S M S F A Money Management supplement
November 11, 2011
P R O F E S S I O NA L
INSIDE 4 SMSFs: RISING TO THE CHALLENGE The unfolding SMSF story is an interesting one, according to DAMON TAYLOR. The sector has enjoyed significant growth and success in recent years and is here to stay, but how will it respond to proposed changes?
10 PLAN BEFORE YOU HOLIDAY
Reed Business Information Tower 2, 475 Victoria Avenue Chatswood NSW 2067 Mail: Locked Bag 2999 Chatswood Delivery Centre Chatswood NSW 2067 Tel: (02) 9422 2999 Fax: (02) 9422 2822
When a self-managed superannuation fund (SMSF) member or trustee travels overseas for an extended period, their SMSF could lose the tax concessions it enjoys. NICHOLAS ALI outlines strategies to avoid this particular consequence.
Publisher: Zeina Khodr Tel: (02) 9422 2198 email@example.com Managing Editor: Mike Taylor Tel: (02) 9422 2712 firstname.lastname@example.org News Editor: Chris Kennedy Tel: (02) 9422 2819 email@example.com Features Editor: Milana Pokrajac Tel: (02) 9422 2080 firstname.lastname@example.org Journalist: Tim Stewart Tel: (02) 9422 2210 Journalist: Andrew Tsanadis Tel: (02) 9422 2815 Melbourne Correspondent: Benjamin Levy Tel: (03) 9527 7392
11 FROM LITTLE THINGS Advisers need to be wise when recommending insurance options within their clients’ self-managed super funds. WARRICK HANLEY explains how small mistakes can lead to big consequences.
12 TIME TO SHIFT INVESTMENT GEARS? The recent interest rate cut by the Reserve Bank of Australia has created a number of opportunities for self-managed super funds. PETER VAN DER WESTHUYZEN explains.
14 BORROWING IMPROVEMENTS AND REPAIRS The Australian Taxation Office's (ATO's) recent draft ruling on limited recourse borrowing arrangements has clarified its approach, according to PETER BURGESS.
15 PLAY BY THE NEW GEARING RULES MIKE MITCHELL outlines the strategy implications a recent ATO draft ruling could have for SMSF trustees when deciding whether to borrow to buy property in or outside super.
16 SAVVY CAN RIDE MARKET RECOVERY AARON DUNN lists some of the strategies that self-managed super fund members should start to think about to help bolster their superannuation savings in recovering markets.
17 GREATER CONTROL, GREATER SCRUTINY Having control over investments is the number one reason for switching to self-managed super funds. However, with greater control comes greater scrutiny, writes ROBIN BOWERMAN.
18 SUCCESSION PLANNING REVIEW IMPORTANCE HIGHLIGHTED The ageing population and the ATO’s recent draft pensions ruling highlight the need to review clients’ overall succession planning, according to DANIEL BUTLER and NATHAN PAPSON.
November 24, 2011
ADVERTISING Senior Account Manager: Suma Donnelly Tel: (02) 9422 8796 Mob: 0416 815 429 email@example.com Account Manager: Jimmy Gupta Tel: (02) 9422 2850 Mob: 0421 422 722 firstname.lastname@example.org Adelaide Agent: Sue Hoffman Tel: (08) 8379 9522 Fax: (08) 8379 9735 Queensland Agent: Peter Scruby Tel: (07) 3391 6633 Fax: (07) 3891 5602 PRODUCTION Junior Designer/Production Co-ordinator – Print: Andrew Lim Tel: (02) 9422 2816 email@example.com Sub-Editor: Marija Fletcher Sub-Editor: Daniel Winter Graphic Designer: Ben Young Subscription enquiries: 1300 360 126 Money Management is printed by Geon – Sydney, NSW. Published every week, recommended retail price $6.95 Subscription rates: 1 year A$280 incl GST. Overseas prices apply. All Money Management material is copyright. Reproduction in whole or in part is not allowed without written permission from the Editor. © 2011. Supplied images © 2011 Shutterstock. Opinions expressed in Money Management are not necessarily those of Money Management or Reed Business Information.
Average Net Distribution Period ending March '11 10,207
Why do 1 in 4 SMSFs use the Macquarie Cash Management Account? It’s easier to keep your clients’ SMSFs on course when you have a complete view of their cashflow. With the Macquarie Cash Management Account, you can track each fund’s cash transactions, generate reports and integrate directly with your back office systems. Plus, consolidated statements take the pain out of accounting, administration, tax returns, end of year auditing and compliance monitoring.
Macquarie Adviser Services Call 1800 005 056, talk to your Macquarie BDM or visit macquarie.com.au/cashflow
* Source: Macquarie Bank Limited data, ATO Self-Managed Super Fund Statistical Report. The Macquarie Cash Management Account is a deposit account provided by Macquarie Bank Limited ABN 46 008 583 542 (“Macquarie”). Fees and charges may be payable. Terms and conditions are available upon request. Macquarie Group Limited is regulated by Australian Prudential Regulation Authority (“APRA”), the Australian banking regulator, as the non-operating holding company of an Australian bank (Macquarie, a wholly owned subsidiary of Macquarie Group Limited). As a licensed Australian bank, Macquarie is subject to regulation by APRA. Macquarie also holds Australian Financial Services Licence No. 237502 and is subject to regulation by the Australian Securities and Investments Commission. This information does not take into account your clients’ objectives, financial situation or needs. Therefore, in deciding whether to acquire or continue to hold an investment in the above products, your clients should consider the relevant offer document, which is available from us.
RISING TO THE
The unfolding SMSF story is an interesting one, according to DAMON TAYLOR. The sector has enjoyed significant growth and success in recent years and is here to stay, but how will it respond to proposed changes?
November 24, 2011
here is little doubt that the selfmanaged funds sector of superannuation has made some significant strides in recent years. Love it or hate it, the sector now enjoys an enviable position in terms of funds under management, industry acknowledgement, and apparent popularity. But while it is easy to point to superannuantsâ€™ desire for control as the reason for such a trend, principal and head of superannuation audit and consulting for WHK, Chris Malkin, believes that position has been brought about by a combination of factors. â€œItâ€™s certainly not confined to the desire for control,â€? he said. â€œIâ€™d say thereâ€™s probably a bit of uncertainty as a result of Europe and the impact that that has on the marketplace in Australia, but I also think people in the very large funds have probably been a little bit sceptical about their returns over a long period of time.â€? â€œSo [it is] the fact that they hold such a view, combined with their own expertise and the ability for a self-managed fund to diversify away from managed investments into property and direct share investments,â€? continued Malkin. â€œIt means they feel that they can do it as well, if not better, and probably contain the fees a lot as well.â€? â€œThereâ€™s no one reason here; itâ€™s definitely a combination of factors.â€?
