Chapter 3: Setting up a self managed super fund: the good, the bad and the ugly
A self managed superannuation fund (SMSF) is worth contemplating if you run your own business or you’re in your mid forties and have an existing superannuation fund with an accumulated balance of more than $250 000. Although you can gain significant benefits from managing your own fund, like all good things in life, it comes at a cost. There are strict rules and regulations you must obey, and stiff financial penalties apply if you contravene them. So it’s best to familiarise yourself with these statutory provisions before you commit yourself. If you’re not sure what to do, you should seek advice from professionals who hold an Australian Financial Service Licence (such as financial planners and certain accountants). In this chapter, I discuss how to establish an SMSF, and the benefits and limitations of running the show yourself.
Do-it-yourself super funds
The Income Tax Assessment Act permits individuals to set up and manage their own superannuation funds. According to the Tax Office, SMSFs are now the largest and fastest growing segment of the superannuation industry. There are currently around 440 000 SMSFs in existence, and the number of SMSF members is estimated to be around 820 000 (which is great news if you happen to be a tax consultant or person who specialises in auditing SMSFs).
An SMSF is defined as a fund with fewer than five members, which means that you can have only a maximum of four members in your fund. You also need to comply with a number of technical rules. The main ones are listed here:
• Each individual member of your fund must be made a trustee (or director if you have a corporate trustee for your fund). You need to do this because an SMSF is technically a trust.
• All the members need to be aware of their statutory duties and responsibilities with respect to managing an SMSF (and ignorance of the law is no excuse).
• No member can be an employee of another member unless they are related.
• Trustees cannot be remunerated for their services. However, according to Tax Office Ruling Self Managed Superannuation Funds Ruling (SMSFR) 2008/2: ‘trustees may reimburse themselves or pay out of the trust property expenses that have been properly incurred in the performance of those duties’; see also appendix B, Reimbursement of expenses incurred by trustees.
Generally the members who run an SMSF normally have a family relationship (for instance, husband, wife and children) or are close friends. The members of an SMSF can also include business partners.
At a glance: benefits of running your own fund
Some of the benefits you can gain from running an SMSF are listed overleaf.
• You can manage and control your own super fund.
• You can select the investments to help fund your retirement, such as real estate, shares listed on the Australian Securities Exchange, and managed funds (see chapter 7).
• An SMSF can own rental properties, and after you turn 60 years of age, any capital gains you make on the sale of rental properties during the pension phase is tax free (see chapter 8).
• You can make personal superannuation contributions to your SMSF.
• An SMSF can receive employer superannuation guarantee contributions.
• An SMSF can purchase your business premises and lease it back to you (see chapter 4).
• An SMSF is concessionally taxed at the rate of 15 per cent, and it’s possible for your fund to pay no tax if it receives dividend franking credits (see chapter 6).
• You can transfer listed securities (for instance, your share portfolio) to your super fund. But you could be liable to pay capital gains tax if you make a capital gain at the time of transfer; as there will be a change in ownership (see chapter 4).
• You can roll over (transfer) benefits you have in other super funds into your SMSF (see chapter 5).
• An SMSF can pay you a tax-free pension after you turn 60 years of age and retire, or it can pay a transition to retirement pension once you turn 55 years of age (see chapter 8).
• You can outsource administrative duties to superannuation fund specialists.
• You can instigate estate planning strategies.
• An SMSF can take out life insurance on behalf of its members and the premiums payable are tax deductible.
Although these benefits may look appealing, you need to weigh up whether you have the necessary investment skills and commitment to manage and run a complying super fund. The bad news is that stiff penalties apply if you contravene the Superannuation Industry (Supervision) Act 1993 (SIS Act), so it’s important that you know your duties and responsibilities. A key test of whether it’s a good idea to operate your own fund is whether you can outperform the professionally managed industry funds and retail funds. Furthermore, you will incur ongoing running costs, such as accounting and audit fees, and an annual $180 supervisory levy (see chapter 6). The amount of fees you pay each year will depend primarily on whether you outsource the administrative duties to super fund specialists, the category of investments your fund holds, and whether you intend to have individual trustees or corporate trustees operate your fund. But the good news here is these outlays are ordinarily a tax-deductible expense.
