The continued solid growth in self managed superannuation funds (SMSFs) indicates that plenty of Australians consider themselves at least as capable of successfully managing their retirement savings investments as the professionals (or perhaps more so).
But some in the industry are concerned that the growth in SMSF numbers is not necessarily a good thing, with reservations that many trustees/members may disregard or at least not give full attention to all the requirements and responsibilities that come with running one’s own super fund.
The Tax Office stated in its SMSF compliance program for 2011-12 that it would be focusing on:
- newly registered funds, to ensure they have not been established to provide illegal early release of superannuation benefits to their members
- funds lodging their first annual return to ensure they are entitled to receive their ‘notice of compliance’
- auditor contravention reports
- related-party investments, to ensure they are not contravening the prohibition of lending to members or the 5% in-house asset limit
- exempt current pension income and non-arm’s length income, and
- re-reporting of contributions and compliance with excess contributions tax release authorities.
The importance of staying compliant cannot be overemphasised. For an SMSF to be found to be non-compliant will at the very least see the fund lose its concessional tax treatment, and be subject to tax at a rate of 45% on, broadly, the net value of the fund. There could also be hefty penalties and the possibility of prosecution.
While an SMSF can be a very powerful retirement savings vehicle when run correctly, and good for long-term wealth accumulation and asset protection within a tax-effective structure, there is plenty of scope to lose your footing over some of the basic (but admittedly numerous) compliance tasks. If mishandled, the potential pitfalls can easily outweigh the benefits.
Tripping up on the contributions cap
One common inadvertent mistake that SMSF professionals say is the likeliest problem a trustee will face is exceeding the annual concessional contributions cap. The caps are listed in the table below:
|Year||Age and applicable cap amount|
|2016-17||Under 49: $30,000||49 and over: $35,000|
|2015-16||Under 49: $30,000||49 and over: $35,000|
|2014-15||Under 49: $30,000||49 and over: $35,000|
|2013-14||Under 59: $25,000||59 and over: $35,000|
|2012-13||All ages: $25,000|
|2011-12||Under 50: $25,000||50 and over: $50,000|
Of course this can affect everyone in superannuation, but an added complication for SMSFs is that most funds will have their administration tasks completed annually, and in arrears. Hence, members may not find out that a contribution took the member over the contributions cap until the accountant does the books for the fund, which could be months after the end of the relevant financial year.
Another SMSF pitfall to watch out for is investing in property in an inappropriate manner. One way this can happen is where an investor puts a deposit on a residential investment property, and then sets up an SMSF with the aim of owning that property through the fund. But in these circumstances, it is not the SMSF that has bought the real estate but a private person.
And once the SMSF is established, it can only acquire certain assets from related parties such as ‘business real property’.
Tangles on pension tax, and exceeding limits
Ordinary income and statutory income that a complying SMSF earns from assets held to provide for super income stream benefits is exempt from income tax. This is referred to as exempt current pension income (ECPI), and the Tax Office reports that this is an area that causes headaches for SMSFs claiming tax deductions.
It says calculation errors often occur, but also that SMSFs mistakenly deduct items such as investment expenses and management and administration expenses against ECPI. The Tax Office says that funds may need an actuarial certificate to determine the correct amount of income which will be exempt.
The Tax Office says it is important to make sure that:
- all assets are re-valued to current market value before starting to pay a pension
- if the fund has income tax losses, not capital losses, the loss amount is reduced by the net ECPI amount. Any remaining tax losses can be offset against the SMSF’s assessable income
- all income earned during the financial year in the SMSF annual return is reported (although not necessarily taxed), even if the fund is in 100% pension phase
- the fund doesn’t claim a deduction for expenses relating to pension assets as the income is non-assessable
- if the fund has both assessable and non-assessable income, the expenses should be apportioned.
Also on the subject of pension payments, another inadvertent mistake is not meeting pension standards when the SMSF is in pension mode – either not meeting the minimum pension, or exceeding the maximum (if applicable). The minimum drawdown limits are shown in the table below.
Investment reporting and personal use of assets
According to the Tax Office, another prevalent mistake is capital gains from a fund’s investments being incorrectly classified and reported as ‘other income’.
Payments from the fund ostensibly made as investments have sometimes proven to be outside the scope of the regulations – such as a loan to a relative to launch a business, or who might be in financial trouble.
In a similar vein is the act of paying expenses out of the fund that are not fund expenses. This can be as simple as using the wrong chequebook, or of course being unaware of the strict rules that apply. But these breaches may put an SMSF in danger of having penalties apply or being deemed non-compliant.
SMSFs … an eye to the future
Before establishing an SMSF it is important to consider long-term objectives of the members and the obligations which are created. For example: acquiring your business premises in an SMSF may seem an attractive proposition, however before doing so it would be prudent to contemplate the administrative complexities, in particular when limited recourse borrowing arrangements are involved.
Another outcome could be that when people are well into retirement, they may simply become less capable of managing their financial affairs, which can have a detrimental effect on the super fund.
Also, sometimes one member of a fund is very engaged, and perhaps was the driving force in setting up the SMSF. But they may have a spouse who is more of a passive member. If the active spouse dies, the passive spouse can get thrust into the driver’s seat without any preparedness to manage the fund.
A way around this potential problem is to have a clear succession plan, or at least an idea of ceding control of the fund in some way. Perhaps this could involve bringing in a child, or winding up the SMSF, but these choices very much depend on individual situations. Please contact this office if you wish to discuss your options.
|Age||Minimum % withdrawal|
2011-12 and 2012-13
|Minimum % withdrawal
2013-14 and future years
|65 - 74||3.75%||5%|
|75 - 79||4.5%||6%|
|80 - 84||5.25%||7%|
|85 - 89||6.75%||9%|
|90 - 94||8.25%||11%|
|95 and older||10.5%||14%|