By Graeme Colley
Life’s unpredictable – and there’ll be occasions which place an SMSF’s future in doubt. It may be the divorce of a member, or death, or incapacity, or bankruptcy. Or it could be the loss of willingness and commitment. Or simply that the fund has run out of money.
Whatever the case, it’s important to take a considered approach. As I’ll show in the following case studies, sometimes it’s best to keep the fund going, and other times it makes sense to shut up shop and redeploy the money.
James and Michelle are both in their seventies and have had an SMSF for many years. Their combined balance is around the $1m mark which provides them with pensions. The minimum pension taken each year must be at least 5% of the opening pension balance. However, they are nearing the time when they feel their pension account balances will decline faster than the income the fund earns on its investments. Fund earnings are around 7% p.a., with 4% paid as dividend income and 3% as capital gains. The fund’s investment strategy is simple with 2-3 years of pension payments held in cash and the remainder in Australian shares. The administration costs of the fund are very low which James and Michelle don’t see as an issue.
Deane is 72 and retired. His partner Charlene is 59, works full time on a modest salary and has plans to retire soon. To make use of their SMSF most effectively, Deane has been drawing down a tax-free pension to top up their living expenses. Deane’s balance in the SMSF is now about $4,700 and Charlene’s balance is about $154,000. Fund earnings are around 7% p.a., with 4% as income and 3% as capital gains. The investment strategy is simple, consisting of cash and Australian shares. Administration costs in dollar terms are similar to James and Michelle – but are higher as a percentage of the fund’s total value.
For each couple, is the right decision to keep the fund going? Or close the fund and invest the money elsewhere? Well, it really just depends.
But before we consider each of the couples, let’s examine the features of investing inside and outside of super.
| Inside an SMSF | Outside of superannuation | |
| Taxation |
A flat rate of tax is payable irrespective of the fund’s investment income. Taxable capital gains receive a 1/3rd discount. This equates to CGT of 10% for qualifying investments that have been owned for longer than 12 months. Franking credits can be used efficiently. Up to 30% of the franking credits received by the fund can be applied against any tax payable. Excess franking credits are refunded to the fund. Account-based pensions paid by the fund to anyone under 60 are taxed at personal rates less a 15% tax offset on the taxable portion of the pension. Once the pension is paid to anyone 60 and older, the whole of the pension received is tax-free. |
Any taxable investment income is taxed at personal rates on amounts in excess of the tax-free threshold, which can depend on the person’s age and other circumstances such as eligibility for social security benefits. The tax rates increase the greater the taxable income. Taxable capital gains are eligible for a 50% discount for qualifying investments that have been owned for longer than 12 months. Franking credits are applied against a person’s tax payable and may result in a refund where the credits are greater than the tax payable. Income earned jointly can be split equally against each joint owner. |
| Fees and charges |
Fees and charges may vary depending on the amount of work a trustee is prepared to undertake. These costs can be controlled as the trustees may have accounting or investment management skills which they can provide at no cost to the fund. The fund will have some unavoidable costs such as the annual independent audit of the fund by an approved SMSF auditor and may require an actuarial valuation to calculate the fund’s taxable and tax-exempt income. Other fees and charges such as brokerage, bank fees and other charges would be payable on the SMSF’s investments. |
Generally, fees can be controlled by the individual who may keep some records for taxation purposes but there is no other statutory reason to prepare and retain records compared to an SMSF. Other fees and charges such as brokerage, bank fees and other charges would be payable in relation to the investments held personally. |
| Investments |
An SMSF is required to have an investment strategy stipulating its investment objectives and allowable investment categories. It should be in writing, regularly reviewed and should consider the personal circumstances of fund members, including their age and investment risk tolerance. Depending on the investment provisions in the SMSF’s trust deed and investment strategy, a wide range of investments may be permitted including public and private company shares, managed funds, private trusts, cash and term deposits, direct property and even artworks and collectibles. However, there may be restrictions or prohibitions on some types of investments, especially where they involve related parties such as members, trustees, their relatives or private companies or unit trusts that they may control. |
There are few restrictions on investments made personally. Access to the amount invested may occur within a relatively short period but would depend on the type of investment. On the death of a joint owner, investments revert to the surviving joint owner(s) automatically. If the investment is owned as tenants in common, the share of the investment owned by the deceased would usually be subject to the terms of their will. |
| Other important features |
Once a member’s benefits have been withdrawn from super, returning the money to the fund as contributions may be difficult, especially after reaching 65. On the death of a fund member it is possible to pay a tax-exempt pension to a surviving dependant of the deceased such as the member’s spouse. Accounts and records for the SMSF are required to be kept for periods set out in the legislation. |
If James and Michelle keep their SMSF, all fund income and capital gains are tax free. Any amounts that are withdrawn from the fund as pensions would also be tax free to them.
If they withdrew their money and invested it outside of super on the same terms, it’s reasonable to expect the income would be tax free due to some of the tax offsets that may be available to them. However, if they sold some of the investments and made taxable capital gains, they could face a tax bill if they were to exceed their tax-free threshold. Their tax position would also depend on other income they may be currently earning.
It seems wiser for James and Michelle to retain their fund. Being in retirement phase, fund income, CGT and fund withdrawals are tax free. However, they should review their position periodically to decide whether it’s worthwhile to withdraw their fund balance and invest it personally. This may come at the time when they qualify for social security benefits – but the decision would be guided by other assets and income they have in addition to their SMSF.
Deane and Charlene are currently in a less flexible place with their SMSF. Without retiring, Charlene is not able to withdraw her super as a lump sum and invest it in her name or jointly with Deane. If she was to ‘retire’ as defined for a person under age 60, she may be able to access the money.
If Deane and Charlene wished to retain the SMSF, Charlene could access her superannuation as a transition-to-retirement income stream (TRIS). Tax would payable on the taxable component of the TRIS until age 60.
The alternative could be to wind up the SMSF and rollover the amounts to another superannuation fund. Whether this is worthwhile could depend on the fees and charges and how long it is before Charlene retires.
Other relevant factors in retaining their SMSF: do Deane and Charlene have other super money they could rollover to their SMSF? And for how long does Charlene intend to make super contributions?
In both cases, there are external factors to consider in deciding the fate of the fund.
However, for James and Michelle, retaining the fund is probably the better option for the time being, though this would need to be reviewed periodically.
As for Deane and Charlene, it seems best to wind up their SMSF and rollover Charlene’s benefit to a lower-fee super fund until she retires. Or otherwise: delay winding up the SMSF until she has reached 60 and retired.