At a glance: what you can’t do in an SMSF
Members of an SMSF are prohibited from the following:
• acquiring property from a related party (for instance, from a member or member’s relative)
• residing in a residential property that is owned by your SMSF
• enjoying a direct or indirect benefit from your super fund’s investment holdings; for instance, you can’t display works of art your super fund owns in your place of residence or wear jewellery your super fund may own as an investment asset
• benefiting from using shareholder discount cards that companies may offer their shareholders
• using your super fund’s assets as a guarantee to secure a personal loan
• selling SMSF assets and providing financial assistance to a member to pay off debts that a member may personally owe; see appendix B, Financial assistance to members
• lending money to a member or to a member’s relative, such as a spouse, child or parent; this could become a major dilemma if you need money urgently and you have substantial investment assets sitting in your super that you can’t access
• carrying on a business as an SMSF, as the sole purpose of running a super fund must be to provide retirement benefits or benefits to dependants in the event of a member’s death.
Getting started: the steps you need to complete
Setting up an SMSF is relatively straightforward. For an initial outlay of around $1000 you can buy a ready made complying superannuation fund package that sets out the various steps you need to follow; including all the legal paperwork you have to complete and sign. Your accountant or tax agent can help you get hold of a complying super fund package tailored to meet your particular circumstances. See also the Tax Office publication Setting up a self managed super fund (NAT 71923).
The key steps and documents you need to attend to when establishing an SMSF are listed here.
Trust deed
You need to sign a properly drafted superannuation fund trust deed. This legal document sets out the governing rules your fund must comply with in order to qualify for certain tax concessions. A trust deed is essential to prove that you have a genuine SMSF. The trust deed will set out the following important rules.
Fund’s objectives
The sole purpose of setting up an SMSF must be to provide benefits to members upon retirement, and to dependants in the event of a member’s death.
Appointment of trustees
Because an SMSF is a trust, the trust deed must specify how to appoint (and remove) trustees. It will also set out your intention to appoint a corporate trustee (corporate basis) or individual trustee (pension basis) to manage and run your super fund. The duties and responsibilities of the trustee under each option are similar. If you have a corporate trustee, you can make a lump sum payment or pension on retirement. On the other hand, if you have an individual trustee, the sole purpose of running the fund is to pay a pension. But in this case you also have discretion to commute (change) the payment into a lump sum. You need to weigh up the administrative costs, and legal advantages and limitations regarding each option. Discuss this matter with your super fund provider at the time you set up the fund. Incidentally, all the members of your SMSF must be trustees (or directors if you decide to have a corporate trustee).
Powers of trustees
The duties and responsibilities of trustees, such as lodging an annual super fund tax return, and appointing an approved auditor to check that the fund is a complying fund, must be set out in the trust deed. The Tax Office expects all members to be aware of all the stringent rules and regulations associated with running an SMSF. It also expects that you do not contravene the sole purpose test (per superannuation Tax Office Ruling SMSFR 2007/D1).
According to the Tax Office Self managed super fund trustee declaration form — trustee duties, an individual trustee or director of the corporate trustee must:
• act honestly in all matters concerning the fund
• exercise skill, care and diligence in managing the fund
• act in the best interests of all the members of the fund.
Member application
This clause sets out who can be a member of your SMSF, such as members of your immediate family.
Contributions
The rules for making a contribution to your super fund must be in accordance with the Income Tax Assessment Act 1997 (see figure 5.1 on p. 85). All the members of your fund will need to provide their individual tax file numbers (TFNs) at the time the fund is established. Everyone needs to do this before your super fund can accept member contributions.
Payment of benefits to members
This section sets out how benefits are to be paid when a member meets a certain condition of release (such as the payment of pensions or lump sum cash withdrawals, or a combination of the two — see chapter 8).
Winding up fund
This sets out the procedures you need to follow if you wind up your SMSF.
Election to be regulated
You must lodge an election to become a regulated SMSF under the Superannuation Industry (Supervision) Act 1993 (SIS Act). This election is irrevocable: you can’t change your decision at a later date. You need to do this within 60 days of setting up the fund. For more details, see the Tax Office publication How your self-managed super fund is regulated (NAT 71454).
Tax file number (TFN)
Your TFN is your superannuation fund identification number. You will ordinarily be issued a TFN at the time you make an election to be regulated. You need to quote this number when you lodge your Self managed superannuation fund annual return.
