Managing your clients' SMSF strategies

As the self-managed super fund industry continues to grow rapidly, Andrew Yee explains how to ensure your clients effectively manage their SMSFs.

With the number of self-managed superannuation funds (SMSFs) increasing dramatically, it is no surprise that regulation and supervision is also on the rise, impacting the responsibilities of advisers.

SMSFs are now not only the largest sector in superannuation (by asset) but also the fastest growing, increasing in number by about 6 per cent a year.

The control and flexibility that SMSFs offer, as well as the tax-planning and estate-planning features and the possibility of lower costs than publicly-offered superannuation funds, make them attractive to pre-retirees in particular.

With demographic surveys of SMSF members showing that they tend to be older, wealthier, and financially literate, there are clearly benefits to being in a position to advise clients with SMSFs.

However, this also brings challenges for financial planners. While ultimate responsibility for managing a SMSF rests with the trustees, they are increasingly likely to seek advice from a range of professionals, including accountants and financial planners, in order to satisfy their legal requirements.

They will expect timely, tailored and useful advice to make sure they take advantage of opportunities as well as avoid breaching regulations.

New SMSF trustees are now required to sign a declaration that acknowledges an understanding of their obligations and responsibilities as a trustee, and to show that their primary concern is the management of the fund for the benefit of members in their retirement.

The declaration also requires a signed acknowledgement of the Australian Taxation Office’s (ATO's) sanctions should they fail to comply.

If trustees get anything wrong or are not complying with the rules, the ATO has an increasing range of powers and penalties. Statistics show that the ATO is increasingly likely to use its powers to make a fund 'non-complying' — up from five funds in 2007 to 99 in 2009.

This is another indication that the ATO is increasing its compliance and enforcement presence, and its focus on this is overtaking its previous policy of trustee education.

The cost of losing compliance can be very significant for a fund and, if it happens, trustees are likely to look for others to blame. Advisers therefore need to ensure that they are aware of all regulatory changes and can help trustees comply with their obligations, as well as provide appropriate and adequate advice.

Some of the key areas for advisers to monitor and assist their clients with include the following.

Excess contributions

This has become an increasingly common problem, particularly since the super contribution caps were halved last year.

Excess concessional contributions are taxed at 31.5 per cent on top of the standard 15 per cent tax on superannuation, while non-concessional contributions are taxed at 46.5 per cent on top of the standard 15 per cent.

Non-concessional contributions also include excess concessional contributions, so if both are exceeded then the tax could amount to 93 per cent.

Common traps include:

• Directing employers to make a one-off employer super contribution at year end based on their maximum concessional cap without taking account of the compulsory 9 per cent super guarantee payments their employer have already made during the year;
• Not updating current year salary sacrifice arrangements to reflect the new, higher concessional contribution cap;
• Maximising one’s personal non-concessional and concessional contributions for the year up to the cap and then finding that one is ineligible to make a personal concessional contribution, thereby creating an excess non-concessional contribution situation; and
• For those over 65 at the start of the year, making a non-concessional contribution of $450,000 for the year when they are not eligible for the bring-forward rule.
• People who receive an excess contributions tax assessment from the ATO can apply to the ATO to have contributions disregarded or re-allocated to another financial year, but only if there are special circumstances involved.

Change in trustees

If there has been a change in the trustee, or members of a SMSF, this must be reported within 28 days to the ATO. Failure to do so can result in heavy fines being imposed.

If a corporate trustee is involved, the Australian Securities and Investments Commission (ASIC) must be notified. Any change should also be formally documented and minuted.

Trust deeds

It is essential to ensure that a SMSF’s trust deed is up-to-date and that the fund is fully complying with it. If it has not been reviewed recently, it could be that the trust deed itself no longer complies with recent regulatory changes.

This means there could be inconsistencies between current regulations, investment opportunities and the trust deed.

For instance, a trust deed may need to be amended to allow the SMSF to have geared investments such as instalment warrants.

If this has not been done then the SMSF cannot legally invest in geared products. Not only do non-compliant funds run the risk of losing their tax-advantaged status, they will also miss out on many of the advantages that SMSFs offer.

From an adviser’s point of view, they must ensure that the investment advice they give, and the strategies they recommend, are permitted under the deed. Examples of aspects that should now be reflected in SMSF trust deeds include:

Benefits and nominations

In the event that a member becomes disabled, either permanently or temporarily, SMSF trust deeds must allow for benefits to be paid to that member.

Minors

If people under 18 are to become members of the SMSF, the deed must specifically permit this, and include guidelines on how the SMSF will be administered on that person’s behalf until they come of age.

Legislative changes

The most critical point is that all changes in regulations or legislation should be reflected in a SMSF trust deed. For instance, it’s not uncommon to come across older SMSFs that still refer to pension-payment provisions, reasonable benefit limits and compulsory cashing rules for those over 65, but the changes in contribution caps (for instance) are left out.

Breaches and contraventions

Any funds that are in breach of rules may lose their favourable tax status or be fined.The most common problem areas for SMSF trustees are:

• Borrowing money — with very limited exception, a SMSF is generally prohibited from borrowing money or maintaining an existing borrowing of money. The most well-known exception is instalment warrants (see below).
• Breaching the ‘sole purpose’ test — a SMSF can only be managed in the interests of all its members during retirement. It cannot do anything that will benefit one member above others.
• Making loans — a SMSF cannot lend money or use funds to help a member financially.
• Breaching the in-house asset rules — a SMSF cannot acquire or hold in-house assets in excess of 5 per cent of the market value of total assets. Trustees must review the fund annually to ensure assets held have not risen above
• per cent.
• Holding assets in someone else’s name — all the fund’s assets must be in its own name not in that of trustees.
• Failing to provide appropriate records — trustees must provide auditors with documents within 14 days of a written request being made.
• Gearing
• Despite changes two years ago to allow SMSFs to borrow to invest, their take up has been modest, but it is expected to increase, particularly through instalment warrants. Many trustees have been wary of the approach, either because they feared the rules would change again, or because of the downturn in markets that made ‘borrowing to invest’ seem like a high-risk strategy.

In addition, there are strict conditions that must be satisfied. The key ones are:

• The fund would be able to invest in the asset directly anyway, such as listed shares; and
• The loan on the investment product is limited in recourse to the underlying asset only (that is, the shares involved).

However, with markets at the lower end of valuations, more trustees may be considering leveraging, so it is imperative they understand the rules, that it is allowed in the trust deed, it is covered in the fund’s investment strategy and it has the sole purpose of providing retirement benefits to fund members.

Also, trustees must make sure that the geared investment does not provide for a charge (such as a mortgage) over an asset of the fund, as this prohibition in the super rules has not changed.

New SMSF registrations

As part of its efforts to minimise and stamp out illegal early release schemes, the ATO will now record newly-established SMSFs on its registration website as “registered status not determined” rather than “complying”.

This status will only change when the SMSF lodges its first annual return. In the early release schemes, promoters set up a SMSF in order to transfer benefits from other funds and then make an illegal payout to the member.

After payout the SMSF is then discarded. This change could cause other problems for transfers into SMSFs.

Andrew Yee is SMSF specialist and director at HLB Mann Judd Sydney.