PETER HOGAN But while Malkin is of the view that self-managed super fund (SMSF) sector growth goes beyond control, Peter Hogan, principal of Plaza Financial and director of the Self Managed Super Fund Professionalsâ€™ Association of Australia (SPAA), said control was commonly held to be the number one reason. â€œWhen you look at all the surveys of trustees of self-managed superannuation funds, control is clearly the number one issue that they cite for setting up a fund,â€? he said. â€œBut that arises for a number of different reasons, and whatâ€™s happening in the market has traditionally been a catalyst for people setting up their own funds.â€? â€œItâ€™s almost like an inverse reaction;
the worse the markets do, the more self-managed super funds are set up.â€? Beyond control, Hogan said an increase in the number of self-managed super fund trustees holding onto their accounts into retirement had also been a factor. â€œThere are also more people hanging onto their SMSF into pension phase now than there were in the past,â€? he said. â€œA lot of people found the whole prospect of running an income stream out of their SMSF quite daunting, particularly when they have to start registering for tax and deducting tax and remitting it to the tax office, and so on.â€? â€œIt was a complex procedure, but itâ€™s less so now, with pensions for over 60s being tax exempt, and generally â€“ provided that the fund is 100 per cent in pension phase â€“ it can be a fairly straight forward exercise these days,â€? Hogan continued. â€œEstate planning opportunities and abilities in that space may also be part of the reason, insomuch as you can be quite specific about who you leave your money to in the event of your death. â€œThat is clearly another advantage available in SMSFs, and just one more part of their overall attraction.â€? Yet while the attraction of an individual being in control of their own
November 24, 2011
retirement destiny is clearly telling, one would hope that the SMSFs can attribute their success to improvements in the sectorâ€™s overall running as well. Fortunately, Hogan believes the sectorâ€™s professionalism has grown in line with its superannuation industry market share. â€œThe quality in terms of the work thatâ€™s being done for SMSF trustees has indeed improved,â€? he said. â€œThe ATO [Australian Taxation Office], for example â€“ while theyâ€™re still saying that there are professionals out there who havenâ€™t done as good a job as what they should have done for their SMSF clients, they have a much greater confidence in the financial planners, the accountants, the auditors, and in the work that theyâ€™re doing in this space all together compared to ten years ago. â€œThere is a higher level of competency in terms of the advice and the assistance being given to trustees of self-managed super funds, certainly.â€? Alternatively, Graeme Colley, superannuation strategy manager for OnePath, said that based upon the evidence available, there was still room for significant improvement. â€œI think the only objective view you CONTINUED ON PAGE 6
can get on this is what the ATO is saying,” he said. “I was on the SMSF working party for this, and the ATO was indicating quite clearly that there were professionals out there that weren’t conducting audits of SMSFs, and the way in which the funds were conducted was very adhoc and very haphazard. “Now if that’s indicative of a portion of the self-managed fund market, then the competencies of advisors certainly need to be improved, particularly on the margins,” added Colley. “So yes, overall, the competency of advisors to this sector has improved, but it still has a way to go. “And you’ll probably see that pan out over the next few months once we start to see the legislation for auditors, accountants, financial planners and to see whether it will actually require another bit of a jump to improve the competency of those professionals further.” However, the important point to be made, according to Hogan, is that there are always going to be opportunities for improvement. “That’s just the nature of the beast,” he said. “At the end of the day, this is a very complicated area, and it does require people with a good understanding of what it is that they’re doing and their role in the area. “Even to simply start an SMSF, you initially have lawyers involved in putting together the trust documents, you’ve got financial planners with the investments, you’ve got your accountants with annual accounts and the audits, and so on,” Hogan continued. “So it’s not just a single advisor structure that you’re dealing with and, in that sense, it’s pretty important that everyone involved in running the fund is doing their part appropriately.” But whether you believe that the running of the SMSF sector is where it
ANDREA SLATTERY needs to be or feel that it continues to cause concern, a certain amount of change has already been flagged in terms of service provider requirement and competency. As Colley has already alluded, the Government has made clear its intention to raise service provider professionalism. Top of the list are auditor registration and independence, and the removal of the accountants’ licensing exemption, but the question remaining is how the sector is likely to respond. For Malkin, however, the sector’s response is not a concern. “I think the sector will respond very positively but, more importantly, I think it has responded very positively to date,” he said. “As far as auditors are concerned – which is my area of interest – I welcome the increasing competency requirements of approved auditors, and I welcome the policing of the standards required within the Australian auditing standards, and of course the application of a lot of the competency requirements put on by the accounting profession – particularly the ICAA [Institute of Chartered Accountants in Australia] and CPA Australia.” “There’s enough rigour in all of
that in order to satisfy the regulator,” Malkin continued. “I also believe that the further restricting of accountants is not a good thing, because I think properly professional and qualified accountants – and again I would reference CPA Australia and the ICAA as being the two major bodies – have disciplines that are very sound.” Also speaking to auditor independence specifically, Hogan said that there had already been strong moves by firms in setting themselves up solely as SMSF auditors. “So that’s all they do, and it’s with a view to having that work referred to them,” he said. “And with the accountants that are referring the audit to them, it’s being done on the basis that they’re independent of the advice that’s being given. “So in the past, accountants have been reluctant to refer any client to someone else to undertake a function due to a concern that that person might actively try to take over more work from that client,” Hogan continued. “But now what we find is that we have purely audit firms that can do audits without having any interest in any of the client’s business outside of that space. “And that’s been a response to that whole issue around independence.” Hogan also predicted that the proposed registration of auditors would cause a number of current providers to move out of the SMSF space completely. “They will just see that the amount of time and effort and work involved in maintaining that registration is not going to make it worthwhile to do,” he said. “That potentially means that there will be fewer auditors available to audit funds, but on the other hand, the auditors who do continue on in that area will certainly be people with
November 24, 2011
a higher degree of capability in doing that work. “It will be a win for the industry overall, because what we need is exactly that – that higher degree of competency.” Changing tack to the proposed removal of what the Super System Review dubbed an artificial licensing exemption for accountants, Hogan said that the carve out that accountants currently had, while partially effective, hadn’t actually given them the scope that they needed to give an appropriate level of advice. “It seems to me that the position they found themselves in, where they could say that someone should be in a self-managed super fund for certain reasons but couldn’t give them any advice about whether they should move any of their existing accounts across or about what level of contributions they should make or investment strategy and so on,” he said, “that position made it awkward for them to operate anyway. “So as to the question of whether the requirements come down to having a full licence or whether there’s some other interim license arrangement for accountants, there's been nothing formally announced in that way so it’s still a case of ‘wait and see’,” Hogan continued. “We’ll have to see what the solution is that they finally come up with, whether it’s that accountants who wish to give advice in this area will need a full AFSL [Australian Financial Services Licence] or be an authorised representative of someone with a full AFSL or whether there’ll be some inbetween licensing regime – it’s just hard to say at this stage.” “But what you may well find is that regardless of the result, accountants who are interested in operating in this space will license themselves to
whatever the law requires in order to give advice in this space - those who genuinely want to operate in this space will just do what's required.â€? According to Andrea Slattery, chief executive officer of SPAA, the simple reality for SMSF service providers generally is that an understanding of the SMSF advice piece well is vital. â€œAnd they have to have the knowledge and competency to back that up,â€? she said. â€œSPAA is all about raising competency, accrediting people to at least an undergraduate level of experience and having specialists in the market that clients or consumers in the market can seek out to get the right kind of advice.â€? â€œProviders should endeavour to get their own personal recognition in their
knowledge in this area and should seek accreditation,â€? Slattery continued. â€œThey just need to become more competent, get recognition and provide their clients with a very professional service.â€? Yet in the wake of the Super System Review and the Governmentâ€™s Stronger Super reforms, it seems clear that the frameworks surrounding SMSFs are set to improve. That area of development is in line with the sectorâ€™s overall growth but what of asset allocation? The stereotypes of highly conservative allocations within SMSFs persist, but according to Hogan, such stereotypes are not necessarily accurate.
