Why your children should not be in your SMSF

Extreme caution should be exercised before admitting children of any age to the same self-managed superannuation fund (SMSF) as their parents.

Extreme caution should be exercised before admitting children of any age to the same self-managed superannuation fund (SMSF) as their parents.

A recent Administrative Appeals Tribunal (AAT) decision illustrates one reason why children and their parents should not be in the same SMSF. 

Facts of the decision

Triway Superannuation Fund and Commissioner of Taxation [2011] AATA 302 considered a superannuation fund established in 2002. It had three members who were also the trustees: a mother, father and their son. The fund was established to be an SMSF and a complying superannuation fund.

The three members rolled substantially all of their superannuation benefits into the fund.

The son had a drug addiction. He took almost all of the money from the fund and spent it or gave it away. The result of his actions was that these amounts were lost. The fund effectively became a shell.

The trustees concealed the true nature of the use and loss of this money. They alleged that they did so on the advice of their tax agent, despite feeling uncomfortable about following his instructions.

On 4 April 2006 the son became a bankrupt. However, he continued acting as a trustee of the fund.

In 2008 the trustees made a voluntary disclosure to the Commissioner of Taxation. On 15 October 2009 the Commissioner issued a notice that the fund was a non-complying superannuation fund because:

• The trustees of the Fund had contravened the sole purpose test;
• The trustees had provided financial assistance to a member; and
• A disqualified person (ie, a bankrupt) was a trustee.

The AAT noted that the mother and father lost their retirement savings balances and now needed to begin the process of saving for their retirement again.

The son accepted that he was responsible for the misappropriations from the fund. He also accepted that he should be responsible for any tax impost as a consequence.

The AAT noted that it was unlikely that the mother and father will recover money from the son in the near future, if at all.

The AAT was asked to review the Commissioner’s decision to not treat the fund as being a complying superannuation fund. Senior Member O’Loughlin had sympathy for the trustees. He noted that addiction to illicit drugs is a scourge of modern society and that it is not just those addicted who suffer.

However, he then considered the role the superannuation legislation plays in encouraging the community to provide for their own retirement. He noted that superannuation eases the strain on public welfare resources.

He ultimately affirmed the Commissioner’s decision to treat the fund as being non-complying.

The Triway decision naturally illustrates the dangers of having children as members in the event that a child becomes addicted to drugs.

However, there are other – even more common – reasons to keep children out of the same SMSF as their parents. 

Relationship breakdown

Many marriages end in divorce. Naturally, legislation provides that superannuation can be divided or split by agreement or court order in the event of a relationship breakdown. These laws cover not just married couples, but also de facto couples including those of the same sex.

Consider a child who is in the same SMSF as their parents. Now assume the child is undergoing a messy divorce and property settlement. The child’s former spouse’s lawyers will most likely be ‘poking’ through the SMSF.

Keeping children out of their parents’ SMSF also prevents lawyers who act for children’s former spouses from making claims against SMSF assets.

These lawyers might claim that the accounts have been manipulated to understate the true value of the child’s interest.

Accordingly, lawyers might try to claim assets that that the parents considered to be their own to be actually that of the child’s. Naturally, this is a messy situation that is best avoided entirely. 

Succession planning

Having children in the SMSF can also have negative implications upon death or loss of capacity.

Consider the well-known case of Katz v Grossman [2005] NSWSC 934. Here a father appointed his daughter as a trustee (and purportedly a member) of an SMSF.

The father had a son who was not appointed. The father made a non-binding nomination that his benefits in the fund be shared equally between his daughter and his son.

When the father died, the daughter had effective control over the fund. Presumably she exercised a discretion to pay all benefits to herself personally and none to her brother.

It is very difficult to attack a discretionary decision of a trustee. Instead, the brother attacked the appointment of the sister as a trustee and a member (and also the appointment of the sister’s husband as a trustee). The appointment of the trustees was held to be valid.

This situation may well have been avoided if the daughter was kept out of the fund. 

Conclusion

Although at first glance it might seem congenial to have a ‘family’ superannuation fund, it can give rise to many risks. Typically, children should not be in the same SMSF as their parents. 

Bryce Figot is a senior Associate, and Tina Conitsiotis a consultant, at DBA Lawyers.