Australian business number (ABN)
You may need to quote your Australian business number (ABN) if your super fund enters into certain financial transactions. You will ordinarily be issued an ABN at the time you make an election to be regulated. The ABN is used by employers and other super funds to check on the federal government Super Fund Lookup website <www.superfundlookup.gov.au> which shows whether your fund is a complying fund, and whether it can accept super contributions and rollover payments (see chapter 1).
Trustee declarations
All super fund members must sign a trustee declaration form to certify that they consent to be trustees. You need to do this within 21 days of becoming a trustee or director. There is a further requirement that all trustees need to be aware of their legal duties and responsibilities. You can’t be a trustee if you’re a ‘disqualified person’ (for instance, an undischarged bankrupt or person convicted for dishonesty) or if you’re under 18 years of age. For more details see the Tax Office publication Trustee declaration (NAT 71099).
Investment strategy document
You need to formulate an investment strategy for your SMSF, setting out the types of investments you intend to consider to help build member benefits (see Investment strategy in chapters 4 and 6).
Bank account
You need to open a superannuation fund bank account (in the name of the fund) in order to make cash contributions (or roll over, or transfer, money from other funds you may belong to into your SMSF), and meet any expenses or liabilities your fund may incur. The Tax Office has advised that the fund’s assets should be held in a legally recognised ownership arrangement, for instance:
• in the names of all of the individual trustees as trustees of your fund
• in the name of the company as trustee for your fund in the case of a corporate trustee.
Membership application form
You will need to provide a membership application form which members will need to complete when they join the fund. A disqualified person cannot be a member of an SMSF, and the member must be an Australian resident.
GST registration
Under certain circumstances your super fund may need to register for goods and services tax (GST), for instance if your super fund owns a commercial property and receives rent that exceeds $75 000 per year. If you register for GST your super fund can claim a GST credit in respect of any GST payments the fund may incur in administering the fund. The GST credit is limited to 75 per cent of the GST payment.
Binding death benefit nomination forms
It is recommended that you provide binding death benefit nomination forms for members to nominate their beneficiaries — who should receive their super in the event of the member’s death. Members need to complete a binding death benefit nomination form if they want their benefits to be paid to a specific dependant (or to your estate) in the event of your death (see chapter 1). If you plan to make a binding nomination, make sure you follow all the proper legal procedures in accordance with the trust deed. Legal disputes can arise if your instructions are not clear and precise; see appendix B, Self managed superannuation funds (and death benefit payments).
Estate planning
Your fund needs to know how to deal with member benefits in the event of a member’s death. When dealing with legal issues (and to avoid potential legal disputes), it’s best that you discuss this matter with a solicitor at the time you set up the fund. For a discussion on estate planning issues, visit the Australian Government website <www.seniors.gov.au> and go to ‘Estate planning’.
Insurance cover
It’s recommended that each member should consider taking out adequate life insurance cover in the event of death or disability. Death and disability premiums payable by a complying super fund are a tax-deductible expense (see chapter 6).
Record keeping
You need to establish a proper recording system to record minutes of trustee meetings, the receipt of member contributions, and the fund’s earnings and expenditure. You also need to keep separate accounts for each member to record their member benefits. Your accountant can help you with this exercise. There are also numerous accounting software packages that can do all of this for you. You can find them on the internet: key search words are superannuation accounting software packages.
Transfer forms
To transfer any benefits you have in other super funds into your SMSF, you will need to fill in the form Completing the request to transfer whole balance of superannuation benefits between funds (NAT 71223).
Administration
The trustees of the SMSF can appoint service providers, such as an accountant, to administer the fund and an approved auditor to check that you’re not contravening the SIS Act. If you breach any provisions the auditor must report the contraventions to the Tax Office. The auditor must be an independent auditor (meaning they can’t be the same person who prepared your accounts). An audit must be done each financial year, and before you lodge your super fund’s annual tax return (see chapter 4).
Useful references
Australian Taxation Office publications
• GST and financial supplies for self-managed super funds (NAT 71512)
• Is self-managed super right for you? (NAT 13556)
• Keeping good records
• Request for self-managed superannuation fund specific advice (NAT 72441)
• Running a self-managed super fund (NAT 11032)
• Self-managed super funds — setting up a self-managed super fund (NAT 71923)
• Thinking about self-managed super (NAT 72579)
• Winding up a self-managed super fund (NAT 8107)
• Your trust deed