Chapter 12 Self-managed superannuation funds PowerPoint presentation by Fariba Ahmadi-Pirshahid ©2014 John Wiley & Sons Australia, Ltd

Learning objectives After studying this chapter you should be able to: describe the history and growth of SMSFs outline the major steps involved in setting up an SMSF describe the contribution opportunities provided by SMSFs outline the investment opportunities and constrains faced by SMSFs explain the process by which SMSFs can pay tax-free benefits to members explain the strategies that can be employed by a SMSF to improve estate planning outcomes describe the role of the SMSF auditor and other SMSF professionals in delivering services to SMSFs model a cost–benefit analysis to determine whether establishing a SMSF structure is warranted explain compliance and penalties.

Introduction Small APRA funds have declined in size in the last decade Funds with four or less members are small funds There are two types of small funds: small APRA funds — regulated by APRA self-managed superannuation funds (SMSFs) — regulated by ATO. Small APRA funds have declined in size in the last decade SMSFs are similar in many ways to large funds in the way funds are contributed and invested but there are some significant differences

The history and growth of small superannuation funds Referred to as ‘excluded funds’ within the Income Tax Assessment Act The ATO was put in charge of the regulation of SMSFs in 1999 following recommendations of the Wallis Inquiry Separation of the regulatory body has resulted in significant differences between the Small APRA funds and SMSFs SMSFs have grown significantly in the last decade reaching $496 billion in assets in 2013

SMSF selected facts and figures

Setting up a SMSF Getting right advice is important in setting up a SMSF Establishing a SMSF involves: establishment of a trust deed determination of the trustee structure determination of who can be a member set up of investment objectives/strategies establishment of an insurance plan. Advice must be sought from advisers or accountants who have a Financial Services License (FSL)

Establishing the trust deed A trust deed sets out the rules by which the SMSF will be conducted Content of a trust deed includes: objectives of the fund how the trustees can be appointed and removed description of who is eligible to be a member how contributions can be made to the fund how and when benefits can be paid from the fund. To pay the concessional tax rate, a SMSF must be a complying fund A complying fund is one that: Is resident in Australia Has made an irrevocable election to be regulated by the SIS Act Must meet the conditions for compliance as outlined in the SIS Act

Trustee structure Trustee structure can take one of two forms: members of the fund become trustees (all members must be trustees and all trustees must be members) a corporation is established to act as the trustee (this is suitable when the fund has only one member). Individual trustees must be over the age of 18 and must not be a disqualified person A corporate trustee structure can protect the personal assets of individual members against any liabilities the fund may have A person is disqualified if they: Have been convicted of an offence involving dishonesty, or Have been subject to civil penalty under the superannuation laws, or Are an undischarged bankrupt, or Have been disqualified by APRA or the ATO to act as a trustee

Who should be members Anyone can be a member of a SMSF however majority of members are familial Advantages of having a SMSF for family members: more investment opportunities exist because funds are pooled running one fund rather than a few reduces costs assets can be transferred to members without incurring CGT. Receiving benefits may be difficult due to the complexities of family relationships

Setting the investment objectives and strategies Single member: Single investment objective and strategy Multiple members: Difficult to have a single investment objective May result in forgoing of some of the efficiencies associated with individual investment A clearly articulated and regularly reviewed investment plan which includes objectives, strategies and rules can help minimise disputes between members

Building an investment strategy Building strategies from the ground up (bottom-up) is often the best way with objectives emerging at the end The bottom-up process first captures data such as: age work status superannuation rollovers to the SMSF likely contributions to the SMSF anticipated years to retirement. The risk profile of the members is then determined The risk profile is used to decide on the degree of exposure to growth assets If the fund is to have a single investment pool for all members, the exposure to growth assets could be weighed by each member’s contribution to the investment pool to assist in determining an overall asset allocation for the fund

Historical performance of various asset classes

Establishing the insurance plan Less than 15% of SMSF members are estimated to have life insurance Trustee obligation to consider the insurance needs of each member Each member will be individually assessed and insured by the insurance provider Such considerations must be recorded either in the fund’s investment strategy or in the minutes of the trustee meetings

Establishing the insurance plan continued Assets owned by the fund also need to be insured SMSF investments must be kept separate from personal assets of each member Shared ownership of assets should be as ‘tenants in common’ and not as ‘joint tenants’ Auditors have duty to report to the ATO any insufficient separation between the fund’s assets and the personal assets of a member

Contributions To receive a contribution, members have to provide their tax file number (TFN) SMSFs are bound by the same rules as larger funds Some important differences are: ability to make in-specie contributions such as shares, bonds and debentures, real business property and managed funds holdings distinction between selling and contributing to a SMSF tax concessions available to small business owners.

