By Mark Ellem
We’re a nation that loves property – and the ability to buy property within an SMSF can be a significant factor in establishing one.
Based on the June 2017 SuperConcepts Investments Pattern Survey, property makes up around 20% of the value of all funds surveyed. For an individual SMSF, property could conceivably represent the majority of member benefits, with the only other asset being the fund’s bank account. However, because fund payments, such as a death benefit, can’t be made in bricks and tiles, the issue of liquidity needs to be carefully considered.
An SMSF is required to have a formal investment strategy, which must be reviewed on a regular basis. When formulating the investment strategy, the fund needs to consider “the liquidity of the entity's investments, having regard to its expected cash flow requirements”.
Let’s take the example of the Bedrock Superannuation Fund. Its members include Fred, aged 68, who’s retired with all of his benefits in an account based pension (ABP). Other members, all employed, include Wilma, aged 63, and the couple’s adult children, Barney and Betty, aged 42 and 38 respectively. The SMSF has a corporate trustee with all members as directors.
As more than half the value of the fund is in relatively illiquid assets (i.e. commercial property), it needs to consider how it will pay member benefits – particularly death benefits which must, according to law, be paid as soon as practicable after the member dies.
Consider the following issues in the event that Fred dies.
Fred’s benefits, held in his ABP, total $1.8m. It would be expected that as at 30 June 2017 this would be restructured to a retirement phase ABP of $1.6m and an accumulation account of $200k. Assuming his ABP was auto reversionary to Wilma, upon his death the value of his ABP, say it’s still $1.6m, would count towards Wilma’s TBC, but not until 12 months after Fred’s date of death.
If at the time of Fred’s passing Wilma has not retired, then she can receive Fred’s reversionary pension, provided it was not valued at more than $1.6m on the date of Fred’s death. This still leaves the balance of Fred’s accumulation account 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, or investments that can easily be converted to cash, to make the lump sum benefit payment. However, what if Wilma wanted to take all of Fred’s benefits as a lump sum, in cash?
If at the time of Fred’s death Wilma has ‘retired’, then it would be expected that she would have used up a substantial portion of her TBC. Again, consideration needs to be given to what amount of Fred’s superannuation benefits could be retained within the fund. You would also need to consider if Fred had competed a binding death benefit nomination, for example, to payout his all of his benefits as a lump sum.
The introduction and restriction of the TBC means that not all of Fred’s benefits could be retained by the fund and paid to Wilma as a death benefit pension or reversionary pension. Even where Wilma had the full use of her TBC at the time of Fred’s passing, there could still be a portion of his benefits that would need to be paid out of the SMSF as a lump sum death benefit. With nearly more than half the fund in illiquid property, how will the fund effect the death benefit payment? By the sale of assets? Or via an in-specie asset transfer
Where an amount of Fred’s benefits is paid out as a lump sum death benefit to Wilma, she may wish to contribute this back to the fund. The question will be: is she able to contribute, and if so to what amount? The non-concessional cap is now subject to a total superannuation balance (TSB) eligibility test. If Wilma’s prior 30 June TSB is at least $1.6m, her non-concessional contribution cap is nil. If she is under age 65 in the income year of making the non-concessional contribution, she may be able to utilise the bring forward rule, however, this will also depend on her prior 30 June TSB.
The trustee of the Bedrock Superannuation Fund is a company, with all members of the SMSF being directors of the corporate trustee. After the passing of Fred, there would be three remaining directors, Wilma, Barney and Betty. If the corporate trustee has a standard company constitution, you would expect that each would have one vote at director meetings. Consequently, you now have a situation where Wilma would have around 85% of the value of the SMSF, but only has one of three votes of the directors of the corporate trustee. This could lead to Barney and Betty outvoting Wilma on fund matters.
It may be now worth considering the options available to Fred and Wilma to ensure that, in the event of one of them passing, the surviving spouse retains control of the SMSF.
There is even a control issue now, with, for example, Barney and Betty siding with Wilma to out vote Fred in any fund matters.
Careful consideration should always be given to bringing adult children into the parent’s SMSF. Just refer to the Triway Super Fund case.
It’s important to regularly review your 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, what are the cash flow requirements to effect the compulsory death benefit payment, either as a lump sum or pension? What if the property is a commercial property used in the business of one of the members of the fund – will the fund be able to 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 trustee needs to consider the risk to cash flow requirements that such assets present. 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 involved in the death of a member.