The benefits and risks of adding children to an SMSF

MLC's Peter Hogan outlines the benefits and risks of adding children or other family members to an SMSF. 

While most self-managed superannuation funds (SMSFs) have two members, it’s possible to have up to four.

There are many benefits of adding children or other family members to an SMSF and the process is relatively straightforward. But considerable thought should be given to the potential risks that can arise when family and money are combined.

The benefits

One of the key benefits of adding members is that the family’s superannuation accounts can be combined.

This can enable the fund to build a bigger and more diversified investment portfolio and buy assets of greater value, such as residential property.

Increasingly, family members are added to SMSFs in order to facilitate the purchase of the business real property used in the family business.

If sufficient super accounts are combined in a single SMSF, it may be possible for the SMSF to purchase the property outright. Alternatively, the purchase may need to be facilitated using a limited recourse borrowing arrangement. 

Either way, the benefits to the family business and their member’s retirement savings may be significant.

The purchase of an asset of the family business by the SMSF can inject significant cash into the business.

At the same time, the business must pay market rent for an asset they may have otherwise owned and used without payment. 

There are two clear benefits that offset this need to pay market rent:

1. Holding business real property in an SMSF is similar to an asset protection strategy commonly employed by small businesses where assets of a business are owned in a family trust and leased back to the business. Separating the asset from the business protects the asset in the event of insolvency or bankruptcy and provides the opportunity to retain the rental income in the SMSF. 
2. Holding assets in an SMSF offers protection against creditors under the Bankruptcy Act and also provides an income stream to the SMSF that is deductible to the business. This is a bit like having an additional deductible contribution cap for the business and all members of the SMSF benefit from the derivation of this income. 

Creating one fund for up to four family members could also reduce the costs of superannuation for the family unit.

This is because the costs of running an SMSF usually don’t increase when more money is added.

There may also be some estate planning benefits when one fund is established for the family, but this is a topic of its own and will not be covered further in this article.

How you add members

Essentially, any family member can be members of the one SMSF provided they are not a ‘disqualified person’. This is someone who:

• Is disqualified by the Australian Taxation Office or the Australian Prudential Regulation Authority as acting as trustee of a superannuation fund
• Is in bankruptcy, or
• Has been convicted of an offence for dishonest conduct arising out of a law of the Commonwealth, State, Territory or foreign government, such as fraud.

Each member must also become either an individual trustee or a director of the corporate trustee of the SMSF. 

If a child under 18 is to become a member, a parent or guardian must act as trustee/director on their behalf until they reach 18 years of age.

In all circumstances, the new trustee/director must accept their appointment in writing and complete a Trustee Declaration Form within 21 days of their appointment. 

How you combine members’ accounts

Once the membership and trustee requirements are addressed, the new members can arrange to transfer their benefits into the SMSF. This could be done by rolling over cash from a public offer fund, for example. 

Alternatively, if the new member is currently a member of another SMSF, they may be able to ‘in-specie’ transfer the asset. In this scenario, the usual related party transaction rules would apply, even though the asset is held in trust in another super fund, not by the person individually.

As a result, the ‘in-specie’ rollover would be limited to business real property, listed securities, units in widely held unit trusts, and assets that would be considered ‘in-house assets’ in the receiving SMSF where the value doesn’t exceed 5 per cent of the total market value of the receiving fund’s assets.

The new members could also make contributions themselves. Or the existing members could make contributions on behalf of children who join the fund and potentially take better advantage of the children’s contribution caps.

The risks

While adding family to your fund can be a powerful and attractive strategy, there’s a risk things won’t turn out as hoped or expected. Two real life examples illustrate this point.

One is the case where a husband and wife were individual trustees of their SMSF. When the wife died, the husband appointed their daughter as trustee of the fund and nominated that his super be divided equally between his daughter and son when he passes away. 

When he died, the daughter appointed her husband as a fund trustee and, because the death benefit nomination was ‘non-binding’, they decided to pay the entire benefit of approximately $1,000,000 to her.

The son challenged this outcome unsuccessfully, as the daughter and her husband had been validly appointed as trustees and were legally entitled to not follow the father’s non-binding death benefit nomination.

The second example involved an SMSF where the trustees were a husband, wife and son. This was a complicated case and there were many ramifications.

But the key point here was that the son had a drug addiction and withdrew most of the money from the fund. The result was they lost their retirement savings and a tax penalty of 45 per cent had to be paid. 

While these outcomes could have been avoided or reduced with more careful planning, they highlight why it’s so important to consider the benefits and potential risks when adding members to an SMSF.

Peter Hogan is manager of SMSF Advice at MLC Technical Services.

Originally published by SMSF Essentials.