following items as ‘property’ to be divisible amongst the creditors of the bankrupt:

  • property belonging to a bankrupt at the commencement of bankruptcy;
  • property acquired by a bankrupt after the commencement of bankruptcy and before discharge; and
  • the right to exercise the powers over or in respect of property which could have been exercised by the bankrupt at the commencement of the bankruptcy and before the discharge.

However, certain property of the bankrupt is not divisible amongst creditors. In relation to superannuation, interests that are excluded as property divisible among creditors are:

  • the bankrupt’s “interest in a regulated superannuation fund; and
  • lump sum payments from a regulated superannuation fund to a bankrupt on or after the date of bankruptcy.

An “interest” refers to property vested in a bankrupt which has not yet been received by the bankrupt. As such, a superannuation interest would include an entitlement to receive a benefit from a superannuation fund.

A person who is in the accumulation phase will typically have an interest equal to their account balance from time to time. The account balance represents the amount which is vested in the member, and which is the amount that would be paid out of the fund if the member sought to transfer their entitlement to another superannuation fund.

The interest of a person who becomes entitled to a benefit will often similarly be equal to their account balance at that time, albeit that the benefit might have been enhanced, say, through the receipt of insurance proceeds (e.g. in the case of a person entitled to a total and permanent disablement benefit) or as a result of being entitled to a defined benefit in the fund.

A member might subsequently become entitled to be paid a benefit, because they have met a condition of release. For example, where a member reaches preservation age (currently age 57) and retires, there is no longer any “cashing restriction” applying to their benefit. Subject to the trust deed otherwise allowing, the member is free to call on the payment of their full benefit. Whilst this might be seen as liberating the member’s benefit, there is no change from the bankruptcy perspective. The value of the interest does not change, and provided it remains an interest in the superannuation fund, it is excluded as “divisible property”.

A member might request that their benefit be paid out once a condition of release is met where there is no cashing restriction. At that point the benefit is considered an “unrestricted non-preserved benefit”. But as there is no requirement under superannuation law for a benefit to be paid (except in the case of the death of a member), so long as the entitlement remains in the fund it retains the character of a superannuation interest.

If a member requests and is paid their unrestricted non-preserved benefit, upon payment from the fund, the benefit ceases to have the character of a superannuation benefit. The relevant characterisation of the entitlement at the time of bankruptcy is critical.

There is currently no limit on the amount of a bankrupt’s superannuation interest that is excluded from “divisible property”. The protection afforded to superannuation interest applies irrespective of the amount of the benefit.

Protection extends to a payment to the bankrupt from a superannuation fund received on or after the date of the bankruptcy; on the proviso that the payment is not a pension. Therefore, notwithstanding that upon payment of a benefit from a superannuation fund the benefit loses its character as a superannuation interest, if the bankruptcy happens whilst the interest is in the fund, the protection persists despite the subsequent change in character.

This means that a bankrupt with a significant interest in a superannuation fund could be paid that benefit - after becoming bankrupt - and could retain those payments and assets acquired using those amounts, so long as the bankrupt receives the benefits in the form of lump sum payments. If the member was paid the benefit prior to becoming a bankrupt, the payment ceases to be an interest in a superannuation fund – and therefore loses the protection under the Act because the payment occurred before the date of bankruptcy. Consequently, a fund member facing the threat of bankruptcy and who becomes entitled to payment of a benefit should consider whether to retain the benefit in the superannuation fund until either the threat passes, or until they become bankrupt.

Position of Pension Income

Bankrupts are required to contribute part of their income earned during their bankruptcy to their bankrupt estate. The Act defines “income” for contribution purposes under the Act as including a superannuation pension. As such, a member may become liable to contribute part of their pension payments to their bankrupt estate for division amongst creditors.

The Act sets out a formula for determining the amount of a bankrupt’s income which is to be contributed. The bankrupt is required to contribute 50% of the excess over the Base Income Threshold Amount (BITA). The BITA for a bankrupt is set out under s139K of the Act and increases depending on the number of dependants the bankrupt has. The BITA is updated twice a year on 20 March and 20 September, and at the date of this publication is:

 

Number of Dependants

 

Income Limit

 

0

 

$56,674.80

 

1

 

$66,876.26

 

2

 

$71,977.00

 

3

 

$74,810.74

 

4

 

$75,944.23

 

over 4

 

$77,077.73

 

While pension payments have to be relatively substantial to exceed the abovementioned thresholds, the definition of income extends to many areas including income under ordinary concepts and usage, distributions from trusts, payments from employers and the value of fringe benefits. Consequently, it is possible that a bankrupt entitled to a pension entitlement along with other income could exceed this threshold, and therefore it is possible that a bankrupt may be required to contribute up to half of their pension payment to their trustee in bankruptcy.