â€œWhen you look at the statistics that the ATO puts out with respect to selfmanaged super fund asset allocations, and if you compare that to the asset allocation decisions of large funds, thereâ€™s not a huge difference between the two,â€? he said. â€œPerhaps thereâ€™s a stronger allocation to Aussie shares versus international shares, but otherwise, the allocation to cash is probably no more skewed than for bigger funds.â€? â€œProperty is also not quite as large as you might think,â€? Hogan added. â€œThen there are investments that are problem investments, but there always will be.â€? â€œFrom SPAAâ€™s perspective, trustees of SMSFs arenâ€™t really that different in
November 24, 2011
their capacity as trustees as they are in their capacity as an individual investor.â€? For Malkin, there is nothing in superannuation legislation that dictates a requirement to invest in certain products or that certain products are bad investments. â€œYes, there are restrictions as to your ability to invest in certain products, to build some rigour around those investments and ensure youâ€™re not getting a present day benefit,â€? he said, â€œbut embedded into SIS [the Superannuation Industry (Supervision) Act] is the requirement to have an investment CONTINUED ON PAGE 8
strategy which considers diversification and risk, and all of the aspects of any sound investment strategy, and I think that there’s enough rigour around the legislation to do with investment strategies to allow for a wide range of investments. “Also, as far as investments for SMSFs are concerned, I think simple is best,” Malkin continued. “So even if I had the capacity to advise clients – though I don’t, given that I’m an auditor – I would never advise them to go into derivatives that they don’t understand or instalment warrants that they don’t understand or anything complex and of that nature.” “There’s lots of ways to skin a cat, so I would personally prefer a SMSF to be well diversified with a combination of cash, blue chip listed securities that are paying fully franked dividends and, of course, property, because I think property is still a very good investment for self-managed super funds – particularly business real property and particularly if you’ve got an exit strategy for the time at which you wish to retire.” Also stating quite clearly that SMSF allocation stereotypes were misleading, Slattery said the most recent data available from the Australian Prudential Regulation Authority (APRA) showed that most SMSFs
were actually slightly less conservative than a number of APRA-regulated default funds. “So while people may believe that they’re generally conservative, I think they have matured, and I think all the different sectors are maturing,” she said. “You’ll also find that SMSF trustees are able to make decisions in a sometimes more timely fashion, and they’re able to be flexible in the way in which they manage their fund. “So the combination is that SMSF trustees will make decisions based on their personal circumstances rather than having to be in a situation where a decision has been made in bulk for you and sometimes takes a little while to turn around, particularly when you’re meeting barriers or targets that you have to set in a pooled environment.” For Hogan, the reality is that all investors, whether trustees of a SMSF or individuals, are in the same boat. “They will always have to make investment decisions,” he said. “And the unfortunate reality is that some of those decisions will always be better than others.” So, on the back of already significant growth and reform which the sector acknowledges to be positive, the unfolding SMSF story is an interesting one. And regardless of whether they
GRAEME COLLEY become the superannuation vehicle of choice into the future (as some have so recently predicted), Malkin said he had few doubts that they would remain as popular as they are now for some time to come. “I personally think that as long as you’ve got enough money to start a fund and you know what you’re doing with it, they’re the superannuation vehicle of choice now,” he said. “And they’re certainly here to stay.” Similarly, Hogan said there was also little reason to think that recent years’ growth – both in terms of number of funds and funds under management – wouldn’t continue. “That well known average of 2,000 SMSF set-ups a month, that’s been a
November 24, 2011
very long-term average when you think about it,” he said. “It’s gone back even to the days of the introduction of the super industry’s Supervision Act back in 1993-1994 when it saw a decline foπr a very short period of time and then bounced back almost immediately. “So certainly, I think the attraction is still there, and I think Cooper was right when he said that the members of SMSFs are more engaged in their superannuation savings than perhaps are members in other types of funds,” Hogan continued. “But they almost, by definition, need to be.” The reality is, according to Hogan, if a member isn’t terribly interested in what they’re doing with the fund, how they’re investing the money or even in taking an active role, then a self-managed super fund simply isn’t the appropriate superannuation vehicle for them. “It really is that simple,” he said. “But for those people who feel engaged, and for those who want to have that control, a self-managed super fund gives them one of any number of avenues to get involved with their super. “It’s clearly one that’s proved to be popular so far, and so long as people are interested in saving for their retirement, I really can't see that changing.”
Plan before you holiday When a self-managed superannuation fund (SMSF) member or trustee travels overseas for an extended period, their SMSF could lose the tax concessions it enjoys. NICHOLAS ALI outlines strategies to avoid this particular consequence.
t is important for members and trustees of self-managed superannuation funds (SMSFs) to consider app pointing an enduring power of attorney when they go overseas for an extended period. If this is not do one, it is possible that the fund may not meet the definition of an Australian superannuation fund fo or the purposes of the Income Tax Assessment Act 1997. This may mean that the SMSF could lose the tax concessions it enjoys. To be considered an 'Australian superannuation fund': • The fund must have been established in Australia, or any asset of the fund is situated in Australia. • The central management and control of the fund is ordinarily in Australia. Australian Taxation Office (ATO) Taxation Ruling TR 2008/9 shows the Commissioner's interpretation of what constitutes central management and control. This centres on the strategic and high-level decision-making processes, which must be made in Australia. • Either the fund had no member that is an ‘active member’ or at least 50 per cent of: (i) The total market value of the fund's assets attributable to superannuation interests held by active members; or (ii) The sum of the amounts that would be payable to or in respect of active members if they voluntarily ceased to be members; (iii) Is attributable to superannuation interests held by active members who are Australian residents. An 'active member' basically means a member who makes contributions to an SMSF. If any of the above conditions are not satisfied, the fund will be treated as non-complying, with potentially disastrous tax consequences. If the
fund cannot meet the definition of an Australian superannuation fund, an amount equal to the market value of the fund's total assets (less any contributions the fund has received that are not part of the taxable income of the fund, such as non-concessional or undeducted contributions) will be included in the fund's assessable income and taxed at the highest marginal tax rate.
