Insight From Your SMSF Advisor
Did you know that according to the Australian Financial Security Authority report that between 2020-21 there were 10,621 new personal insolvencies reported as well as 6,792 bankruptcies? It’s not all bad, there were falls in all states and territories as total personal insolvencies fell by 49.6% in 2020-21 compared to 2019-20.
So, what is the difference between insolvency and bankruptcy?
- Insolvency is when a company or a person isn’t able to pay debts when they are due
- Bankruptcy is just one option for dealing with personal insolvency.
With insolvency, there are several options available to an insolvent company or an insolvent person:
- The most common corporate insolvency procedures for an insolvent company are liquidation, voluntary administration and receivership
- The available personal insolvency procedures for an insolvent person are bankruptcy and personal insolvency agreements
However, when it comes to bankruptcy, this is a legal process when you’re declared unable to pay your debts. It can release you from most debts, provide relief and allow you to make a fresh start.
But what actually happens to your debts? If you enter bankruptcy, you will find that most debts are covered, meaning that you no longer have to repay them. In some cases, your appointed bankruptcy trustee may sell your assets or use compulsory payments to help pay your debts.
So, is your superannuation safe from bankruptcy? Before we get into the specifics, it’s important to understand the consequences of bankruptcy, the difference between secured and unsecured debts and a few other topics we’re throwing in for good measure!
A Word Of Warning From Your Financial Planner + The Consequences of Bankruptcy
Once a person is declared bankrupt, most unsecured creditors are unable to pursue further legal action.
Also, once the period of bankruptcy ends, the person is ‘discharged’ from bankruptcy and most of the person’s debts are cleared through the sale of assets and compulsory payments as we mentioned above.
However, some of the consequences of bankruptcy include:
- A trustee will be appointed and will manage the bankruptcy;
- Bankruptcy may affect income, employment and business;
- Bankruptcy does not release a person from all debts. If secured debts cannot be paid, the client will have to surrender the secured items back to the creditor;
- Bankruptcy affects a person’s ability to travel overseas;
- The person’s name who declared bankruptcy will permanently appear on the National Personal Insolvency Index (NPII);
- Bankruptcy can affect a person’s ability to obtain future credit. A person’s credit report will continue to show their bankruptcy for either;
- 2 years from when their bankruptcy ended or
- 5 years from the date they became bankrupt (whichever is later)
- The trustee may sell the person’s assets;
- The person may lose their right to make or continue legal action; and
- Bankruptcy normally lasts for three years and one day from the day AFSA accepts the client’s bankruptcy form.
Help from Financial Professionals With Understanding Secured -VS- Unsecured Debts
Unsecured debt is a common form of debt that has no collateral backing. This means that if you default on those debt payments, then the lender has no property to seize or recoup its losses.
Bankruptcy covers most unsecured debts such as:
- Credit cards
- Unsecured personal loans and payday loans
- Gas, electricity, phone and internet bills
- Overdrawn bank accounts and unpaid rent
- Medical, legal and accounting fees
Bankruptcy releases most of these debts when it ends. However, it doesn’t cover all debts, including:
- Court imposed penalties and fines
- Child support and maintenance
- HECS and HELP debts (government student loans)
- Debts you incur after your bankruptcy begins
- Unliquidated debts (e.g. a debt where you and your creditor are yet to determine the amount)
This means that you are still liable for these debts.
Secured debt is tied to a specific property, like a house or a car for example. The creditor has the right to take possession of your property if you don’t make the repayments.
Seek Financial Advice for Superannuation + Bankruptcy
Generally, superannuation is held in a regulated superannuation fund at the date of bankruptcy is considered protected property. Lump sums paid from the fund to the bankrupt during bankruptcy are protected, and any property purchased with those amounts is also protected.
However, in some situations, superannuation is not protected from bankruptcy. When facing a situation where bankruptcy is imminent, there are a few important factors that need to be considered:
- Any superannuation withdrawn prior to the date of bankruptcy is not protected;
- Where property was transferred to a superannuation fund before the date of bankruptcy to defeat creditors, the property is not protected. This includes transfers made by the bankrupt person and any transfers made by third parties for the benefits of the bankrupt person; and
- For the period of bankruptcy, the bankrupt person must make payments to the bankruptcy trustee of half of any income they earn over a certain threshold. Gross annual pension payments from a superannuation income stream are included in the definition of income for this purpose.
Payments from Superannuation Funds Can Affect Your Financial Goals
Superannuation payments (income or lump sum) that are received before bankruptcy:
- Are claimable by the bankruptcy trustee
- The bankruptcy trustee can claim assets purchased with those funds, e.g. a house
Superannuation lump sum payments that are received during the bankruptcy period:
- Are not claimable by the bankruptcy trustee if it is a lump sum payment
- The bankruptcy trustee cannot claim assets purchased with those funds
Superannuation income stream payments that are received during the period of bankruptcy form part of the assessable income. If the income is over a set amount, you may be required to make compulsory payments.
For the period of bankruptcy, the bankrupt person must make payments to the bankruptcy trustee of half of any income they earn that is over a certain threshold. The threshold is set at 3.5 times the maximum basic rate of age pension for a member of a couple. As at 20 September 2021, this is $61,515.00 – however, this number will be higher if the bankrupt person has dependents.
It is important to note that the gross annual pension payments from a superannuation income stream are included in the definition of income for this purpose. When determining whether a bankrupt person should draw a pension payment from their superannuation fund, consideration should be given to limiting the amount of the pension payments to ensure their total income is below the relevant threshold.
Self-Managed Super Funds + Bankruptcy
Every member of a self-managed super fund must be either a trustee of the SMSF or a director of the fund’s corporate structure. If one of those members becomes bankrupt – they cannot have an SMSF.
A person who is an undischarged bankrupt, or has executed a personal insolvency agreement, will be a disqualified person under the superannuation legislation.
The appointment of a restructuring practitioner under the insolvency reform is also an insolvency event that triggers the disqualification of a corporate trustee, custodian or investment manager of a superannuation entity from managing a superannuation entity.
This means that the person:
- Must not act as trustee of an SMSF or act as a director of a corporate trustee of a self-managed super fund; and
- Must immediately inform the ATO that they have become a disqualified person.
The self-managed super fund definition in section 127A of SIS confirms that a legal personal representative is not permitted to act as a trustee in the disqualified person’s place. For example, a trustee who has become disqualified due to becoming bankrupt could not appoint someone else to act as trustee in their place.
While a person who becomes bankrupt must immediately cease to be a trustee or director or a company trustee of a self-managed super fund, the SMSF definition provides a six month grace period during which the person can remain a member of the fund, allowing the SMSF to deal with the issue and make alternate arrangements.
If you have a self-managed super fund with a member that is facing bankruptcy, it is imperative that you seek advice from a self-managed super fund specialist, like Helen Yau on our Canny Advisory team.
Financial Advisory Services from Canny Group + Your Superannuation
If you are finding yourself starting down the unknown road ahead of bankruptcy, it is important that you have the right team behind you, including your lawyer, your financial adviser as well as your accountant to work out if this is, in fact, the best road for you to take. Better yet, if you don’t have either of those… we can help you with all of them, under one roof!
Bankruptcy doesn’t have to be the only option if you are finding it increasingly hard to be able to meet your payment requirements for creditors. Get in touch with our team to have a chat about what your options are – and if it’s bankruptcy, let us help you.