The SMSF Playbook

Fundamentals

The SIS Act stipulates that to be an SMSF, a super fund needs to fulfil these requirements:

• It has fewer than 5 members
• Each member of the fund is a trustee of the fund
• No member is an employee of another member of the fund unless they are related
• No trustee of the fund receives any remuneration from the fund or any person for their services performed as a trustee

An SMSF is essentially a trust structure but by fulfilling the SMSF definition above the SIS Legislation applies. This means that every SMSF must have a Trust Deed that contains the rules of the fund. The Trustees of SMSFs must follow the rules set out in the Trust Deed, whilst still maintaining compliance with the SIS Legislation. 

An important requirement of the SIS Legislation is the Sole Purpose Test. All trustees of SMSF’s must ensure that the Fund is maintained for the sole purpose of the provision of benefits on the member’s retirement or death. Your SMSF is likely to fail the sole purpose test if anyone directly or indirectly obtains a financial benefit when making investment decisions. Contravening the sole purpose test is very serious and you as trustee could incur civil and criminal penalties. Trustees should ensure that they consider this when making any decisions in relation to their Fund.

Trustees – Corporate vs Individual

One of the key decisions you need to make when establishing your SMSF is whether to use individual trustees or a corporate trustee. 

Corporate Trustee

A corporate trustee structure has some significant advantages which should be considered when making your trustee decision.  

Easier Administration

A corporate trustee makes the ongoing administration of the fund smoother along the way.  Members will die or may get divorced, new members may join (e.g. members children) or members may become mentally incapacitated over their lives.  A corporate trustee structure allows these changes to be addressed without the need to change the ownership structure of the fund assets unlike if individual trustees were appointed.  

Increased Level of Control

A single-member fund cannot have one individual trustee, so in circumstances where a member has passed on or exited a fund, however, the survivor wants to continue in it, they are forced to appoint another trustee in order to do so.  With a corporate trustee in place, an additional trustee is not required so the control continues to reside in your hands.

Protection of Assets

A corporate trustee offers a level of protection similar to running a business through a company structure rather than in your own name.  If the fund was to be held liable for an accident on a property held by the fund under a corporate trustee, the liability is generally limited to the fund assets.  If individual trustees are appointed this protection does not apply, and the individual trustees may find their personal assets outside superannuation at risk.

Separation of Assets

A corporate trustee can be used to clearly delineate assets held by the fund from assets held personally. It becomes very easy to prove to the ATO or auditors the ownership of the asset when it is held by a separate legal owner. 

Limited Recourse Borrowing Arrangement (LRBA) Accessibility

Should you think that the fund may enter into a Limited Recourse Borrowing Arrangement (LRBA) to purchase assets within the SMSF it is increasingly likely that your financier will require a corporate trustee to be in place.

Reduced Penalties

Should the fund be assessed under the ATO’s penalty regime the directors of a corporate trustee will be personally liable to pay the penalties, however, the penalty will be applied only once.  In the case of individual trustee’s, the penalty will be applied to each individual trustee resulting in a doubling of the penalty when compared to a corporate trustee. 

Individual Trustees

Low Cost

The key advantage of individual trustees is that there is no additional cost to set these up when establishing the SMSF and the initial administrative burden is lessened. In addition, unlike with a corporate trustee, there is no annual ASIC fee that is applied to individual trustees.

Less Compliance

There are no ongoing ASIC reporting obligations for individual trustee’s and it can also be easier to administer the fund on a procedural basis at times as there is no requirement to abide by a company constitution when compared to a corporate trustee arrangement.

It is our belief that the vast majority of funds should be established with a corporate trustee to help overcome the myriad of challenges that the fund is likely to experience as its members move through their lives.

Trustee obligations

The ATO has strict rules that you need to follow as a trustee of an SMSF. Ultimately you as the trustee, are responsible for running your SMSF, so it is important that you understand your duties, responsibilities and obligations. The ATO self-managed super fund trustee declaration outlines your responsibilities to ensure you operate your fund in accordance with the SIS Act and other relevant legislation. 

Steps to set up SMSF

Once a decision has been made to set up an SMSF, a number of administrative procedures need to be followed in order to ensure that the fund is a complying fund and, as a result, is entitled to the tax concessions which apply.

