Super's 'special' status in bankruptcy
By Claudine Siou, Senior Technical Services Manager
An aim of bankruptcy law is to provide a ‘fresh start’ for a person after they have been discharged from bankruptcy. The concept of a fresh start is embodied in bankruptcy laws which release the person from the future liability of having to repay their existing debts, allowing them to start afresh and rebuild their financial security.
Superannuation has a ‘special’ status in bankruptcy as it is property that is not divisible among creditors. This excludes situations where super contributions are recovered by the trustee in bankruptcy (the trustee appointed to manage the bankruptcy).
This protected status is given to very few other assets and where it is granted - those assets may be restricted in value. Super has a ‘special’ status in bankruptcy law because there is no limit on the value that is protected. Super’s special status is highlighted by contrasting it with the family home which is not protected in bankruptcy but which has prime status in other areas, for example social security and tax.
The protection of super from creditors recognises that the accumulation of super over a person’s working life is instrumental in giving them a fresh start after bankruptcy.
The personal impact of bankruptcy
Bankruptcy doesn’t only affect a person’s economic status, it also has other consequences.
- a bankrupt person must surrender their passport and cannot travel overseas without the consent of the trustee
- a bankrupt is automatically disqualified from managing a corporation and ceases to be a director of a corporation
- a bankrupt cannot be a member of a self-managed superannuation fund (SMSF). A bankrupt is disqualified from being an individual trustee and ceases to be a director of a corporate trustee. A bankrupt member has six months to exit the fund or restructure the fund to be a small APRA fund.
What property is divisible among creditors if a person becomes bankrupt?
Property owned by the bankrupt at the commencement of bankruptcy and property acquired by, or devolves on, the bankrupt, from the commencement of bankruptcy until discharge, vests in the trustee in bankruptcy and is divisible among creditors, subject to some exceptions.
Property owned by the bankrupt at the commencement of bankruptcy which vests in the trustee could include:
- the bankrupt’s home or share of their home. The rights of secured creditors, normally a mortgagee, are generally not affected.
- superannuation payments and life insurance proceeds received before bankruptcy.
Property that vests in the trustee as soon as it is acquired by, or devolves on, the bankrupt during bankruptcy may include:
- an inheritance from a deceased estate
- proceeds of a lottery win.
What superannuation contributions are voidable?
Superannuation contributions made, by a person who later becomes bankrupt, at any time before bankruptcy are void against the trustee, if the trustee can establish:
- the property would probably have become part of the bankrupt’s estate or been available to creditors if the contribution was not made, and
- the person’s main purpose in making the contribution was to prevent (or hinder or delay) the property becoming divisible among creditors (meaning their intention was ‘to defeat creditors’).
Superannuation contributions made by a third party, for example an employer or spouse, for the benefit of the bankrupt are voidable under similar conditions, where the contribution was made under a scheme, to which the bankrupt was a party. Employer salary sacrifice and spouse contributions made from a joint bank account could be captured under this provision.
Void means ‘voidable’ which generally requires the trustee in bankruptcy to undertake legal proceedings to have the contribution declared void by a court. This is an important point because unless the trustee takes action and succeeds in recovering the property, the contribution remains valid.
How can the court determine the individual’s main purpose in making super contributions was to defeat creditors?
In determining whether the person’s main purpose in making the contribution was to defeat creditors:
- the trustee needs to establish the person’s actual intention was to defeat creditors. However, an intention to defeat creditors may be inferred in circumstances where the contribution leaves the person with insufficient assets to meet their debts, as the result is the property is not available to be divided among creditors.
- the bankrupt is deemed to have that main purpose, if it can reasonably be inferred that at the time of the contribution the person was, or was about to, become insolvent. The actual intention of the contributor is irrelevant.
- the court must consider whether, at any time before the contribution was made, the person had established a pattern of making contributions and whether that contribution is out of character.
- ‘out of character’ contributions are not automatically assumed to have been made with the main purpose to defeat creditors.
- ‘out of character’ contributions may however indicate the contributor was aware of impending insolvency.