Strategies to Protect the Pension

Because pension payments are considered ‘income’, it is imperative that the bankrupt is aware of their BITA and considers whether current pension payments from their superannuation fund (together with other income) would exceed this amount. If the applicable threshold has been or is likely to be exceeded, then the bankrupt might consider taking steps to either reduce or terminate their pension. In most instances it will be possible to stop the pension, and roll the benefit back into accumulation phase.

Particular care needs to be taken with respect to a death benefit pension. Where a death benefit is paid as a pension, and subsequently rolled back, it cannot remain in accumulation phase. It must be paid out of the fund as a lump sum (or a new pension commenced). If a bankrupt ceases a death benefit pension and takes the benefit as a lump sum, the protection afforded under the Act still applies. However, in the longer term, it might be undesirable to have a benefit leave the superannuation environment given that there may be other reasons to retain the benefit in the fund (most notably the concessional tax treatment that applies to the income on the assets supporting the pension). Consequently, where a bankrupt is in receipt of a death benefit pension it may be appropriate to consider which is the lesser of two evils – continuing the pension but having to make contributions of part of the pension to the bankrupt estate; or ceasing the pension and paying it out of the fund as a lump sum benefit. At the very least, if the pensioner is taking pension payments higher than the minimum required by the superannuation rules, the pensioner should consider reducing the pension payments to the minimum amount. This may reduce the bankrupt’s income below the BITA, or at least reduce the level of contribution otherwise required.

Where a pension is able to be rolled back to accumulation phase (i.e. a non-death benefit pension), it will be possible for the bankrupt to cease their pension, but continue to access their entitlement where the benefit is an unrestricted non-preserved benefit. The member could elect to take lump sum payments from the fund. When rolling back the pension, it is relevant to note that income on the assets which were supporting the pension and which was not taxable will become taxable in the fund.

Despite lump sum payments being exempt as property that will vest in the trustee in bankruptcy, it may be prudent to ensure that such payments are not made at regular intervals and in similar amounts. Such conduct might arguably mimic pension payments, and might otherwise be sought to be characterised by the trustee in bankruptcy as an income stream and therefore property divisible amongst creditors.

Finally, if large lump sum amounts are taken out of the fund (e.g. where a death benefit is rolled back and paid from the fund), consider the impact of the way in which those amounts are invested. Whilst those amounts, and the assets acquired, are protected, to the extent that the amounts or assets generate income, the contribution rules will apply. It may make little sense to remove assets from the superannuation fund if the income they generate outside the fund for the bankrupt is similar to the income stream the bankrupt received from the pension.

The strategies outlined above consider potential approaches that a bankrupt might contemplate. Anyone who finds themselves bankrupted should obtain personal advice which takes into account their objectives, situation and needs prior to implementing any strategy.

In the next Part, we will look at the way in which contributions to superannuation funds prior to bankruptcy may, in some circumstances, be clawed back out of the fund by a trustee in bankruptcy.

McInnes Wilson Lawyers has the experience and expertise to assist medical practitioners in relation to their personal asset protection structuring requirements, as well as assisting with superannuation related matters.

Further information can be obtained by contacting Neal Dallas on (07) 3014 6598.

DISCLAIMER: McInnes Wilson Lawyers Pty Ltd ABN 30 137 213 015 | The information provided in this article is of a general nature and does not take into account individual objectives, legal and financial situation or need.

This article is intended to provide general information only. It is not intended to be formal advice and should not be relied upon as such. Formal advice should be sought for any particular circumstances pertaining to the reader of this disclaimer. The author disclaims liability for any loss incurred by any person who acts in reliance upon the information contained in this article.

Should the contents of this article be posted on any other publication then the reader of this disclaimer acknowledges that the author has no control over its nature, content and accuracy Any references to the author do not imply a recommendation or endorsement of the views in those other publications. 

The Private Practice Magazine


Practice, financial and lifestyle 
management insights relating 
to medical professionals



head-settings Created with Sketch.

Protect yourself early

McInnes Wilson Lawyers has the experience and expertise to assist medical practitioners in relation to their personal asset protection structuring requirements, as well as assisting with superannuation related matters. If you are looking for advice, please contact us for an introduction to Neal Dallas or one of his team today.

Contact us for an introduction 

Call us on 02 9229 9731 or leave your details, including the name of person you would like an introduction to and we will be in touch.

By signing up, you confirm you are happy to be contacted about The Private Practice Services and offers. View our privacy policy.