The steps are as follows:

1. Appoint a Trustee.
2. Trustees must sign the ATO Trustee Declaration stating that they understand that they are responsible for ensuring that the fund complies with all relevant legislation. 
3. Establish a trust deed.
4. Lodge the notice to become a regulated fund with the ATO.
5. Obtain a Tax File Number (TFN) and an Australian Business Number (ABN).
6. Request that the members join the fund, complete relevant paperwork, ensure members nominate beneficiaries (for death benefit purposes) and give members a copy of the fund rules and benefits.
7. Open the fund’s bank account (or other appropriate investments).
8. Transfer any existing superannuation benefits members might have.
9. Request that the members supply their TFNs to the fund.
10. Appoint relevant service providers, including auditors.
11. Establish an investment strategy for the fund.
12. Arrange for any disability/life insurances.
13. Establish appropriate accounting systems for the fund (keeping a separate account for each member).
14. Gain an understanding of the operational requirements of the fund.
15. Ensure that annual returns and income tax returns are lodged with the Australian Tax Office.
16. Ensure that minutes of meetings in relation to the superannuation fund are recorded and retained for 10 years.

Investment

A key reason to establish (and continue to run) an SMSF is for investment flexibility. SMSFs do allow you to invest in a larger range of investments than industry or retail superannuation funds. Such investments include (but are not limited to):

• Direct property
• Gold bullion
• Cryptocurrency.

You are free to choose what type of assets you may invest in, providing those investments:

• are permitted by your fund’s trust deed
• are not prohibited by the super laws
• meet the sole purpose test.

For instance, you need to be aware of the in-house asset rules and acquisitions from related party rules. You also need to be aware of the non-arm’s length income rules for income tax purposes.

Investment strategy

You need to prepare and implement an investment strategy for your SMSF, and you need to ensure that your fund’s assets are held in line with the investment strategy. For your investment strategy to be valid it needs to consider the following:

• Diversification of the Fund;
• The risk and likely return from investments, to maximise member returns;
• The liquidity of the fund’s assets;
• The fund’s ability to pay benefits when members retire and other costs the fund incurs;
• The members’ needs and circumstances; 
• Whether the trustees of the Fund should hold a contract of insurance that provides insurance cover for one or more members of the Fund (or whether this should be obtained outside of the fund);

You need to make sure that your funds are owned in the correct manner. They should be held in the name of the trustee/s of the SMSF As Trustee For the SMSF. 

Investments of superannuation entity to be made on an arm's length basis 

All investments made by the trustee must be conducted on an arm’s length basis.  Dealing on an arm’s length basis means a transaction where buyers and sellers act independently without one party influencing the other. As a minimum, the terms should be no more favourable to the other party than would reasonably be expected if the transaction was at arm’s length in the same circumstances.

When assessing whether a transaction has been undertaken on an arm’s length basis the Trustee should make an objective assessment of all the facts involved. When making this assessment, consider whether a prudent person acting with due regard to their commercial interests would have made such an investment. 

Other factors you should consider when determining if a transaction is on an arm’s length basis include: 

• Does the asking price reflect the expected return of the asset, the risks to which the asset is exposed and the relative liquidity of the asset? 
• Does the contract or agreement adequately protect the interests of the superannuation fund, with clear legal identification of all parties and their rights and obligations?
• Have valuations have been obtained with measurable and supportive data? 

Importantly, the non-arm’s length rules also require that where a trustee deals with a related party in respect to an investment of the fund, the dealing must be on an arm’s length basis. For example, where an SMSF leased commercial property to a related party under the in-house asset rules, the lease arrangement between the trustee and the related party would need to be set and maintained at an arm’s length commercial rate. 

Valuations 

Are you aware that all assets held within self-managed superannuation funds need to be included in the SMSF financial accounts and statements at their market value? Therefore, if you hold property assets within your SMSF, you will need to have the property revalued periodically. 

The ATO has provided valuation guidelines for self-managed superannuation funds and we have set out below further information to assist you in obtaining acceptable valuations. 

As part of the ATO compliance process, you may be asked for evidence of the valuation method that has been used in preparing a valuation. A critical element in determining whether the ATO will accept the valuation is that it was based on objective and supportable data. 

As a Trustee of an SMSF, you must be able to demonstrate that the valuation has been arrived at using a “fair and reasonable” process. The ATO would consider a valuation as fair and reasonable where it meets the following it: 

• takes into account all relevant factors and considerations likely to affect the value of the asset 
• has been undertaken in good faith 
• uses a rational and reasoned process 
• is capable of explanation to a third party.

Testing whether the market value of the SMSF’s in-house assets exceeds 5% of the value of total assets held by the fund.

When preparing SMSF financial reports, an external valuation of real property is not required each year. However, a recent valuation would be prudent if you expect the valuation is materially inaccurate or an event or occurred may have affected the worth of the property since it was last valued. This may be due to a change in market conditions or a natural disaster. 

When valuing real property, relevant factors and considerations may include:

• the value of similar properties 
• the amount that was paid for the property in an arm’s length market 
• independent appraisals 
• whether the property has undergone improvements since it was last valued for commercial properties, net income yields.

