What happens when a member of a SMSF goes broke?

All members of a Self Managed Super Fund (SMSF) must be the trustees of the super fund, or if the trustee is a company—directors of the corporate trustee. But what happens if a member becomes bankrupt or is subject to a Part X Personal Insolvency Agreement? Quite simply these people are no longer eligible to be trustees of the SMSF or to act as directors of corporate trustees.

What are the flow on effects of being a disqualified trustee?

1. You cannot act as a trustee.Doing so is committing an offence which may lead to fines and/or imprisonment.It may even be an offence for the other trustees who allow you to act as a trustee when they know you are disqualified.

2. You or the other trustees / corporate trustee must notify the Australian Taxation Office (ATO) of the disqualification within 28 days of the change in SMSF members.

3. The SMSF then has six months to either:

a) Roll your benefits out of the fund.

b) Appoint a small fund trustee who is licensed by the Australian Prudential Regulation Authority (APRA). I’m currently only aware of Australian Executor Trustees, and Perpetual Limited offering these services.Apparently it costs about $7,000+ to set up and $2,000+ in annual fees.

c) Wind up the fund.

If none of the above options are actioned, the fund automatically becomes ‘non-complying’ and will pay more in tax.

These implications do not bode well for the huge growth in SMSFs, particularly those that are buying investment properties using debt. In this scenario when a SMSF member goes bankrupt, how do you roll the bankrupt’s benefits out of the fund? You sell. Not an attractive option if there is little or no equity in the investment property.

The ATO’s website says to contact them about your options, but also says that a disqualified person (due to being an insolvent under administration) cannot have the disqualified status waived.

With 20,000 people going bankrupt last financial year, I’d say there is one or two wondering what to do with their SMSF!