The importance of establishing a pattern of super contributions
Irrespective of circumstances which may clearly indicate the person was insolvent or was to become insolvent, the court ‘must’ consider whether the person had established a pattern of contributions. If the contribution formed part of an established pattern of contributions, it would not be seen as ‘out of character’ and therefore would not indicate that the person was aware of becoming insolvent. By establishing a pattern of contributions, an unlimited amount of superannuation funds may be accumulated and protected in bankruptcy.
Property that is not divisible among creditors
Property which is protected in bankruptcy includes:
- an interest of the bankrupt in a super fund, except super contributions recovered by the trustee in bankruptcy
- a payment, except a pension, from a super fund, received on or after the date of bankruptcy
- life and endowment insurance policies on the life of the bankrupt (or their spouse) and proceeds from such policies received on, or after, the date of bankruptcy
- damages and compensation amounts paid for personal injury, wrong or death, in certain circumstances, whether recovered before or after bankruptcy
- property held by the bankrupt in trust for another person
- household items deemed reasonably necessary for the domestic use of the bankrupt’s household
- a vehicle primarily used for transport worth up to $8,000 (the current threshold)
- tools of trade worth up to a total of $3,800 (the current threshold).
Are payments from a super fund protected from creditors?
Apart from pensions, all payments from a super fund received on, or after, bankruptcy, are protected and are not divisible among creditors. The protection is not qualified by who receives the payment from a super fund and reflects that a payment may be made not only to a member, but also to a spouse, child or other dependant of a deceased member. However, only payments made directly from a super fund are protected.
A super death benefit may be paid to the legal personal representative (the executor or administrator of the deceased estate) in which case a beneficiary receives the payment from the deceased estate. The payment loses its character as a payment from a super fund and is not protected from creditors of a bankrupt beneficiary.
Bankruptcy of a beneficiary is an important aspect of estate planning for super. Provided the beneficiary is an eligible dependant, a binding nomination in favour of a bankrupt beneficiary will ensure the payment is made from a super fund and protected from creditors. Careful consideration is required when nominating a beneficiary who is at risk of bankruptcy. If the super death benefit is paid prior to bankruptcy, the payment is divisible among creditors. If the direct payment occurs after bankruptcy it is protected.
What’s considered protected money?
Protected money includes a payment from a super fund and any proceeds of life and endowment policies on the life of the bankrupt or their spouse, received on or after bankruptcy. Property which is acquired wholly or substantially with protected money is also protected and not divisible among creditors.
What income contributions must be made during bankruptcy?
A bankrupt is required to make income contributions if their income exceeds the relevant threshold. This is currently $59,031.70 (after tax) for a person with no dependants and increases depending on the number of dependants. Half of any income which exceeds the threshold is a contribution for the benefit of creditors. Income is classified as ordinary income but may also include:
- employer super contributions in excess of an employer’s obligation to make superannuation guarantee contributions (currently 9.5%), under an industrial agreement solely between the employer and bankrupt
- an annuity or pension paid from a super fund
- a payment to the bankrupt in consequence of termination of employment
- an annuity or pension from a policy of life or endowment insurance.
Bankruptcy statistics indicate that payments of income contributions are a far more effective way to recover property. Registered trustees recover almost three times the amount of money for creditors from income contributions than voidable transfers of property.1
When is a bankrupt discharged?
A bankrupt is automatically discharged three years after the date the individual files their ‘Statement of Affairs’ with the Australian Financial Security Authority (ASFA). The period of bankruptcy can be extended up to eight years if the trustee objects to discharging the bankruptcy based on a range of grounds. Failure to comply with requests by, or disclose information to, the trustee are grounds for objection. Therefore a bankrupt has a strong incentive to co-operate during bankruptcy.
Super’s special status in bankruptcy provides the possibility of a fresh start
Making regular super contributions helps clients achieve their retirement objectives. The added benefit of establishing a regular pattern of contributions is that the client is reassured that if they become bankrupt, their superannuation will be protected from creditors. Upon discharge from bankruptcy, a client who has accumulated super in this way, may have ample resources to facilitate a fresh start.
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.