Business real property acquired from a related party of the SMSF must be made at market value. Disposals of real property to a related party of the SMSF must be conducted at arm’s length. When valuing real property assets for SMSF financial reports, the valuation may be undertaken by anyone as long as it is based on objective and supportable data. A valuation undertaken by a property valuation service provider, including online services or real estate agent would be acceptable. 

The main factor in the new guidelines is that you need to be able to demonstrate how the valuation was arrived at. To assist you in obtaining acceptable valuations of your SMSF properties, examples are set out over the page, based on the ATO guidelines.

Administration and Tax

Tax

SMSFs are not a set and forget superannuation vehicle. It needs to pay tax on its earnings, and fulfil a number of important reporting obligations each year. 

These are:

• Lodge SMSF annual return with the ATO each year;
• Financial accounts and statements are required to be completed and audited by an SMSF auditor each year. The SMSF annual return cannot be lodged with the ATO until the audit has been finalised;
• Effective from 1/7/21, your fund can no longer be audited 

* your SMSF annual return and financial statements will also include payment of the supervisory levy and contributions reporting which are required. 

Lodgement dates are different depending on the status of your fund – 

• For first-year funds – the lodgement date is around 28 February of the year following the end of the financial in which the fund was established;
• For funds that did not lodge on time the previous year, then the lodgement date is usually 31 October;
• For funds that have been lodged on time, then the lodgement date is usually around 15 May. 

If your SMSF has tax payable when lodging your first tax return with the ATO, then you will need to enter the ATO’s PAYG instalment scheme. 

The tax applicable for the SMSF depends on whether the fund is in Accumulation or Pension phase. The Accumulation Phase is when you are accumulating funds in superannuation, and you are not receiving a pension or income stream from your account balance. The Pension Phase is when you have commenced a pension or income stream. It is possible to have both an Accumulation Account and Pension Account running at the same time. 

Record Keeping

You really need to ensure that you keep the SMSF funds and assets separate from your personal assets. A handy tip is to hold the bank account for the SMSF with a different bank/financial institution than your personal everyday working accounts so that you don’t inadvertently pay for expenses out of the incorrect account.

As we’ve already mentioned above, your fund’s financial statements need to be audited each year. This means that you need to retain documents that substantiate all the payments made from your SMSF bank account. Retain all documents (such as invoices) in a folder to provide to us at the end of the financial year. 

The following records must be retained for a minimum of 5 years:

• Accurate and accessible accounting records that explain the transactions and financial position of your SMSF;
• Copies of the financial statements and tax returns of the SMSF
• Copies of other statements that are required to be lodged with the ATO.

The following records must be retained for a minimum of 10 years:

• Minutes of trustee meetings and decisions affecting your fund*
• Records of all changes of trustees
• Trustee declarations recognising the obligations and responsibilities for any trustee
• Copies of all reports given to members

Some handy hints:

• To make sure that you don’t mix up your SMSF Bank account with your other personal bank accounts, open your SMSF account with another financial institution.
• Only pay for fund expenses from the SMSF working account, this allows us to more easily keep track of fund expenses and assets; 
• At the end of the financial year, print off your SMSF bank statement and use it as a checklist to make sure you have paperwork substantiating each payment 
• *Retain important minutes of meetings of trustees (such as pension commencement minutes and trust deed matters) for as long as those pensions keep running for. We have found that some minutes are still required long after the 10 year period is over. 

Running an SMSF takes time and effort, and it is important to keep track of your fund at every stage. We have created a Year End Checklist to help you manage your fund and meet your SMSF obligations.

Compliance

SMSFs are more stringently monitored than other superannuation vehicles, to ensure that Trustees don’t access their superannuation benefits earlier than they should, and that the member/trustee relationship is monitored to ensure that it continues to satisfy the legislative requirements. 

SMSFs are governed by the Australian Taxation Office (ATO). The primary aim of the ATO is to ensure that SMSFs:

• Comply with the relevant provisions of SISA
• Are administered in a sound manner consistent with retirement income policy, and
• Use superannuation money for appropriate retirement purposes. 

An SMSF must also have a Trust Deed which contains the governing rules of the fund. So how does the Trust Deed rules interplay with the SIS regulations? You must operate your SMSF in line with the rules set out in your Trust Deed, as long as those rules don’t contradict the SIS regulations. 

If you breach the SIS regulations, then this will typically be picked up in the audit of your fund each year. The auditor will then need to prepare a contravention report that they lodge with the ATO. If you have breached the legislation then penalties may apply. 

In the worst-case scenario, your fund can be made non-complying which can have a significant financial impact on the SMSF because:

• for every year the fund remains non-complying, its assessable income is taxed at the highest marginal tax rate
• in the year it becomes non-complying, it includes in its assessable income 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.

