Don’t Start Your SMSF On The Wrong Foot

Are you considering setting up a self-managed superannuation fund (SMSF)? If you are, you should know that there are many rules and regulations set by the Australian Taxation Office (ATO) that you must be aware of, and comply with, if your fund is to remain compliant and attract tax benefits.

Knowing these rules and regulations in detail before you start will set you on the right path to building retirement wealth, but what is equally important is knowing that there are some things you cannot do with your SMSF. As fund trustee, you are responsible for making sure that the fund complies with all regulatory and compliance obligations. Failure to do so could see your fund hit with significant penalties and possible loss of its complying status.

As a quick example, here are five common things that some trustees have been found to be doing that have attracted the attention of the regulators.

Using the SMSF to Provide Financial Assistance to a Family Member

Trustees can purchase property as an investment for the fund, and some have leased this property to a family member. Their argument for this arrangement is that it is no different from leasing to a stranger, and they fully intend to operate it on commercial terms. However, their close family relationship prohibits this. The arrangement is considered to be providing financial assistance to a family member and also fails the sole purpose test.

Using Borrowed Funds to Improve Properties Owned by the Fund

What is important to know is that you can make improvements to property assets, provided the extent of the improvements does not change it into a different asset. To clarify that statement further, the improvements must not change the character and nature of the property.

The trustees can make these improvements using the SMSF’s own resources, that is, cash, but they cannot borrow to do so. The ATO does allow the fund to borrow for the acquisition of a single acquirable asset, as well as any costs associated with repairing or maintaining the asset, but not to make improvements.

Not Keeping Personal or Business Assets Separate from Those Held by the SMSF

This should be a “no-brainer”, especially as many trustees of SMSFs are business owners or managers. Keeping personal and business income and expenses separate has been a fundamental part of our tax structure for decades, so it should be second nature to run an SMSF the same way. However, there have been cases where the trustees have not kept records sufficiently detailed to show this separation.

Investments on behalf of the SMSF must be registered in the name of the fund with all trustees shown as signatories. They must not be used for personal or business purposes under any circumstances. To do so is a breach of superannuation law, which states that the purpose of fund investments is to provide for members in retirement.

Using SMSF Funds to Buy Residential Property for Yourself

This makes perfect sense if we go back to the sole purpose test, that is, the fund exists to provide for its members in retirement. Superannuation rules state that the trustees cannot get a benefit from their fund until they are retired. This means that you cannot buy a house to live in, regardless of the circumstances, including a holiday house through your own SMSF.

Fail to Properly Discharge Your Duties as Fund Trustee

This is one area a trustee cannot ignore. The penalties for non-compliance with the administrative and regulatory requirements are severe. Lodging all the forms and returns correctly and on time each year is part of the responsibilities of being a trustee. Doing this will keep your fund compliant. You must therefore make sure you understand and also discharge all these responsibilities.

If this all seems too much work, and changes in superannuation laws and regulations are becoming too frequent and complex, there are options available. There are now several companies in the superannuation industry, such as SMSF Assure, that provide a range of services to trustees to help them keep their funds compliant.

Would Your SMSF Portfolio Benefit From Diversification?

Are you the type of investor who is actively seeking wealth-building opportunities for your SMSF (self-managed superannuation fund), or is your approach conservative, preferring to settle for smaller returns in exchange for a higher level of security? While we can all understand the reasoning behind the latter approach, is there a better alternative?

According to the ATO (Australian Taxation Office), current SMSF fund trustees have placed their investments predominately in property, cash and Australian shares. While there is nothing wrong with that, they may be missing opportunities to build more diverse and robust portfolios. They may also be exposing their funds to diminished returns should the Australian market drop sharply against the rest of the world.

It all depends on the asset class that features most strongly in their fund portfolios. Not all asset classes perform at the same level in the same time frame. For example, since 2008, interest rates have fallen to unprecedented levels. A fund that holds the bulk of their assets in cash will not have built as much wealth for its members as one that invested heavily in property during the same time period.

Many SMSF trustees are comfortable with outsourcing the administration of their fund to companies such as SMSF Assure, but some of them still prefer to make the investment decisions themselves. When they first established their fund, they were required to develop an investment strategy with a licensed financial adviser but, too often, they stick with this strategy year after year. This may not deliver them the best long-term outcome for their members, especially if their knowledge is limited to domestic shares and property.

