What professionals need to know about superannuation and insolvency

Insolvency can be a complex and stressful experience, especially when superannuation and self-managed super funds (SMSFs) are involved.

This article explores the key intersections between superannuation and bankruptcy, offering practical insights for professionals and their clients.

Superannuation Protections in Bankruptcy

Under the Bankruptcy Act 1966, most superannuation assets are protected from creditors. Specifically, funds held in regulated superannuation funds are considered “non-divisible property,” meaning they cannot be claimed by a bankruptcy trustee. This protection also extends to payments received from such funds after the date of bankruptcy. However, if a bankrupt individual receives a superannuation payout before being declared bankrupt, those funds lose their protected status and become part of the estate because they are simply money in a bank account. Even assets purchased with those funds may be claimed by the trustee.

Income Contributions During Bankruptcy

Bankrupt individuals may be required to contribute part of their income to their estate. This includes income from employment and certain superannuation payments.

Pensions and annuities paid from super funds during bankruptcy are considered income and therefore, may trigger obligations under the income contribution regime.

Lump sum payments, however, are not income under the Bankruptcy Act and therefore are neither divisible property or subject to the income contribution regime. The distinction between an income stream and a lump sum is largely dependent on the definitions in the trust deed and/or the Superannuation Industry (Supervision) Act 1993, and also revolves around the regularity of the payment.

Compulsory employer contributions are excluded from income calculations.  However, voluntary contributions, such as salary sacrifice arrangements, are included and may increase the bankrupt’s liability to pay income contributions.

Clawing Back Pre-Bankruptcy Contributions

Bankruptcy trustees have the power to void certain pre-bankruptcy transactions, especially those made with the intent to defeat creditors. This includes out of character contributions to superannuation funds made shortly before bankruptcy.

Sections 128B and 128C of the Bankruptcy Act allow trustees to recover such contributions if:

• The transfer was made to an eligible superannuation plan.

• The asset would have otherwise been part of the bankrupt estate.

• The main purpose was to shield the asset from creditors.

Even contributions made by third parties on behalf of the debtor can be voided if they were part of a scheme orchestrated by the debtor. Courts may infer intent based on timing, financial records, and the debtor’s solvency status.

To prevent abuse, the Bankruptcy Act includes a rebuttable presumption of insolvency if the debtor failed to maintain proper financial records. This shifts the burden of proof to the bankrupt to demonstrate solvency at the time of the transaction.

ATO Garnishee Notices and Superannuation

The Australian Taxation Office (ATO) can issue garnishee notices to recover tax debts from third parties holding money for a debtor—including superannuation funds. However, these notices only become effective once the member’s benefits are payable (e.g., upon retirement or death).

While there’s limited case law directly addressing garnishee notices on super funds, precedent suggests that future entitlements can be garnisheed if they are due and payable within a reasonable timeframe.

This may cause a cashflow problem for a bankrupt. They may be found liable for income contributions based upon pensions and annuities paid from super funds during bankruptcy but not actually receive the money because of an ATO garnishee notice.

SMSFs and Insolvency: Immediate Action Required

Section 17A of the SIS Act requires that all members of a Self-Managed Super Fund must be the trustees of the super fund, or if the trustee is a company, directors of the corporate trustee.  If a trustee or director of an SMSF becomes insolvent, they are automatically disqualified from acting in that role. This triggers a compliance risk for the fund, which must act swiftly to avoid penalties.

Within six months, the SMSF must:

1. Roll over the disqualified member’s interest to another complying fund.

2. Appoint a licensed small fund trustee (e.g., Australian Executor Trustees or Perpetual Limited).

3. Wind up the fund.
   
   Failure to act renders the fund non-compliant, which can result in significant tax consequences. The ATO may offer informal grace if the trustees proactively communicate and demonstrate intent to comply.
   
   
   

Final Thoughts

Superannuation is often a person’s most valuable asset, and its treatment during insolvency can have lasting financial implications. Understanding the protections, obligations, and risks associated with superannuation and SMSFs is essential for professionals advising clients or managing their own affairs.

If you have questions or need tailored advice, contact a Worrells principal in your area or visit www.worrells.net.au.