CASE STUDY Richard and Sandra are trustees and members of the Smith Family Superannuation Fund, which is an SMSF. Richard is seconded to work for an extended period in Dubai, and Richard and Sandra have no planned return date to Australia. They earn income in Dubai and are Dubai residents for tax purposes. Neither Richard nor Sandra intend contributing to superannuation whilst they are overseas. However, in this instance, central management and control – the high level and strategic decision making – of the Smith Family Superannuation Fund will most likely be conducted outside Australia by Richard and Sandra.
Tasks performed by accountants, administrators or investment managers would not normally constitute highlevel central management and control, but rather operational and day-to-day management of the fund's activities. The Smith Family Superannuation Fund had the following value and components at the end of the financial year: Fund value Less non-concessional contributions Total Tax at 45%
$1,000,000 $200,000 $800,000 ($360,000)
Therefore the Smith Family Superannuation Fund will lose $360,000 in tax. The Tax Commissioner is not able to exercise any discretionary powers where a fund is made non-complying due to it failing to meet the definition of an 'Australian superannuation fund'. As can be seen from the above example, this is a disastrous outcome for Richard and Sandra's retirement savings. One effective way to ensure central management and control remains in Australia is for members to execute an enduring power of attorney in favour of
November 24, 2011
someone who will remain in Australia and be able to make decisions about the operation of the fund. An enduring power of attorney is simply an instrument that enables a person (the donor) to empower another person (the attorney) to make financial and property decisions on their behalf. Therefore, whilst fund members and trustees are outside Australia, they may establish Enduring Powers of Attorney in favour of someone else to ensure central management and control remains in Australia and maintain the fund as a complying superannuation fund. The attorney stands in the non-resident trustee's place and can act as individual trustee or director of the corporate trustee, undertaking the high level and strategic decision making in Australia. As outlined in TR 2008/9, it is important the central management and control is being made by the attorney, and they are not acting on instruction from the trustee/member whilst they are overseas. If this is the case, central management and control may be considered to reside with the trustee/member who is not in Australia, and the SMSF may not satisfy the definition of an 'Australian superannuation fund'. Implementing an enduring power of attorney is a crucial consideration for those who have their own SMSF and are considering working or residing overseas. Planning prior to the trustees/members leaving overseas can mitigate against the fund becoming non-complying and the adverse tax consequences that come with it. Nicholas Ali is a technical services specialist at Super Concepts.
From little things Advisers need to be wise when recommending insurance options within their clients’ self-managed super funds. WARRICK HANLEY explains how small mistakes can lead to big consequences.
here are many reasons to recommend that insurance for a self-managed super fund (SMSF) member is heeld in their super fund. However, very careful consideration is required with respect to the purposee and the premium payments if the insurance is to fulfil its function properly. This is most topical when non-related parties are in the same SMSF (such as in the case of business partners) and there is a large disparity in premiums between the parties. It can also be tricky if you are not in control of the SMSF administration. Take, for example, two business partners (Bill and Ted) who formed an SMSF and leveraged the purchase of their business premises. Their intention was for the property to stay within the fund and continue as the business premises. To protect the asset, they are advised to take out insurance. They only want to insure for the value of
their member benefits. Bill is 40 years old and Ted is 57 and their premiums are $1200 and $6700 respectively. Because of the cost differential, they decide that each member will be responsible for meeting their own insurance cost (premiums credited to each member’ss account). See Table 1. What happens if Ted dies? Because the insurance premiums were paid directly, the proceeds must also be allocated to his member account. The result is that his balance now becomes $800,000 and this has to be paid out as a death benefit. The amount exceeds the cash in the fund by $300,000 and there is a good chance that a lot of planning will need to be unwound at great expense and anguish. If instead of treating the insurance individually, Bill and Ted had viewed the cost holistically as the cost of protecting their long-term plans, the result would be quite
different. See Table 2. Here the fund paid the premiums, not the member. Assuming (don’t assume, you must check the deed) the trust deed does not require insurance proceeds to be allocated to the member, when Ted dies the money could go to a reserve. Ted’s member balance remains $400,000 but the fund has $500,000 in cash. Ted’s death benefit can be paid out and the long-term planning remains in place. The reason it can also be tricky if you are not in control of the fund administration is because your plans may not be reflected in the accounts. You will need to check the financials of the fund each year to ensure that the fund – rather than the members – paid the premiums. It’s a small mistake from an administrator’s perspective, but it has very big consequences. Warrick Hanley is the chairman of online training resource SMSF Education.
November 24, 2011
TABLE 1 Fund Assets Property Debt Cash at bank Net Assets
$1,500,000 $1,400,000 $800,000 $100,000 $700,000
Bill’s Balance Insurance Bill’s Net Balance
$301,200 ($1,200 for $300k) $300,000
Ted’s Balance Insurance Ted’s Net Balance
$406,700 ($6,700 for $400k) $400,000
TABLE 2 Fund Assets Property Debt Cash at bank Net Assets
$1,500,000 $1,400,000 $800,000 $100,000 $700,000
Bill’s Balance Ted’s Balance
Unallocated Income Insurance cost
Time to shift investment The recent interest rate cut by the Reserve Bank of Australia has created a number of opportunities for self-managed super funds. PETER VAN DER WESTHUYZEN explains.
ith the Reser ve Bank of Australia (RBA) cutting the cash rate recently, and the possibility of further rate cuts in the near term, self-managed super fund (SMSF) investors now have the opportunity to chaange gear in their investment strategy to make the move out of cash. A leveraged solution may help SMS SFs get the most out of Australian equities which right now are delivering attractive dividend return ns and franking credits. While leveraging into shares can magnify losses if the market falls, it can also help diversify your portfolio and generate long-term returns, even if equity markets remain flat for the next three to five years. With historically high dividend yields and franking credits, there is currently an opportunity for SMSF investors with the right set of circumstances to generate returns by leveraging into some of Australia’s largest listed companies.
were five years ago. This recent attraction to cash has been quite appealing for investors. Many investors are shifting their investments into cash to take advantage of its perceived safety, and returns from term deposits that are being offered by some with interest rate premiums of greater than 1.50 per cent over the RBA cash rate. However, the RBA’s November rate cut has potentially put an end to that party. In addition, two-year Australian bond yields are pointing toward further interest rate cuts over the next 24 months. It is likely that this expectation has contributed to a noticeable slowdown in the rate of growth of deposits held on the Australian books of individual banks in September 2011, compared to the previous two months. With such a large amount of cash sitting on the sidelines, it is worthwhile reconsidering Australian equities as an investment class.