Contributions continued In-specie contributions are subject to the same concessional and non-concessional contribution limits as cash contributions Selling assets to the SMSF is not in-specie contribution so the limits do not apply All transactions must be on an ‘arm’s length’ basis Small business owners are able to access: a 15 year active asset exemption a small business retirement exemption.

15 year active asset exemption Example:

Small business retirement exemption Example:

Investment restrictions SMSF investments must meet the ‘sole purpose test’ i.e. solely for the purpose of providing retirement benefit breach of this rule could result in criminal and civil penalties The value of ‘in-house’ assets can not exceed 5% of all assets ‘in-house’ assets are those purchased from a ‘related party’ Long term borrowing for the purpose of gearing returns are not allowed Trustees are not allowed to lend money to provide financial assistance to members or related parties

Investment choices Access to the same range of assets as larger funds SMSFs can also invest in: Collectables and personal use items such as artwork, jewellery, antiques, coins, stamps etc. Leverage their investment portfolio through the use of investment warrants Invest in business real property which is exempt from the 5% in-house asset rule

Investment trends

Resident status To be a complying fund under the SIS Act, a SMSF must be ‘resident’ in Australia which means that: the fund was established in Australia the fund satisfies the active asset test having either: no active members and therefore no active accounts, or more than 50% of the fund’s assets held in ‘active’ accounts. central management and control of the fund remains in Australia.

Bankruptcy Funds held in superannuation including SMSFs are protected from creditors while in accumulation mode Becoming undischarged bankrupt or entering into a personal insolvency agreement prohibits a person from being a trustee or a director of a corporate trustee of a SMSF In the event of likely bankruptcy, the individual member has to plan for the relinquishment of their trustee status In the absence of a plan, the member will be given 6 months to rectify the situation

Paying benefits to members To receive benefits a member must have reached preservation age and stopped working Consideration must be given to: Pooling and segregation Having a separate investment pool for each member eases the separation of assets to be paid as benefit to a member Types of pension options available Account-based pension Non-account based pensions Lifetime income stream Transition to retirement

Estate planning Death benefit lump sum Superannuation death benefits can be paid to a beneficiary or to multiple beneficiaries In the absence of a binding death benefit nomination the death benefits will be distributed at the discretion of the trustees of the SMSF Death benefit lump sums are tax free if received by dependants Adult children are not dependants Benefits are split into a tax-free and a taxable component Taxable component will be taxed at their marginal tax rate

Death benefit lump sum example

Estate planning Death benefit income streams Income streams cannot revert to non-dependants and must be converted into a lump sum Where: an income stream is funded by a tax-free and a taxable component, and the deceased and the dependent beneficiary are both under the age of 60, the income stream will be taxable at the dependant’s marginal tax rate but will be reduced by 15% rebate. If both the deceased and the dependant beneficiary are over the age of 60, the income stream will be tax free.

SMSF estate planning strategies Strategies to improve the estate planning outcome in the event of death of a member include: ensuring where possible that superannuation is left to dependants and non-super assets are left to non-dependants increasing the tax-free component through recontribution regularly selling assets when in pension mode using a corporate trustee to ensure trustee arrangements stay on the death of one member (e.g. a husband and wife fund) determining how assets might be transferred between generations maximising taxation entitlements.

Auditors, actuaries and other SMSF professionals Certain functions of a SMSF are required by law to be done by professionals rather than trustees of the fund All SMSFs must appoint an auditor The auditor needs to: provide the SMSF with an annual audit report notify the trustees of any concerns raised through the audit process notify the ATO of any serious contraventions of the relevant law. Services of an actuary will be needed when one member goes into pension mode Accounting, legal, investment and other professionals may also be appointed to provide support for DIY functions of a SMSF

The cost of establishing and running a SMSF Establishment cost ranges between $1000–$4000 It is more expensive to establish a corporate trustee Additional costs include annual running costs which may be variable, semi-variable or fixed An example of a fixed cost is the annual supervisory ley of $250 per year payable to the ATO Auditor fees are semi-variable cost as the fee changes with the level of services used Costs associated with investment such as brokerage fees are variable costs

The cost of establishing and running a SMSF continued Average operating expense ratios to assets by SMSF fund size

Compliance and penalties ATO holds SMSF trustees liable for the actions of the fund and encourages SMSFs to: self-manage self-regulate self-assess. SMSFs are expected to keep detailed records including: records of financial transactions annual operating statements and statement of financial position copies of audited annual returns lodged with the ATO minutes of trustee meetings copies of reports to members.

Summary Establishing a SMSF has many advantages including: cost savings control over the investments and assets of the fund flexibility in terms of the type of contributions allowed tax advantages for small business owners and as part of estate planning. Some disadvantages include: considerable responsibility on trustees for compliance possibility of disagreement between members possibility of getting bad investment advice and loss as a result. It is believed that SMSFs continue to grow as they have been in recent times