Superannuation and Bankruptcy

When someone declares bankruptcy in Australia, one of the most common questions is whether their superannuation can be used to repay creditors. 

In most cases, superannuation held in a regulated super fund is protected in bankruptcy and cannot be used to repay creditors. However, superannuation may become available to a bankruptcy trustee if funds were withdrawn before bankruptcy, transferred to avoid creditors, or held outside a regulated super fund.

Understanding how superannuation is treated in bankruptcy can help you make informed decisions and avoid legal consequences.

Is Super Protected from Bankruptcy

What the Bankruptcy Act Says About Superannuation

Section 116 of The Bankruptcy Act 1966 (Cth) states that a regulated superannuation fund and an approved deposit fund are not divisible amongst creditors, meaning your super is shielded from creditors during bankruptcy. The protection extends to payments received from regulated funds on or after your bankruptcy date. 

Superannuation is generally protected when:

• Funds remain inside a regulated superannuation fund
• The super fund complies with the Superannuation Industry (Supervision) Act
• The funds have not been withdrawn before bankruptcy
• A super payment is received after the bankruptcy begins

The Bankruptcy Act was modified with effect from 28 July 2006 to prevent debtors from funnelling assets into superannuation to avoid creditors. Trustees will look into contributions made after this date to determine if they were made to defeat creditors.

Regulated vs Non-Regulated Funds

Protection applies only if your superannuation sits in a regulated fund as defined by the Superannuation Industry (Supervision) Act 1993, an approved deposit fund, or an exempt public sector superannuation scheme. The fund must be a complying fund. 

Industry funds and self-managed superannuation funds (when structured properly) qualify as regulated funds.

Lump Sum Withdrawals

Timing determines whether your superannuation withdrawals receive protection. Withdrawals made before bankruptcy become simple cash in your bank account. Your trustee can claim these funds and any assets purchased with them.

Lump sum payments received during or after bankruptcy remain protected. Assets you purchase with post-bankruptcy lump sums also cannot be claimed by your trustee. This creates an important exemption because most assets acquired post-bankruptcy vest in the trustee as after-acquired property.

When Superannuation May Be Claimed in Bankruptcy

While superannuation is usually protected, there are situations where it may become available to a bankruptcy trustee.

Super Withdrawn Before Bankruptcy

If superannuation is withdrawn before bankruptcy and the money is placed into a personal bank account or used to purchase assets, the funds may become part of the bankrupt estate.

Once withdrawn, the money is no longer considered superannuation and may be accessible to creditors.

Contributions Made to Avoid Creditors

In the past, individuals facing potential bankruptcy would sometimes transfer funds into superannuation because those assets were protected from creditors. However, amendments to the Bankruptcy Act 1966 after 28 July 2006 gave bankruptcy trustees the power to recover certain contributions made to super funds.

Under sections 128B and 128C, contributions made by the bankrupt or by third parties may be void if the funds would otherwise have formed part of the bankrupt estate and the main purpose of the transfer was to prevent creditors from accessing the money.

Trustees often examine whether contributions increased significantly before bankruptcy. Unusual or large payments that differ from a person’s normal contribution pattern may be challenged and recovered for the benefit of creditors.

Super Paid as Income

If superannuation is received as an income stream or pension, the payments may be treated as income. In this situation, the income may count towards bankruptcy income thresholds, which could require contributions to the trustee.

Non-Regulated Super Funds

Protection only applies to regulated superannuation funds.

If money is held in a structure that does not qualify as regulated super under Australian law, the funds may not receive the same protections.

Self-Managed Superannuation Funds (SMSF) and Bankruptcy 

The situation becomes more complex when an individual’s interest is held as a beneficiary entitlement in an SMSF.

Why Bankruptcy Disqualifies You as an SMSF Trustee

Bankruptcy classifies you as a disqualified person under the Superannuation Industry (Supervision) Act 1993, meaning you can’t continue as a trustee of an SMSF or as a director of a corporate trustee. The Corporations Act 2001 prevents undischarged bankrupts from managing corporations.

You must retire as a trustee right away and notify the ATO in writing since acting as a trustee while disqualified carries significant penalties. 

The 6-Month Compliance Window

You have six months after you resign as trustee to restructure your SMSF. You must also exit the fund as a member because all members must be trustees or directors of the corporate trustee. Your SMSF balance requires careful handling after you seek legal and financial advice.

Options for Your SMSF When You Become Bankrupt

Three main alternatives exist to restructure:

• Roll over to a complying fund: Transfer your benefits to a retail, corporate, or industry fund
• Appoint an approved trustee: Convert to a small APRA fund by appointing a professional licensed trustee regulated under APRA
• Apply for court leave: Seek Federal Court permission to continue as director of the trustee corporation under certain circumstances

Non-Compliance Consequences and Tax Penalties

Your fund becomes non-compliant if you fail to act within six months. The tax consequences are severe: 45% tax applies to the fund’s income and the market value of assets just before the start of the year, less members’ tax-free component. Civil and criminal penalties may also apply. Your disqualification lifts once you are discharged from bankruptcy, and you can become a trustee again.

Examples of Superannuation and Bankruptcy

Below we’ve outlined three possible scenarios of how the rules apply in practice. 

Protecting Your Retirement Savings: What You Need to Do

Your retirement savings can survive bankruptcy intact if you take proactive steps.

Seek Professional Advice Early

Financial advisors or SMSF specialists will ensure your fund adheres to regulatory requirements and that you understand your rights and responsibilities under the Bankruptcy Act. Qualified SMSF auditors identify compliance issues before they escalate through regular audits.

Roll Over to a Complying Fund

Rolling benefits into a retail or industry fund within six months maintains compliance if you hold an SMSF. Your SMSF contains liquid assets rather than property, and this option works best.

Understand Family Court Settlement Protections

Superannuation entitlements are often a significant issue in Family Court matters involving the division of assets between the parties. Transfers into superannuation under court orders following Part VIIIB or VIIIC of the Family Law Act 1975 receive protection from clawback provisions.

Avoid Common Mistakes That Trigger Non-Compliance

Funds withdrawn from super before bankruptcy lose protected status. Trustees can void out-of-character contributions. Resign as SMSF trustee immediately upon bankruptcy and notify the ATO within 28 days.

How Can SV Partners Help? 

If you are facing financial pressure or considering bankruptcy, understanding how your superannuation and other assets may be treated is essential. Every situation is different, and the way the law applies will depend on your specific financial circumstances. Speaking with an experienced insolvency professional can help you understand your options and make informed decisions before taking action. 

The team at SV Partners can provide confidential advice tailored to your situation and guide you through the best path forward. Reach out to SV Partners to discuss your circumstances and find the best path forward.