INVESTMENT AND RETURNS FROM CASH ARE NOW SLOWING
WHY CONSIDER A SHIFT IN INVESTMENT STRATEGY?
On 1 November, the RBA lowered the cash rate for the first time in over two years from 4.75 to 4.50 per cent. This shift in RBA monetary policy comes at a time when deposits on the Australian books of individual banks had increased by over 16 per cent in the two years to September 2011, rising from $1.23 trillion to over $1.43 trillion. During that time, the average Australian household saving rate had also been on the increase, with the average Australian saving almost twice as much of their household income than they
The stock price declines in many of Australia’s largest listed blue chip companies over the past 18 months have seen dividend yields on a number of ASX top 10 listed companies increase to levels not seen since the early 1990s and immediately after the global financial crisis. In fact, the average dividend yield on the ‘big four’ Australian banking stocks has recently traded at a premium of over 5 per cent relative to the rate of return on twoyear Australian government bonds, for only the third time in the last 20 years (see Chart 1).
For some of Australia’s largest blue chip companies, dividend yields when grossed-up for franking credits are trading at levels above 10 per cent, providing SMSF investors with the ability to use leverage as an opportunity to generate returns even if stock prices remain flat over the next five years (see Chart 1). Incidentally, if one had purchased shares in any of the ‘big four’ banking stocks over the last 20 years on
November 24, 2011
a day in which the stock traded on a dividend yield with a premium of five per cent or more over the twoyear government bond rate and held the investment for five years, the average annual capital return (unleveraged, and excluding dividends) would have been 21.5 per cent. On all 548 occasions in which that investment opportunity was available (ie between 1991 and 2006), a positive return would have
gears? Chart 1: Spread Differential – Big four average dividend yield versus two-year Government bond rate 15
that the underlying share portfolio achieves zero capital growth over the next five years. Other key details included in Table 1.
THE RETURNS ANALYSIS
1 t9 2 Oc t9 3 Oc t9 4 Oc t9 5 Oc t9 6 Oc t9 7 Oc t9 8 Oc t9 9 Oc t0 0 Oc t0 1 Oc t0 2 Oc t0 3 Oc t0 4 Oc t0 5 Oc t0 6 Oc t0 7 Oc t0 8 Oc t0 9 Oc t1 0 Oc t1 1
Big 4 +ve spread
Source: Bloomberg, Macquarie
Table 1 SMSF cash contribution Outstanding instalment balance Total investment Leverage to value ratio SMSF tax rate Investment term Variable interest rate Estimated deductible rate
$50,000 $50,000* $100,000* 50% 15% 5 years 9.95% pa 8.80% pa
*Figures immaterially rounded up for ease of reference
been returned 100 per cent of the time. Of course, it is important to remember three important investment principles: past performance is not necessarily an indicator of future performance and should not be relied upon as such; there are no guarantees when investing; and any investment decisions must consider not only the potential for gain but also the risk of loss.
CASE STUDY Tan and her husband Philip are trustees of their family SMSF. They, like many investors, have a historically high percentage of their total SMSF assets allocated to cash. Anticipating further cuts to
Table 2: Returns comparison – final value of investment, net of cashflows and tax* Initial Contribution $50,000
If share prices remain flat $92,000
If share prices fall by 12% pa $49,854
*The franking credit and dividend assumptions are based on public statements by the listed entities and sourced from Bloomberg consensus data as at 3 November 2011. The share portfolio is assumed to have an equal weighting (in dollar terms) to NAB, WBC, ANZ and CBA purchased using share prices available on 3 November 2011.
the official cash rate, Tan and Philip would like to take advantage of the high dividend yields currently available in Australian banking stocks. After assessing their risk profile, they are comfortable taking on the risk of leveraging into equities through the use of a leveraged investment product. They also understand that the use of leverage can potentially magnify gains as well as losses. Tan and Philip use an instalment receipt to leverage half the amount of a $100,000 investment into ‘big four’ Australian banking stocks. They determine that they are prepared to invest on the assumption
By using an instalment receipt, the SMSF is entitled to the dividends and associated franking credits (subject to the SMSF’s particular circumstances) based on the entire investment amount (ie $100,000) and not just on the cash contributed. In Philip and Tan’s case, their investment strategy immediately generates income for their SMSF. The income earned from the dividends and the franking credits results in the investment being cash-flow positive within the first year. Over a five-year term, the SMSF has during that time generated more than $71,000 worth of dividend income and franking credits for an interest outlay of a little more than $20,000. When measured net of cashflows and tax after five years, the value of the investment into banking shares to the SMSF is worth over $92,000, significantly higher than the $50,000 cash initially contributed. This return has been achieved assuming a flat equity market providing zero capital growth. Conversely, assuming negative capital growth each year over the five-year period, the underlying prices of the shares purchased would have to fall by 12 per cent per annum (or roughly halve in value during that time) for the final value of the leveraged investment in equities to be worth roughly the same as the initial $50,000 cash contributed. This provides a significant downside buffer if Tan and Philip are concerned about a falling share price environment. However, it will expose them to increased losses if share prices fall by greater than that amount (see Table 2).
November 24, 2011
SO, WHICH PRODUCT DO I BUY? A number of leveraged SMSF products offer ‘built-in protection’ features, such as loan protection or put option fees. While these may appeal to some, protection comes at a cost. In some instances, loan protection premiums, often paid in advance, can cost as much as $4,600 on a $50,000 leveraged amount, requiring the underlying portfolio to generate a positive return just to earn back that ‘protection premium’. Instalment receipts, on the other hand, can offer SMSFs a lower-cost alternative to use leverage in their investment strategy. Instalment receipts generally have a loan-tovalue-based early repayment trigger and may not protect the starting value of the underlying investment portfolio. However, they are generally limited recourse obligations, meaning that the SMSF’s exposure is limited to the initial amounts invested and any additional amounts that the SMSF elects to pay in response to an early repayment trigger. Instalment receipts may not come with all the bells and whistles of some other leveraged SMSF products. However they can provide the SMSF with a high degree of transparency and liquidity, and access to the benefits of leveraged investing (such as dividends and franking credits). At the same time, they also have the potential to fulfil the investment objective of getting from A to B without the high expense. When it comes to investing, being able to arrive at your destination should be the primary consideration. After all, there is no point shifting gears if it isn’t going to get you to where you want to be. Peter van der Westhuyzen is the head of Macquarie Specialist Investments. MONEY MANAGEMENT
Borrowing improvements and repairs The Australian Taxation Office's (ATO's) recent draft ruling on limited recourse borrowing arrangements has clarified its approach, according to PETER BURGESS.
