Do I really need a self-managed super fund?

Today we’ll take a look at the self-managed super fund arena.

While this subject will be a bit dry for some and might well verge on the ‘pulling teeth’ for others, it’s important to consider some of the problem areas of this growing sector of our superannuation industry.

SMSFs account for the largest superannuation fund assets by size. With over 400,000 now in operation and close to 800,000 members/trustees they are now extremely popular.

The numbers are good, should I join the queue?

While conceptually being able to ‘control the direction of your investments’ and ‘determine where they are invested’ might be appealing, for many this is merely a ‘perception’ created by the false information emanated by the many who recommend their creation to justify why you should have one.

If you’re thinking about setting one up and believe you’ll be able to put all your assets, such as the business, home and beach house in it or siphon some cash out to invest in the business – I’m afraid you’ve been led up the garden path.

Eat my cake and have it all

Running a SMSF comes with a raft of rules, regulations and duties. I’ve seen many mistakes made based on bad advice and misrepresentations and operating mistakes are rising faster than the take up rate.

I’ve seen many cases where the powerful motivation of ‘control’ has outweighed the downside.

Trustee responsibilities

In forming a SMSF you have to become a trustee and as a trustee you have to become a member. You cannot become a member without being a trustee and vice-versa. If you fly solo you may have a corporate trustee but you cannot be sole trustee and member.

As a trustee you have certain responsibilities and duties to undertake and if you have no financial experience and cannot understand the roles of a trustee then congratulations you’ve just failed the first step – no need to proceed any further.
These rules exist to allow the concessional tax treatment of the fund, in other words: we’ll give you generous tax treatment if you abide by our rules.

Let’s take a look at a few of the most commonly contravened rules.

Sole purpose test

The first test is the sole purpose test, which requires that an SMSF be established with the sole purpose of providing retirement funds. About 50% of compliance infringements relate to members/trustees who operate the fund as an extension of their personal financial affairs.

Nearly 40% of SMSF trustees/members are self-employed and half of all SMSFs have at least one member who is self-employed or derives their income from a related entity or trust.

The relationship between the establishment of SMSFs generally and related business interests is particularly high and the majority of the 50% caught under this test use their SMSF fund to shift assets on a day-to-day basis as an extension of their personal dealings.

Loans to friends and relatives account for nearly 20% of these breeches.

In-house assets test

Loans and investments made to a related business entity, such as a family company in excess of the limit of 5% of the total market value of the fund.
Failures of the in-house rule account for around 17% of contraventions.

Separation of assets

Generally the law requires that an SMSF maintain its assets separately from those of business entity or trustee. This is to guard against the trustee being declared bankrupt or the business going into receivership.

In certain cases, such as the new borrowing agreements, an asset can be held in trust with clear legal evidence of SMSF ownership.

Contraventions relating to the separation of assets account for about 13%.

Faux pas

If found to be in breach of the rules your fund will be deemed non-compliant and the earnings in the fund taxed at the top marginal rate – ouch!

I’ve really just merely touched on a few of the issues here and a few of the rules that are commonly breeched.

I’ve seen many cases where I’ve been asked by a referring accountant to do an ‘investment plan’ for an SMSF client, only to find that when I make an appointment to see them and explain the duties, responsibilities, costs, restrictions and the penalties if they are not followed, I’ll often find I’m heading back to the office with orders from the client not to proceed or wind it up.

I have often seen a client who has set up an SMSF, then rope the spouse into becoming a trustee because they only focus on the fact that it seems like a good thing to do at the time without considering their spouse who has no interest, nor understands, what their duties are and knows nothing about financial products or investments.

This can cause all sorts of problems if the well intentioned financial savvy partner dies.

I have also seen clients with an SMSF recommended by their accountant with less than $10,000 total in assets.

Audit my SMSF

An SMSF audit is required to be independent and conducted yearly by a member of the accounting profession. But the difficulty with this strategy is audit is a legal competency. In other words if your accountant is doing the annual return, administration, audit and recommendations for your SMSF then the independence test is failed, that may mean you are likely to continue breeching the trustee duties and therefore more likely to be caught by the ATO.

Financial advisers with SMSF experience are well positioned to play a support role in educating trustees about their fund management responsibilities and to ensure that an SMSF is well positioned to satisfy an annual compliance audit.

Your intelligent adviser can provide a pre-audit compliance review which could make a difference in averting any possible regulatory changes concerning SMSFs.

Nick Christian is a Financial Adviser and planner and authorised representative of Millennium3 Financial Services.

The views and opinions expressed within this letter are those of the author and do not necessarily reflect those of Millennium3 Financial Services Pty Ltd.

The above is general in nature and should not be acted upon without seeking the advice of a professional licensed financial planner.