18 Jan Considering a SMSF? Read This First
Self-managed superannuation funds (SMSFs) are a popular choice for individuals saving for their retirement. There is no doubt that these an appropriate way to hold your superannuation if you want more control over how you invest, how much you pay and the option to hold property investments. Individuals with a level of satisfaction to be enjoyed from managing your investing arrangements exactly as you want and to be able to directly invest in assets that are not offered by retail fund.
However, establishing and running your own SMSF is not all plain sailing and you need to consider the responsibilities of a fund trustee and just how well prepared you are to choose your investment approach.
Quite often I speak to fund trustees for whom the initial euphoria of having control and flexibility has been overwhelmed by the drudgery of ongoing accountability and reporting that come with being a trustee of an SMSF
In a recent Kaplan article ‘Are SMSFs the right fit for everyone?’ (Nov 2017) Philip La Greca from Super Concepts made the following points:
“This is not something where you put money in, maybe pick a few assets and that’s it. You have a whole range of other responsibilities that will cause you to have to invest your own time. The name ‘self-managed super fund’ is a bit of a misnomer. It’s more self-directed than self-managed,” he said.
“You’ve also got to engage with others to prepare financial statements, tax returns, have an auditor, possibly get an actuary involved and have these accounts lodged with the Tax Office. It is a time commitment, and considering how little time people have outside of work and family, it’s a big issue.
”No-one really talks about what you actually have to know to run the fund. There is a trustee declaration that the ATO requires you to sign, and it says you understand a whole range of rules, but you really wonder how many actually do.”
The Trustee Responsibility
This is not something that you can get around. Essentially, all members either have to be trustees or directors of a trustee company. In effect, you are responsible and accountable for the decisions your fund makes and for keeping all required records.
The Australian Tax Office (ATO) is responsible for monitoring the trustees of self-managed funds. Previously the ATO took a conciliatory approach and gave warnings for identified breaches. However, more recently the ATO has taken a strong stance on trustees not understanding their responsibilities and has wielded the considerable powers and penalties available to penalise trustees that take their responsibilities too lightly.
One of the scariest outcomes is where the super fund is ruled as non-compliant. Where this occurs the tax penalty applicable is charged at the top marginal rate (45%) and this penalty is applied to all contributions and fund earnings from the time that the fund was considered non-compliant. Whilst non-compliant the fund cannot accept any superannuation contributions. Not a cost and issue that you are likely to come across using your average retail fund!
To be deemed as non-compliant the fund may have failed to fulfil the sole purpose test. This can occur where an investment is entered into which does not have a proper link to the future retirement of members. Often trustees fail to keep adequate records of their decision making process and as such, can have difficulty justifying an investment which attracts the ATO’s attention from the fund’s ongoing reporting obligations.
The Sole Purpose test
The sole purpose test requires a superannuation fund to be maintained for the sole purpose of providing its members with retirement benefits, or providing its members’ beneficiaries or dependants with benefits in the event that the member dies before retirement.
Specifically, a regulated superannuation fund must be maintained solely for at least one of the legislated core purposes, or for at least one of those core purposes and one or more of the ancillary purposes. It is a contravention of the sole purpose test for a superannuation fund to be maintained only for one or more of the ancillary purposes.
These are defined in the SIS act as the:
- Provision of benefits for each fund member on or after the member’s retirement from any business, trade, profession, vocation, calling, occupation or employment in which the member was engaged (whether the retirement occurred before or after the member joined the fund)
- Provision of benefits for each fund member on or after the members reaching age 65
- Provision of benefits to the legal personal representative (LPR), and/or the dependants of a fund member, on or after the death of the member, provided that the death of the member occurred before they retired or attained age 65.
Ancillary purposes are those for which a superannuation fund may be maintained in conjunction with at least one of the core purposes:
- The provision of benefits for each member on or after termination of employment from an employer or any associates who had, at any time contributed to the fund in relation to the member, when termination includes resignation and redundancy
- The provision of benefits for each member on or after the member’s temporary or permanent cessation of work on account of physical or mental ill health
- The provision of benefits in respect of a deceased member, to the member’s LPR and/or to dependants of the member, where the member dies after retirement or after reaching age 65 (also known as “reversionary benefits”)
- The provision of such benefits as APRA approves in writing, including benefits approved previously by the Insurance and Superannuation Commission.
The fund has to lodge annual reports and potentially be audited. Depending on the investments held and the stage of a members accounts (accumulation or pension), the reporting can become more complicated and thus, more expensive.
The ATO recommends that a fund should have a minimum balance of $200,000 prior to commencing so that the reporting costs are attributable to a reasonable sized asset base.
The Investment Strategy
According to the ATO website:
Before you start making investments you must have an investment strategy. This sets out your fund’s investment objectives and specifies the types of investments your fund can make. Your investment strategy should be in writing and must:
- be reviewed regularly to ensure it continues to reflect the purpose and circumstances of your fund and its members (your review and any decisions made should be documented)
- consider whether to hold insurance cover (such as life insurance) for each member of your SMSF.
Given the obligations of the trustees to meet the sole purpose test for their fund and the onus of the investment’s held being aligned with this test, not having an up-to-date Investment Strategy or investing in a manner not keeping with the existing strategy is potentially an expensive arrangement.
Arm’s length and non-arm’s length investments
Often individuals are seeking to commence a SMSF to hold specific or unusual assets and unfortunately these often run foul of the arm’s length and in-house asset rules.
There is a fundamental principle when investing for an SMSF that transactions must be made and maintained on an arm’s-length basis. In other words, non-arm’s length transactions are prohibited.
The arm’s-length requirement does not necessarily prevent SMSF trustees from entering into investment transactions with related or associated parties, however, market value must be used at all times. Using an independent valuer can help to establish that market value is met. However, it is important to remember that other investment rules may prevent or limit such transactions.
The ATO defines an in-house asset as:
An in-house asset is a loan to, or investment in, a related party, an investment in a related trust, or an asset of your fund that is leased to a related party. In-house assets can’t be more than 5% of your fund’s total assets.
The rules around this are complex following a number of amendments but this can restrict the fund holding assets where the member has involvement. This rule is instrumental in preventing the transfer of an existing residential rental property into a SMSF.
Ongoing Obligations in your Old Age
Concentrating on meeting the trustee responsibilities in old age often becomes very burdensome on trustees. Adding to this, often elderly members have converted to the pension phase, requiring additional reporting obligations and a annual payment out of the fund. Where these requirements are missed there may be additional reporting, tax and advice costs which are incurred by the fund.
Often at this stage, as the interest in managing your own retirement investments wanes, trustees seek to exit from a Self-Managed Fund and wind the fund up.
Costly and Sometimes Difficult to Wind-up
It’s always good when you start something to have an exit strategy in mind. One of the issues with commencing a Self-Managed Superannuation fund is the time and administration effort required if you decide to wind-up an existing fund.
There are generally two major reasons for winding up an SMSF:
- The client comes to a conclusion that it is not for them (e.g. it does not deliver what they thought or involved more work than they anticipated)
- One trustee passes away and suddenly all responsibility now falls to the surviving trustee.
A typical issue that occurs with ceasing a self-managed fund is where the assets held are real property or illiquid. Where such assets are held in the fund, since these assets are impossible to transfer into a retail fund, the SMSF needs to be retained (ongoing obligations and costs met) until these assets can be sold to cash.
These are just some of the issues to keep in mind when considering whether a SMSF is right for you. If you wish to discuss your personal circumstances please call us on 02 9633 5530 and we can help.