n 14 September 2011, the Australian Taxation Office (ATO) released Draft Self Managed Superannuation Fu unds Ruling SMSFR 2011/D1. The draft ruling explains key concepts relevant to limited recourse borrowiing arrangements (LRBAs) put in place on or after 7 July 2010. Importantly, the draft ruling clarifies the ATOâ€™s previous preliminary view on asset improvements and provides a number of examples to illustrate the extent to which improvements or alternations can be made to an asset acquired under a LRBA without contravening the asset replacement rules in section 67B of the Superannuation Industry (Supervision) Act 1993. The draft ruling states that an asset acquired under a LRBA can be improved as long as the improvement is not funded by a borrowing under the LRBA, and the improvement does not result in a new asset being created. In the draft ruling, the ATO defines an improvement as a change to the asset which provides a greater efficiency of function. This usually involves changing the asset in a way which increases the value or desirable form, state or condition of the asset. In other words, an improvement involves the addition of new and substantial features or rights to an acquirable asset that substantially increase the assetâ€™s value or functional efficiency. The ruling provides an example of a SMSF which purchases a three-bedroom residential property under a LRBA. After the acquisition, the SMSF renovates the property by adding a bathroom. As the addition of the bathroom has increased the value of the
property and its functional efficiency, the renovation is considered to be an improvement. On the other hand, a new asset is created if the character or purpose of the original asset has changed as a result of the improvement or alteration. In the above example, the renovation has not changed the character or purpose of the property originally acquired under the LRBA and therefore it is not considered to be a new asset. Importantly, in a LRBA context, the distinction between a repair and an improvement is only relevant if the repair is being financed by a borrowing under the LRBA. This distinction is not relevant if the repair is being financed by the SMSF directly or by some other source. All that matters in these situations is that the change to the acquirable asset does not fundamentally change the character or purpose
of the asset such that it becomes a different asset. This approach also enables the use of insurance proceeds to rebuild a property destroyed or damaged by an insurable event such as a fire or cyclone. Because the reconstruction or repair is not being financed by a borrowing under the LRBA, it is irrelevant whether or not the construction merely repairs or improves the property. However, it is important that the repair or reconstruction does not result in a different asset to the original asset acquired under the LRBA. An important consideration would be whether the asset has been entirely replaced by another asset, as this would constitute a new asset under section 67B of the Act. The draft ruling uses the example of a house which is destroyed by fire and is subsequently rebuilt using the insurance proceeds. As rebuilding the house is restoring the asset to what it was at the time of entering into the LRBA, it does not result in a new asset for the purposes of section 67B of the Act. Although the house has been entirely replaced, the acquirable asset itself has not been entirely replaced because it has been constructed on the same land as the previous house. In contrast, if the acquirable asset was a piece of artwork which was being stored in a professional gallery and the gallery and the artwork was destroyed by fire, replacing the artwork with a similar piece of artwork would be in breach of section 67B. The artwork in this situation has been replaced in its entirety, and the replacement piece of artwork is not covered by section 67B.
November 24, 2011
Whether or not the asset has been improved or replaced in a LRBA context requires an assessment of the extent of the improvements to determine whether the improvements have fundamentally changed the character of the asset such that it becomes a different asset. In some situations, it may be difficult to determine whether the improvements have resulted in a new asset being created. For example, what if when rebuilding a house destroyed by fire an additional shed is also added which will be used for commercial purposes? In this situation, a further assessment would need to be undertaken to determine whether or not the acquirable asset is now serving a different function and purpose to that previously served by the asset originally acquired under the LRBA. The draft ruling suggests there is a significant amount of scope to improve or alter an asset without that asset being considered a new asset for the purposes of section 67B. The draft ruling uses the example of a property which is damaged by a cyclone and states that the addition of a second storey to the house at the time the house is repaired would constitute an improvement but not a new asset for the purpose of section 67B. Similarly, the addition of a new pool or a new garage to that asset would be an improvement but not a new asset for the purposes of section 67B. Peter Burgess is the national technical director of the Self Managed Super Fund Professionalsâ€™ Association of Australia.
Play by the new gearing rules MIKE MITCHELL outlines the strategy implications a recent ATO Draft Ruling could have for SMSF trustees when deciding whether to borrow to buy property in or outside super. 2. Does the SMSF have the capacity to fund the borrowing arrangement? Not only will the fund need to meet loan interest payments, there will be insurance premiums and other related expenses. Cashflow problems could arise if the rental income doesn't cover the expenses and: • There are limited liquid assets (such as cash) in the fund that could be drawn on, and/or • The members have limited capacity to make additional contributions (which are subject to caps). Cashflow problems could be further magnified if the property is not tenanted for a significant period, and/or the fund is in pension phase, where pension payments will need to be met.
n 14 September 2011, the Australian Taxation Office released its Draft Tax Ruling SMSFR 2011/D1 to pro ovide some clarity on how the limited recourse borrowing arrangement (LRBA) provisions in section 67A of the Superannuation Industry Supervision (SIS) Act should operate. Since section 67A received Royal Assent in July 2010, there has been some confusion regarding the application of certain elements and a need for some provisions to be relaxed to make LRBAs more workable.
KEY IMPLICATIONS The more significant announcements are: • Super fund trustees can now use other funds (but not borrowings) to improve the asset, provided it is not seen as a different asset. When making this assessment, trustees will need to consider if there has been a substantial increase in the features or rights and hence whether the structure has been altered into a more valuable or desirable form than a repair would do. • An asset that straddles more than one land title that cannot be dealt with separately will now be seen as a 'single' asset and can be acquired using an LRBA. Where an asset is divided or can be dealt with separately, it will generally fail the single acquirable asset definition. • If an asset is destroyed, insurance proceeds may now be used in certain circumstances to replace the asset without contravening the LRBA rules. Once finalised, these and other changes will provide more certainty and flexibility for self-managed superannuation fund (SMSF) trustees. They are also likely to make
3. Will the asset be positively or negatively geared? It's important to assess the starting tax position, and whether this is likely to change for a significant part of the anticipated holding period. borrowing to buy a property in super more attractive than was previously the case. However, the new rules don't necessarily mean that using an LRBA to acquire property in super will suit all SMSF clients.
ADVICE ISSUES When advising SMSF clients, some of the key issues to consider include: 1. Are alternative sources of finance available? For example, could the trustees borrow in their own names or via an entity such as a company? If no other finance options are available, then borrowing in super may be the only solution.
4. What marginal (or other) tax rate would be payable if the property was purchased outside super? As a general rule, borrowing in super can be more tax-effective if the investment is positively geared and the alternative tax rate payable on surplus investment income is greater than the maximum rate of 15 per cent that is payable in super. Conversely, negatively geared investments can be more tax effective if held outside super when the alternative tax rate is more than the super tax rate. In this scenario, the individual (or company) will receive more value for the excess tax deductions than a super fund would.
