No room for error on self managed super

After much deliberation, the Senate passed the member/ trustee laws late last year which have significanrt ramifications for self managed super funds (SMSF). The March 31, 2000 deadline requiring all members of a SMSF to become trustees of the fund, is looming large for many clients.

After much deliberation, the Senate passed the member/ trustee laws late last year which have significanrt ramifications for self managed super funds (SMSF). The March 31, 2000 deadline requiring all members of a SMSF to become trustees of the fund, is looming large for many clients. With potential fines and jail sentences for trustees, financial planners and accountants that get it wrong, there is no leeway for mistakes.

As financial planners, however, we need to offer more than just strict compliance with the laws. We need to go beyond the call of duty and offer strategic advice to our clients. We must consider whether the trust deed that our client has in place really copes with modern strategies and the new member/ trustee rules.

Test your skills on the following client case study. This is a real-life client scenario put to The Strategist Group by one of our members. It is a time bomb waiting to explode.

A member/ trustee disaster

Your client Jim Jones, aged 45, is a successful small business owner. You have known him for 15 years and he has been a good source of business and referrals for you. He is married to June who is aged 31. The couple were married three years ago and have twins, Gary and Gwen, aged 5.

This is Jim’s second marriage and at present, the marriage is not going too well. Jim works more than 80 hours a week to keep his business successful and Jim thinks June wants too much. “She has threatened to leave me if I don’t stop working so hard; but with a mortgage, kids and a business, my work is my number one priority.”

Two years ago Jim established a family SMSF with himself and June as the sole members of the fund. Last year at June’s insistence, Jim’s in-laws, Fred and Judy (aged 62 and 61 respectively), became members of the fund. Currently the fund has more than $600,000 in investments and the breakdown between the members is:

Jim: $275,000

June: $25,000

Fred: $150,000

Judy: $150,000

The SMSF has been set up with Jim as the sole trustee of the fund. Jim is worried that the new member/ trustee rules that are to apply from 1 April, 2000 may cause him some grief.

From 1 April 2000, the Jones family SMSF is required to include each member as a trustee of the fund. This means that on the stroke of midnight of 31 March 2000, the fund is required to appoint June, Fred and Judy as trustees of the SMSF in addition to Jim. Jim will lose control of the fund, even though he has the largest account in the fund.

This should cause Jim and his financial adviser grave concern. In particular, they should carefully consider the trust deed to ensure that the loss of control by Jim does not cause him financial harm.

For example, the majority of trust deeds that we review at The Strategist Group include a forfeiture clause to the effect that:

“If a member to whom a benefit may or will in future become payable out of the fund is found by any competent Court, or is shown to the satisfaction of the trustee, to be mentally ill or of unsound mind or incapable of managing his own affairs then that benefit is forfeited to the fund. The trustee may, subject to the Act and Regulations, pay or apply the whole or any part of the benefits which have been forfeited in accordance with this clause to or for the benefit of the Member or any other member of the fund.’

Remember, in our case study that Jim’s marriage is on shaky ground. If push comes to shove on the marriage front, Jim may find his super benefits in a precarious position. Sure we can assume that June and her parents probably have as little idea about super as Jim, however, the same may not be said of June’s lawyer. They can be ruthless when it comes to super and should Jim’s benefits be forfeited, then legally, the only redress that Jim has is through an action of abuse of trustee powers in the Supreme Court ? a costly exercise. Remember the Superannuation Complaints Tribunal has no jurisdiction when it comes to SMSFs.

Our solution to Jim’s potential disaster is simple. Either he gets out of the fund now or he kicks the parents and perhaps June out of the fund before 31 March, 2000. There are, however, three potential problems with this scenario:

The first is a poor trust deed. Jim may not have the power to kick the parents out of the fund. In most cases, once a member always a member, until death do you part. So Jim may not have the power to actively kick Fred, Judy and for that matter June out of the fund.

The second problem could arise if Jim decides to leave the fund. If Jim makes the decision to move, then he will have to withdraw his assets from the fund. If the fund is run as a pooled fund, that is all members share in the earnings on fund’s assets proportionately to their fund balance, then he will have to decide which assets to take. This however, may trigger an angry outburst from the other members of the fund if Jim takes what are considered to be the best assets. It may also result in a capital gains tax liability in the fund. As the fund’s adviser you will need to adjust Jim’s balance by any CGT liability.

Finally, you may run out of time. With 31 March 2000 fast approaching and this sort of problem repeated many times over in a client base, there is simply not enough time for a financial adviser to take fast enough action to protect Jim’s interests. Or is there?

A potential strategy

It is difficult to protect Jim’s interests where he has to bring in his estranged wife and in-laws as trustees. However, if there is a corporate trustee in place, it may be possible to give different voting rights and different powers to each of the fund’s members. This may enable Jim to continue to control the balance of power in the fund should the going get rough in his marriage.

In that regard, the member-trustee rules in section 17A(1) of the SIS Act provide that where the fund has a corporate trustee, all members of the fund must be directors of the corporate trustee. There is no requirement in the legislation, however, that all directors must have equal voting rights or that members must be shareholders of the corporate trustee with equal shareholdings.

Accordingly, it may be wise for a corporate trustee to be appointed to the SMSF prior to 1 April, 2000. Importantly, the sole shareholder of the trustee should be Jim. The memorandum and articles of association of the company should ensure that as sole shareholder, Jim has the power to appoint or remove directors in a general meeting.

At the same time, the fund’s trust deed would need to be amended to insert a specific clause stating that where a member, who is a director of a corporate trustee, is removed from their position as a director, they are to leave the fund no later than six months from the date of their removal as director.

Grant Abbott is a director of The Strategist Group.