A better solution could be to diversify their portfolios across a range of investments to not only spread the risk, but also to even out the peaks and troughs that occur in any type of market. Managed funds are one option that could appeal to fund trustees who are ready to be a little more aggressive in their investment choices, but still want a reasonable level of safety.

Managed funds offer both diversification and professional expertise. Instead of the fund trustee being responsible for investment decisions, these decisions are made by professional investment managers. Provided the trustees understand there is still a risk that the products chosen by these investment managers may not perform as expected, managed investments offer the opportunity to hold diverse assets that most direct investors cannot access.

The purpose of setting up an SMSF is to provide an income in retirement, so every trustee must be aware that investment requirements will change over time. New members may join the fund as old ones depart or retire, and these changes will alter its priorities and goals. An annual review of asset allocations should be part of the role of every trustee, offering the opportunity to change the mix of investments to suit these new goals and priorities.

Transforming your current SMSF portfolio is not something that should be rushed into, but given serious thought in conjunction with professional advice. As with any investment decision, ensure that the benefits and risks of diversification match the goals and risk tolerance of you and your members. What is right for your SMSF may be inappropriate for others.

Does your LRBA comply with the new ATO requirements?

Since the rules around using an SMSF to purchase property were relaxed, first in 2007 and with further amendments in 2010, thousands of SMSF trustees used this as an opportunity to invest in both residential and commercial property. However, loans were restricted to a limited recourse borrowing arrangement or LRBA and this practice continued for a decade.

Two issues arose in that time, and the first was concern by the Reserve Bank of Australia about the number of SMSFs going into significant debt to acquire property. The second came from the ATO (Australian Taxation Office) and the possibility that some taxpayers were dodging superannuation caps. By using LRBAs, they could place extra money into their super funds where they would be taxed at concessional rates.

As a result, the ATO issued new guidelines to SMSFs choosing to use related-party loans rather than bank finance to purchase property. Trustees had until 31 January 2017 to review their fund arrangements and it is possible that some trustees have not yet made the necessary arrangements to ensure compliance with the new rules.

Trustees must understand that any loan terms they have accepted to buy property must be “an arms-length commercial arrangement”. In some cases, LRBAs have been established with related-party lenders on terms that would not typically be accepted as a commercial arrangement. Usually these terms are more generous than bank finance with lower interest rates, excessively long loan terms and no requirement to make regular payments.

While this may seem a good deal at the time, it puts at risk the overriding purpose of establishing an SMSF, which is to provide retirement income for the fund members. There are key issues with some LRBAs that put this purpose at risk such as:

  • The possibility that there will be insufficient income and contributions into the SMSF to service the loan;
  • How the members would pay out the loan when they have retired and are no longer making contributions to the fund; and
  • Whether the property or properties will be sufficiently liquid or earning enough income to pay pensions to members in retirement.

SMSF trustees who did not use bank finance for their property purchases and who have not sought information about the new rules themselves or by consulting SMSF service providers such as SMSF Assure should act immediately. It could be that they need to wind up the LRBA or refinance their loans on commercial terms, and notify the ATO that this has been done.

These are major changes to previously accepted loan arrangements that will have financial consequences for members if they are not addressed. The income from these properties can be taxed at the highest rate of 47% instead of the 15% concessional rate. If you are a fund trustee and have not addressed this issue yet, get professional advice on what steps to take, and act now.

Setting Up Your Own SMSF? With Rewards Come Risks

Setting up your own SMSF (self-managed superannuation fund) is a bit like becoming a parent. Everyone thinks it is a great idea, many of us become one at some stage, but we don’t know how it feels until it happens. We look for advice so we can be good parents, but at the beginning, we can only imagine the joys and the challenges before us.

How is that like setting up an SMSF? Well, everyone thinks it is a great idea; many Australians have one but until it is up and running, the trustees can only guess at the responsibility and the time involved to get the best result for their retirement. Will the challenges outweigh the joys? Can investment decisions be made while keeping the administration up to date?