November 24, 2011
But even if an investment is negatively geared at the outset, borrowing in super may still be a better option. This is because negatively geared investments can become positively geared over time. Also, regardless of the gearing position, less capital gains tax will generally be paid on the sale of the investment if it's held in a super fund. 5. Is buying property in super suitable for (and reflected in) the fund's investment strategy? Under the general SIS covenants that apply to SMSFs, trustees must formulate and give effect to an investment strategy that has regard to the whole circumstances of the fund. This means the assets acquired must suit the entire operations of the fund and the investment strategy should consider matters such as: • Diversification and the impact a large single asset could have on the fund's performance; • The potential risks and returns from the property and other potential investments, and • The capacity to meet current and future fund expenses, such as operating costs, tax liabilities, pension and death benefit payments. When assessing whether SMSF clients should use an LRBA to acquire property in their super fund, it's important to consider a range of issues such as taxation, diversification and liquidity. If buying a property is what they really want, in some cases financing the acquisition outside super can be a better solution. Mike Mitchell is a senior technical consultant at MLC Technical Services.
Savvy can ride market recovery AARON DUNN lists some of the strategies that self-managed super fund members should start to think about to help bolster their superannuation savings in recovering markets.
he last month has seen the Australian Stock Exchange (ASX) recover strongly after a disastrous start to the new financial year. While we are well short of the ASX highs of mid-2007, we may start to see so ome stability with recent positive news from Europe and other parts of the world. From a strategic point of view, it is important to start thinking about some key strategies that will bolster your clients' superannuation savings in a market recovery:
1. BOOST THE 10 PER CENT PENSION LIMIT WITH A TRANSITION TO RETIREMENT 'REBOOT' This transition-to-retirement strategy, effectively implemented, can add tens of thousands of dollars to a member's retirement savings. For some clients who regularly take a 10 per cent maximum pension, recovering markets can provide the ability to roll back the existing income stream and reset the pension with a higher balance. Conversely, if clients are looking to take the smallest pension possible, especially in light of the 25 per cent reduced minimum for the 2011/12 financial year, now may be an opportune time to roll back their pension to
reduce the amount required to be taken for the financial year.
2. LOCKING IN TAX-FREE PROPORTIONS The use of recontribution strategies is still one of the most effective tools to build greater tax efficiency in income streams under age 60 and for estate planning purposes. The creation of multiple pensions with additional contributions or recontributions allows a member to potentially benefit from a higher tax-free proportion when drawing an income stream from the fund. Subject to the level of pension taken each financial year, you can continue to grow the higher tax-free super balance when markets rebound. In poor markets, there are some significant tax savings that can be obtained by rolling back pension to accumulation phase to 'absorb' the negative returns against the member's taxable component, rather than proportionately against their tax-free and taxable components. At an appropriate time in response to recovering markets, the ability to recommence the pension allows for the member to lock a higher tax-free component, saving tax on pensions taken prior to 60 and providing long-term benefits for non-dependent beneficiaries.
3. HAVE YOU CONSIDERED SEGREGATION? To further benefit the use of multiple pensions, trustees have the ability to segregate specific assets to different members, pools of members or different superannuation interests. For example, by applying the fund's growth assets to a member's super interest with a 100 per cent tax-free proportion, it can potentially: • Accelerate the growth of the account balance; • Provide a greater pension amount that can be withdrawn under a transition-to-retirement income stream; and • Decrease the fund's potential future exposure to death benefits tax for non-dependants. Segregation may also be useful where the fund is not 100 per cent in pension phase (ie one member in accumulation, one in pension). It could be used to assist in the realisation of a particular asset which has risen significantly off a low cost base. By applying segregation, the particular asset(s) with a significant capital gain is fully exempt from tax, rather than partially exempt by having an unsegregated fund. It is important that any segregation strategy is appropriately documented by the trustees to show specific assets being
November 24, 2011
applied to a particular member, interest or pool of members.
4. TIME TO BUILD RESERVES? Reserves within a self-managed super fund can play an important currentday and longer-term estate planning role. For the majority of self-managed superannuation funds (SMSFs), you typically see any positive returns applied towards each member's balance. However, it is important to consider whether, to capture some of these positive earnings into fund reserves, to look at implementing a range of strategies including future anti-detriment payments, self-insuring members, enabling future crediting of 100 per cent tax-free pensions, etc. Fund reserves can play an integral role in any SMSF and are typically generated by earnings over time. Planning to capitalise on recovering markets allows for SMSFs to implement many of these reserving strategies effectively. These are just some strategies that you can start to plan with your clients to help bolster your clients’ superannuation savings in recovering markets. Aaron Dunn is the managing director of The SMSF Academy and author of thedunnthing blog.
Greater control, greater scrutiny Having control over investments is the number one reason for switching to self-managed super funds. However, with greater control comes greater scrutiny, according to ROBIN BOWERMAN.
here are many good reasons to set up a self-managed super fund (SMSF), with greater control over invesstments and lower costs topping the lists of most investor research reports. However, shouldering the compliance burden of a superannuation trustee or responding to an audit request from the tax office perhaps does not have quite the same popular appeal. But they are just as real, and SMSF trustees should be aware that the tax office – in its role as SMSF regulator – is stepping up its efforts over the next 12 months to ensure that more funds comply with superannuation and tax law. The Australian Taxation Office’s (ATO’s) compliance program for the next financial year (released this week) indicates a clear willingness to strip wayward funds of their complying status for breaches ranging upwards from repeatedly failing to lodge annual returns. It’s interesting that the compliance
program notes that 70 SMSFs were declared non-complying in 2010-11. At first glance, 70 funds may not seem many, considering that over 445,000 funds are in existence. However, a non-complying fund can lose almost half its assets in penalty tax. If a fund is made noncomplying, the market value of its assets – less any non-concessional or undeducted contributions – is taxed at the highest marginal rate. In wealth creation terms, that is the nuclear strike option, and to be fair, one the ATO does not exercise lightly. In other words, the penalty for being declared non-complying is typically devastating for all members of an SMSF, including those who do not take an active role in their fund’s affairs. So being declared a non-complying fund is the one thing you really want to avoid as an SMSF trustee. The latest compliance program warns that the ATO’s SMSF focus in 2011-12 includes:
• New funds to check whether their trustees are participating in illegal schemes to gain early access to super savings. • Related-party transactions – in part, to ensure compliance with the 5 per cent limit on in-house assets. • Unrectified contraventions of superannuation law which had been brought to the attention of fund trustees by a fund’s approved auditor. • The performance of approved auditors of SMSFs – the regulator threatens to disqualify auditors that “pose an ongoing risk”. The tax office is right to focus on trustees participating in scams to get early access to super – that is a blatant abuse of the system. Last year, the ATO audited more than 920 individuals and 31 scheme promoters, and as a result raised almost $14 million. However, the other area of focus for the ATO in regards to superannuation in the year ahead is likely to have a much broader impact on ordinary employees. The tax office also has a
November 24, 2011
role to play in protecting super fund member rights by checking that companies are paying the correct amounts as super contributions. A number of businesses will struggle with cashflow or other financial pressures at various times, which can sometimes result in withholding super contributions. Employees will typically notice if salary doesn’t turn up in their bank account, but it may take a lot longer for someone to notice that money has not been paid into a super fund – the long-term nature of super and the fact it is locked away does not encourage close monitoring. Yet in the past five years, the ATO says its compliance activities have resulted in about $1.3 billion in extra super contributions being collected on behalf of employees. That is a significant amount of money, but it also points to the need to be vigilant with super contributions. Robin Bowerman is the head of corporate affairs and market development at Vanguard Investments.
