By Graeme Colley
Executive Manager, SMSF Technical & Private Wealth
If the current frenzy in property prices is anything to go by, there’s no doubt we’re a property loving country. Purchasing a property directly or indirectly via an SMSF can be one of the significant factors in establishing one.
Around 20% of the value of all funds surveyed have an investment which incorporates property. For some SMSFs, property may represent the vast majority of the fund’s assets and the only other asset is the fund’s bank account. However, because the payment of some super fund benefits, such as a death benefit pensions, can’t be made in bricks and mortar, the liquidity of the fund needs to be considered seriously.
What’s important?
To comply with the superannuation laws all SMSFs must have an investment strategy, which is reviewed regularly, at least annually. When putting the investment strategy together, the fund needs to consider “the liquidity of the entity's investments, having regard to its expected cash flow requirements”.
As an example, let’s consider the Easy Future Superannuation Fund. Its members include Harry, aged 68, who is receiving an account based pension (ABP). The other members of the fund who are all in employment are Naomi, Harry’s spouse, age 63, and the couple’s adult children, James, aged 42, and Alicia aged 38. The SMSF has a corporate trustee with all members as directors.
| Harry |
$2,000,000 |
Bank account |
$150,000 |
| Naomi |
$1,500,000 |
Commercial Property |
$3,500,000 |
| James |
$700,000 |
Listed shares |
$600,000 |
| Alicia |
$450,000 |
Managed funds |
$400,000 |
More than half the fund is invested in a commercial property which makes it relatively illiquid. The trustees need to consider how the assets, such as the commercial property, are able to pay member benefits. This would apply particularly to any death benefit lump sums which must be paid as soon as practicable after the member dies. Liquidity may not be as important if death benefit pensions are paid from the fund as the capital supporting the pension remains in the fund.
Consider the following issues should Harry die.
Transfer balance cap (TBC) issues
Harry’s benefits, held in his ABP, total $2m. Assuming his ABP reverted to Naomi, the value at the time of death would count towards he Transfer Balance Cap (TBC), but not until 12 months after Harry’s date of death.
If the partner is still working…
If at the time of the Harry’s death, Naomi had not retired, she will receive the reversion from Harry’s ABP. However, Naomi may need to commute (convert) part of the ABP to a lump sum to ensure they don’t exceed her TBC on the anniversary of Harry’s death. This will still leave any lump sum from the commutation of the ABP to be paid “as soon as practicable” as a lump sum death benefit to a SIS dependent. Based on the makeup of the SMSF’s investments, there should be enough cash (about $400,000) or investments that could be transferred to satisfy payment of the lump sum. But what if Naomi wished to receive all of the death benefit lump sum in cash?
…and if the partner retired…
If at the time of Harry’s death Naomi had ‘retired’, it could be expected that they may have used some of their TBC . Again, consideration needs to be given to the amount of the death benefit, if any, could be retained within the fund and paid as a pension. Consideration needs to be given to whether Harry had a binding death benefit nomination and required that all of the death benefits be paid as a lump sum.
Cash flow issues
The impact of the TBC means that not all of Harry’s death benefits could be retained in the fund and paid to Naomi as a death benefit pension or reversionary pension. Even where Naomi had full use of their TBC at the time of Harry’s death, there could still be part of their benefits that need to be paid as a lump sum death benefit. With over half the fund in an illiquid property investment, the challenge for the trustees is how the fund can pay the death benefit payment? By the sale of assets? Or via an in-specie asset transfer?
Contribution issues
Where the death benefit is paid as a lump sum, Naomi may wish to contribute some of it back to the fund. The question will be, can they contribute, and if so to what amount? Non-concessional contributions are limited by a person’s total super balance on 30 June in the previous year, their age and is capped at a dollar amount.
Control of the SMSF
The trustee of the ABC Superannuation Fund is a company, with all members of the SMSF being directors of the corporate trustee. After the death of Harry, there would be three remaining directors, consisting of Naomi and the two children. If the corporate trustee has a standard company constitution, it would be reasonable to expect that each would have one vote at trustee meetings. Consequently, you now have a situation where the partner would have the lion’s share of the value of the SMSF, but only has one of vote out of the three directors of the corporate trustee. This could lead to the children outvoting Naomi on fund matters.
It may be worth considering the options available while all members are alive to ensure that, in the event of one of them passing, control of the SMSF is vested in the member with the largest balance.
Careful consideration should always be given to bringing adult children into the parent’s SMSF as illustrated by many court and tribunal cases.
When to review the fund’s investment strategy?
It’s important to regularly review the fund’s investment strategy, particularly in light of changed circumstances. A review is required at least annually.
In the event of the death of a fund member there are a number of issues to be considered:
• review the fund’s investments to make sure adjustments are made to the investment strategy to ensure they are consistent,
• review the cash flow requirements if a death benefit lump sum or pension will be made, either as a lump sum or pension,
• if an asset of the fund is a commercial property used in the business of one of the members of the fund – does the fund retain ownership, or will the property have to be transferred out?
There’s no rule against the fund having illiquid assets and those assets forming a large portion of the fund. However, the trustees need to consider the risk to the fund’s cash flow requirements. Consideration of liquidity risk would also be integral to the fund members’ respective individual estate plans.
So, get out the fund’s investment strategy, review the fund’s investment portfolio, understand the estate plans of each member and consider the liquidity requirements if one of the members was to pass away.
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