By Graeme Colley
Executive Manager, SMSF Technical & Private Wealth
With the potential increase in self-managed fund members from 4 to 6 has meant an increase in enquiries whether it is worthwhile to have children as members of the parent’s or ‘family’ SMSF. The options are, should the kids join the fund, have their own or go elsewhere to an industry or retail fund.
Let’s face it, on the positive side SMSFs are a good way of building retirement wealth and if done properly can boost the financial literacy of all members regardless of age – so why not have one exclusively for the whole family?
Would you recommend a family SMSF?
Many media commentators tell you that they wouldn’t recommend children as members or trustees of a family SMSF. In some cases it can work exceptionally well and the children play an important co-operative component in the fund. There’s a high level of respect amongst the family and decisions are made collaboratively to the benefit of everyone.
At the other end of the spectrum, however, have a look at the ever-increasing number of court cases which are littered with sad stories. Some involve children taking money from the family fund for their own purposes and other situations where children weaselled their way into the fund as trustees and took over the parent’s super.
Whether the family SMSF should include children depends on the reasons for having them as members, their ages, personal situation and whether they are genuinely willing to take responsibility as trustees. Let’s look at the good, bad and the ugly of having children involved with the family SMSF.
Reasons to include family members
There is no doubt that every family member is different and so is each child within that family. Parents need to exercise judgement on which child should be admitted as a member of the family super fund. A child who has difficulty managing their own personal finances will probably have the same issues as a member or trustee of an SMSF. They may be better off as members of a retail or industry fund where professional managers look after the fund investments.
Children can be split into three categories for superannuation purposes by age and circumstance – those under 18, single adult children and those children in a relationship, possibly with their own family.
Children under 18
Super can be provided for children under 18 by a parent or relative making child contributions up to $300,000 over a fixed three-year period which are not tax deductible. If the child happens to be working, contributions of up to $25,000 or more may be made by an employer or the child may qualify to claim a tax deduction themselves. Any contributions will help provide a bigger pool of money for investing and remember the benefit of compound interest on savings cannot be under rated.
A child under 18 can be a member of the SMSF but can’t be a trustee or director of a trustee company until they are at least that age. Under 18, it’s the child’s parents, guardian or their legal personal representative who is the trustee in the child’s place.
18 and over
A child 18 or older has legal capacity in most cases and can be an individual trustee of the fund or director of the corporate trustee. Along with the other trustees of directors they are responsible for the operation of the whole fund as well as all the fund members, not just themselves. This can be a catalyst to get your child involved in the investment of their super savings and understand the workings of an SMSF.
Whether you would allow any of your children who has a spouse but no family themselves to be a member of an SMSF depends on the situation. In many cases it may be worthwhile to include the child until they have enough to start an SMSF for themselves and their partner.
Children with their own family
The time may come when your child has their own family. Whether they should become members of the family SMSF or have their own will depend on the situation. The same outcomes could be achieved by the child having their own SMSF as the fund may be able to make investments jointly with the parent’s fund.
Introducing family members to the ‘family’ SMSF
One way of introducing children to a family SMSF is that investments could be split among the members. Investments supporting the children’s super balances can be segregated from of their parents’ investments within the fund. This could be done by using separate bank and investment accounts and the records left to an SMSF accountant or administrator who has the skills and systems to handle segregated investments without incurring additional administration costs.
Having children in the family SMSF may also enable an inter-generational transfer or family assets – such as a commercial property used in the family business or other real estate. However, a word of warning, if this strategy is used it must be structured and handled correctly otherwise compliance problems can occur. There are a number of ways in which the investment could be owned by the fund either jointly, as a company or unit trust. The strategy can allow ownership of real estate by one SMSF or split across different SMSFs and allows flexibility if one fund wishes to purchase units or the property in future.
Case Study
Mike and Melissa (both age 62) and their two children in their 30s, are members of an SMSF which plans to purchase a shop that is used for the family business. The members’ balances in the fund are just about high enough to purchase the property on commercial terms without seeking a mortgage from a bank. However, to ensure the purchase can go ahead it will require the members to make additional contributions to the family fund.
The four go and see their tax accountant who is an SMSF specialist and she tells them that there are probably a few ways in which the shop could be purchased. Here are the options she has suggested:
1. The fund could purchase 100% of the property but it will require cash from the member’s contributions. This may have some issues as the fund will own a very lumpy asset and the fund’s cash flow will be tight for some years. If the children decide to rollover their super to another fund the shop may have to be sold.
2. The fund could purchase part of the property as tenants in common with the current owners which would be possible from a cash flow perspective. However, the property could not have a mortgage over it and it may be possible to pay out the mortgage as part of the fund purchasing the property.
3. A fixed unit trust or private company could be established and providing there is no mortgage over the property the fund could purchase units in the trust as well as other family members who would own the units personally.
Whatever strategy is decided on, the purchase is helped by family members combining their resources from the SMSF to purchase the shop. In addition, the tax-deductible rent from the shop is paid to the owners which would include the SMSF either directly or indirectly. If the children wished to run the business after the parents retire then having the shop in the SMSF can mean an intergenerational transfer of the asset which is seamless.
Reasons for not having a family SMSF
There may be many positive aspects of having a family SMSF but unfortunately, there is probably a longer list of situations where things may get twisted.
Dipping into the fund
When children become members and trustees of the family SMSF they can be in a position where they can access to the fund’s resources. Access to the fund without proper controls over the fund’s bank accounts and investments can have tragic consequences.
A court case some years ago where the SMSF consisted of a husband and wife and a drug addicted son resulted in the son leaving the fund almost penniless and the fund being treated as non-complying for tax purposes. If better control had been exercised over the operation of the fund and the trustees understood their responsibilities maybe the loss may not have occurred.
Relationship breakdown
In a relationship breakdown superannuation forms part of the partner’s assets which is included in the marriage settlement to determine how the assets will be split between the parties. This means that as part of the settlement that an ex-spouse may have access to their partner’s super in the case of divorce. It could mean having to sell the family business assets to free up cash as part of the marriage settlement agreement. The situation is not isolated to just the parents as the children as members of the fund may also be going through a relationship breakdown
Control on death
When it comes to estate planning and SMSFs, who has control is going is probably the most important factor when ensuring the wishes of the deceased member are carried out correctly.
There are many court cases where children have been appointed as trustees of an SMSF as the legal personal representative of their parents. In one case, a father and daughter were members and trustees of the SMSF. The father completed a non-binding nomination requesting the trustee to split his super balance 50/50 to the daughter and son. The son was not a member or trustee of the SMSF at the time of his death, so the daughter appointed her husband and proceeded to pay 100% of her father’s benefits to herself. The Court found in her favour – as trustee her (and her husband) had discretion as the nomination made by the father was not binding on the trustee.
Even if the nomination was binding, the fact that the daughter was in control of the SMSF could have caused a protracted and costly legal battle between the beneficiaries. Therefore, consideration needs to be given to the loss of control over the SMSF if a trustee or member dies or loses capacity.
To include or not to include, that is the question?
There can be many benefits by including children and other family members to an SMSF. But considerable thought should be given to the potential risks that can arise when family and money are combined.
Weigh up the pros and cons before making your decision as the different needs and motivations of family members may be different to your own and only lead to conflict.
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