Six Common SMSF Trip-Ups and How to Avoid Them
There’s a maze of rules and paperwork to keep on top of.
With the flurry of new superannuation changes, running a Self-Managed Superannuation Fund (SMSF) can be complex. While getting help from professional advisers is encouraged to help you run your fund, ultimately you, as a trustee, are responsible for complying with the superannuation and tax laws.
The vast majority of trustee mistakes result from a lack of up-to-date information and could be minimized with good advice and trustee knowledge.
Here are six common mistakes trustees should be aware of and ensure they are rectified as soon as possible.
Trustees must keep on top of reporting requirements. Too often these obligations are left too late, leaving the SMSF exposed to penalties and excess taxes.
It is important that trustees have the time and knowledge to ensure all paperwork is completed and up to date. If they cannot, they should get professional assistance to ensure their fund is compliant always. Remember, all funds must be audited by a professional SMSF auditor each financial year.
Record-keeping is even more relevant with the requirement that SMSFs report events that affect the $1.6-million transfer balance cap to the ATO from 1 July 2018.
For around 85 per cent of SMSFs, this will be an annual requirement. However, funds with a member who is in retirement phase is receiving a superannuation pension and has a total superannuation balance above $1 million, will be required to report events affecting members’ transfer balance caps quarterly.
Events that affect the transfer balance include starting a retirement phase income stream or stopping this stream. If the $1.6-million transfer balance cap has been exceeded it needs to be rectified immediately. A common way to remove the excess will be to commute in part or in full a Superannuation income stream.
If the $1.6-million transfer balance cap has been exceeded it needs to be rectified immediately. A common way to remove the excess will be to commute in part or in full a superannuation income stream.
2. Investment strategy
A key reason for many individuals choosing an SMSF is to have control over their funds’ investments. However, this freedom of choice must be balanced with trustee responsibilities, which require SMSF Investments to be made in a manner that is prudent and comply with superannuation laws.
A common mistake is a “set and forget” approach. A trustee should regularly review the investments of the fund, considering all the SMSF’s circumstances. These include investment risk, likely investment returns, Liquidity and cash flow requirements, diversification of investments, and insurance for members.
The needs of members throughout the life of the fund will change and should be reviewed regularly and planned for accordingly.
SMSF trustees are generally aware of the benefits of diversification, but many still focus investment portfolios in just two assets: Australian shares and Australian property. Seeking professional advice can help in having a diversified portfolio tailored to your risk profile.
Superannuation laws require trustees to consider insurance for fund members when drafting the investment strategy and require the owner of the policy to be the SMSF trustee. If the policy owner is an individual and not the SMSF, this can be a breach of legislation.
Caution is also required when transferring existing insurance policies into a newly established SMSF. You need to notify the insurer, so it can adjust the policy details.
3. The property trap
Strict rules around real estate investment can catch trustees unaware. An SMSF cannot buy a residential property for fund members to live in or use as a holiday home.
Business real property is the exception to this rule and generally means the land and building is used wholly and exclusively in a business. To avoid breaches around business real property, it is essential that the transaction is done at market value and is well documented.
SMSFs can borrow using limited recourse borrowing arrangements (LRBA) but must comply with very specific legal requirements. Getting professional advice from an SMSF specialist is strongly recommended before entering into an LRBA. Remember, too, that while trustees can maintain a property with borrowed funds, it cannot be improved with borrowed money.
"The vast majority of trustee mistakes result from a lack of up-to-date information."
4. Sole purpose test
This test lies at the core of SMSF compliance. As the title suggests it simply says a fund needs to be maintained for the “sole purpose” of providing retirement and/or death benefits to fund members (or their defendants if a member dies before retirement).
However, some trustees still believe SMSF Assets can have other uses. They cannot and the ATO will penalize you for doing so. It is likely your fund will not meet the sole purpose test if you or anyone else, directly or indirectly, obtains a financial benefit When making investment decisions and arrangements.
When investing in collectables, such as art or wine, make sure SMSF members do not have use of, or access to, the assets of the SMSF.
5. Member loans
A good example of how fund members can transgress the sole purpose test is member loans.
Many small-business people with SMSFs wrongly believe they can tap their superannuation to prop up their business in tough times; the rationale is that it’s their money so what’s the harm in giving themselves a short-term loan?
There are no circumstances where an SMSF can lend money to fund members. Funds that do face strong penalties.
6. SMSF auditor
An approved SMSF auditor needs to be appointed to audit the fund each year. This includes examining the fund’s financial statements and assessing compliance with the relevant superannuation laws.
Many trustees overlook this requirement, where no contributions or payments are made in the financial year. However, an audit is required regardless of the activities and asset values within the fund.
The auditor should advise you of any breaches of the rules. As a trustee, you should rectify any contravention as soon as possible.
These breaches will also be reported to the ATO.
What if it all goes wrong?
Any breaches of the rules should be rectified, the earlier the better. Waiting until the ATO comes knocking may make it more difficult to resolve the contravention.
The ATO’s focus is encouraging SMSF trustees to comply with the super laws, but there may be times when a stronger response is warranted.
The ATO will take into account the seriousness of the breach and the past compliance of the fund. Having up-to-date records and an understanding of your obligations will help. You will also need a plan in place to ensure future compliance.
An SMSF trustee may initiate in writing an undertaking to rectify a contravention. This will include a commitment to stop the behaviour and state the action that will be taken to rectify the contravention.
The key to avoiding contraventions is for trustees to refresh their knowledge of relevant super laws.
Jordan George, Head of Policy, SMSF Association.