Initially, the idea of taking the reins yourself may seem exciting. You may be getting statements from your current superannuation fund and questioning its fees and performance. It is not such a great leap from wondering what is happening to thinking you could do better yourself, but what are the risks if you go your own way?

Lack of time and administration skills are the two obvious risks for trustees of an SMSF. However, there are other, lesser known risks to be aware of. For example, if the SMSF suffers a loss due to fraud or theft in the underlying assets, the members are not eligible for compensation under the superannuation laws. They also do not have access to the Superannuation Complaints Tribunal if there is a disagreement between fund members. There are other avenues open, such as legal action, but these are at the members’ expense.

Limited access to life insurance is another risk worth considering. In a large superannuation fund, life and disability insurance is easy to access, with default levels of cover often given without a medical assessment. With thousands of members, these funds negotiate reduced premiums but for an SMSF, insurance may be difficult to obtain and more expensive.

Also, most people are usually not considering an exit strategy at the beginning, but there are several trigger events that may need one. For example, a trustee may become a disqualified person through bankruptcy. Loss of capacity, losing residency status and the death of a member are other scenarios that could trigger the wind-up of the SMSF.

To ease the time constraints and administration tasks, most SMSF trustees work with experienced SMSF administrators similar to SMSF Assure who are up-to-date with the relevant legislation. They assist fund trustees with lodging returns, compliance issues and other administrative tasks, and generally lighten the load.

As any sole parent will tell you, the biggest challenge they have is being solely responsible for every aspect of their child’s wellbeing. This is not something they can hand to someone else. An SMSF trustee, however, can access the technical expertise of a dedicated and experienced superannuation team.

While the trustees are still solely responsible for the performance of their fund, just being able to talk things through with someone who knows the industry well makes running their own fund less of a burden. Trustees who know the risks as well as the rewards at the start are making a genuinely informed decision.

The Foundation of a Successful SMSF – Informed Decision-making

The number of self-managed superannuation funds (SMSF) in Australia continues to grow as people set up their own funds and take control over how their money is invested for retirement. They are willingly taking on the role of a trustee with the awareness that this control comes with the responsibility for making all the investment decisions.

This is a role that should not be undertaken lightly, and trustees should do their own research before they take the first steps to set up the fund. Many people who consider this step assume that any professional organisation that advertises SMSF services is also able to give financial planning advice. However, this is not the case.

The role of companies such as SMSF Assure is to arrange the establishment of the fund, making sure that every requirement of the ATO (Australian Taxation Office) has been met in the process. They also manage the ongoing administration on behalf of the trustees, which includes meeting reporting deadlines and all other relevant compliance issues, but they do not provide financial product advice.

To provide such advice to an SMSF trustee, an organisation must hold an Australian Financial Services Licence. There are specific, ongoing obligations attached to holding this licence, including compliance with financial services laws. This is just one of many others.

This is an important difference for trustees to understand, especially as they are still responsible for the decisions made on behalf of the fund. This applies even if they have sought and followed the investment advice of one of these licensed professionals.

The fund trustees are responsible for establishing an investment plan for their SMSF when they first set up the fund. This is the point where they make the first of many decisions that will determine the financial circumstances of the fund members when they retire.

Having a well thought out investment plan helps them make those decisions, not only at the outset, but also throughout the life of the SMSF. The plan must be reviewed at least annually to keep it current and responsive to market variations and changes in the life circumstances of its members.

Some trustees are very knowledgeable about finance and investment, and have the confidence to make these decisions without seeking outside advice. For those who are not, the first decision they usually make is to engage a reputable company such as SMSF Assure to help them manage the administration and compliance. Their second decision is to choose a licensed financial services professional to work with them on an investment strategy.

Like any good decision-making process, they then need to:

  • Gather information, review, analyse and check for accuracy;
  • Discard what is not relevant;
  • Use what remains to make a short list of companies that will suit their objectives;
  • Do further investigation including making appointments to meet key people in the chosen companies;
  • Do a final review incorporating any new information; and
  • Select the company they believe will give them the best result in building the assets in their fund.

There is no magic formula to creating a successful SMSF. It is a serious undertaking requiring cool heads, financial knowledge and the clear, long-term goal of a financially satisfying retirement income.