Succession planning grabs The ageing population and the ATO’s recent draft pensions ruling highlights the need to review clients’ overall succession planning, according to DANIEL BUTLER and NATHAN PAPSON.
ith the recent release of the Australian Taxation Office’s (ATO) controversial draft ruling regarding auto-reversionar y pensions (TR 2011/D3), the awareness of effective succession planning has been n highlighted. Advisers should take this as an opportunity to review their current succession plannin n g practices. This article aims to give some general guidance to advisers as to what aspects of succession planning may impact their clients, as well as outlining some of the practical tools and doccuments that may assist advisers.
COMPREHENSIVE SUCCESSION PLANNING FOR CLIENTS Advisers are frequently asked to assist with self-managed super funds (SMSF) succession planning assignments for their clients. More often than not, they will be approached by advisers with the query, “I’d like to update Mr X’s pensions to make them reversionary”, or “Mrs Y needs a Binding Death Benefit Nomination (BDBN) drafted”. However, in order to appropriately plan for Mr X and Mrs Y’s SMSF succession upon their death or loss of capacity, there are a number of things that must be considered.
THINGS TO BE CONSIDERED As a first port of call, the SMSF’s deed will need to allow for other supporting documentation to be
put into place. The SMSF members should then consider having a sole-purpose corporate trustee appointed, with mechanisms in the company constitution that allow for the smooth succession of directors. Thereafter, things such as wills, enduring powers of attorney, pension documentation and BDBNs should all be reviewed and considered. They should first be checked to ensure that they are consistent with one another and are in accordance with their clients’ goals. For example, a BDBN may state that a member’s superannuation benefits are to be paid to their legal personal representative. However, that member’s will may not take their superannuation benefits into account. When an adviser’s client asks them to start a pension or BDBN, the adviser should be thinking about a range of other aspects. The reversionary nomination is now an important decision and has an impact on clients’ estate planning — it affects every pension. Advisers such as accountants, financial planners and lawyers should hopefully be able to formulate strategies that can be applied across all of their clients. Such a strategy should not necessarily restrict clients’ succession planning choices, but rather ensure that: • The adviser is demonstrating to the client that they have the client’s best interests at heart by thinking outside the square; and
• The client will have a ‘rock solid’ SMSF succession planning position at the completion of the engagement.
CHECKLIST A checklist (see Table page 19) has been included as a general guide to assist advisers with a range of SMSF succession queries that their clients may have. The first question in the checklist is arguably the most important. Once a client has decided where they wish their death benefits to be paid, then consideration can be given to the other questions in the table.
November 24, 2011
RECENT SUCCESSION PLANNING ISSUES Some of the recent issues to do with pensions highlight the importance of having the right documentation in place. In recent months, advisers have been divided as to whether a BDBN takes precedence over an ‘auto-reversionary’ pension, or vice versa. The BDBN/auto-reversionary pension controversy arises where, for example, a BDBN stipulates that the member’s benefits are to be paid to the member’s children from a previous marriage, but the pension documentation requests the trustee to pay
the spotlight avoided. BDBNs and auto-reversionary pensions should be consistent, as well as align with the SMSF member’s other estate planning documentation (eg, wills, enduring power of attorney, etc.).
TR 2011/D3 The ATO TR 2011/D3 outlines its view of when a superannuation income stream (eg, a pension) will cease upon a member’s death. The ATO’s view is that a pension will generally instantly cease upon the SMSF member’s death. However, the pension will continue if a ‘dependent beneficiary’ is automatically entitled to receive the pension. There are a number of adverse tax risks that may arise as a result of a pension ceasing — if only for a day — upon a member’s death. These consequences include a ‘blending’ of tax-free and taxable components within the SMSF, as well as losing the ‘exempt’ status of income derived from assets supporting the pension. As such, TR 2011/D3 highlights the need for appropriate succession documentation to be in place for each pension. SMSF Succession Planning Checklist Question/Item Has the SMSF member considered how they wish their superannuation benefits to be paid upon their death or loss of capacity? Have the tax consequences of this also been considered? Does the SMSF have a corporate trustee? (there are a number of succession planning advantages with having a corporate trustee) How is the shareholding of the SMSF’s corporate trustee structured and who will take control of the shares of the corporate trustee on a member’s death or loss of capacity? (this aspect can affect an SMSF member’s succession planning) Does the SMSF member have any enduring powers of attorney (‘EPoA’) in place to deal with their loss of capacity? An EPoA allows a person to represent a member on loss of capacity in an SMSF. Does the SMSF member have a pension? If so, do they have a reversionary pension or BDBN in place that provides for an automatic reversion? Are these consistent with the SMSF deed and with each other? Does the SMSF member have a current will? Does it adequately take into account how they wish their superannuation benefits to be paid (if applicable)? A will can also be a useful fallback if a BDBN fails. Does the SMSF member require a ‘hard wired deed’ or death benefit rule in order to achieve their desired outcome? These seek to enshrine the client’s estate planning directions in an SMSF deed. Depending on the clients’ requirements, do I have access to other professionals that can draft the above documentation?
the member’s benefits to the member’s second spouse. With blended families becoming more common in modern society, this inconsistency is also more common. The correct position is as follows: • A BDBN will usually validly bind a trustee (ie, it is a fettering or limiting of a trustee’s discretion that is usually authorised by the governing rules of the SMSF); and • An auto-reversionary pension, under most SMSF deeds, is merely a request by the member of the SMSF trustee or a trustee resolution. Therefore, if there was a conflict, the BDBN would ordinarily win. However, the conflict can easily be
November 24, 2011
CONCLUSION Advisers should urgently review all clients with pensions following the release of TR 2011/D3 to see if they are exposed by not having an auto reversionary pension. Typically, a conversion to an autoreversionary pension will not address all of that client’s succession planning needs. By utilising the material outlined above, advisers should be able to design comprehensive reviews that will benefit all their clients’ interests. Daniel Butler is director and Nathan Papson a lawyer at DBA Lawyers. MONEY MANAGEMENT
Australia's leading financial services publication, Money Management, provides an indepth guide to the latest in SMSF strategies.
Published on Nov 24, 2011
Australia's leading financial services publication, Money Management, provides an indepth guide to the latest in SMSF strategies.