Ultimately this means that almost half of the fund’s asset value can be taxed if the fund is made non-complying.

We are focused on trustee education and as part of our service to our SMSF clients, we provide:

• access to Class online so you can get up to date information on your fund assets
• access to SMSF connect (include link) – this provides many resources about superannuation and SMSFs
• a meeting with one of our Wealth Managers to present your financials and run you through any important factors to consider with your SMSFs.

How do you avoid a compliance issue in your SMSF? Contact us and ask the question before you enter into an investment or arrangement for your SMSF. There aren’t many questions we haven’t fielded in relation to SMSFs and we have the expertise to send you in the right direction. 

Pensions

When you meet a condition of release (generally retirement) you can access your super in two main ways – as a pension or a lump-sum withdrawal. If the Fund is paying a retirement pension then it provides the Fund with a special tax concession where there is no tax on the earnings inside the Super Fund, and no tax payable on the pension to you (as long as you are aged over 60).  Lump-sum withdrawals may also be received by you tax-free (if aged over 60), however, the Super Fund will still pay tax on its earnings at 15%.

There are several pensions available under the Superannuation Legislation, however, the two most common types are:

Transition to Retirement Pension  

• Must be aged over preservation age (but do not have to be retired)
• Pension will be taxable if aged < 60
• Earnings in the Fund remain taxable at 15%
• Limited to a maximum pension of 10% of your Account Balance

Transition to Retirement Pensions were designed to keep older Australians in the workforce for longer, on a part-time basis where part of their income could be supplemented by a Transition to Retirement Pension (TRIP). TRIPs may be appropriate if you are working less or have debt that you are paying off prior to retirement.

What is a condition of release?

You can access your super when you have met a condition of release:

• when you turn 65 (even if you haven’t already retired), or
• when you reach preservation age (over 57, but depends on your birthday) and retired.

You may meet a partial condition of release under the transition to retirement rules, while continuing to work. 

There are very limited circumstances where you can access your super savings early.  These circumstances are mainly related to specific medical conditions or severe financial hardship.

Preservation Age

If you have reached Preservation age, but have not yet retired you can partially access your super via a Transition to Retirement Pension.

Between the age of 60 and 65, you can access your super if you have retired from a position of employment (as opposed to retiring from all employment).  For example, Ken is aged 60 and works for Education QLD as a supply teacher as well as for the local University as an Exam Marker.  If Ken retires from his position as an Exam Marker, he can access his super even if still employed as a Supply Teacher with Education QLD.

Once you have met a condition of release you can access your super as either a lump sum or as a pension.

Account-Based Pension

If you are considering drawing from your superannuation, you may want to learn about Account-Based Pensions. An Account-Based Pension is the most common form of income stream or benefit payment from a superannuation account. An income stream is a series of payments from your super. The details are:

• You must be aged over preservation age and retired OR
• Aged over 65
• Pension is tax-free if over age 60
• Commencement Value is up to $1.7M (Transfer Balance Cap)
• Earnings in the Fund are tax-free!

Account-Based Pensions are the main retirement vehicle for Australians. The minimum pension you must draw is based on your age and there is no maximum pension amount. Account-Based Pensions are designed to draw down on the capital as you age. Currently, the minimum amounts have been halved as a form of COVID relief, however, the minimum is expected to go back to normal from 01/07/2022.

As shown above, pensions can be drawn out completely tax-free if you are aged over 60 and at the same time the tax rate inside the super fund is also NIL on the earnings on the Super Fund. Thus, for those over age 60, an Account-Based Pension transforms your super into a tax-free vehicle.

What happens if I pass away?

Depending on the rules of your Fund, you may be able to nominate your spouse or Partner as your reversionary pensioner. If you pass away, the pension will then continue to pay to your spouse or partner until the funds run out.

Alternatively, you can implement a Binding Death Benefit Nomination to direct your super as you see fit.

Strategies

Limited Recourse Borrowing Arrangement (LRBA)

An SMSF can invest in residential and commercial property directly if no borrowing is required or by using a limited recourse borrowing arrangement where it borrows to purchase a property. Where you borrow within your SMSF to buy an asset, it is held in trust on behalf of the fund.  

SMSFs are allowed to borrow to make an investment under some very strict rules which must be followed without exception. These arrangements are known as LRBAs and are most commonly used by SMSFs to invest in property. LRBAs involve complex rules and structures and require extensive legal documentation and bank loan approvals. 

LRBAs essentially limit a lender’s rights against the borrower to the property that secures the loan. This means if an SMSF borrows to buy a property via an LRBA and the SMSF is unable to pay the loan, the lender can only seek compensation by taking possession of the property alone and is not able to access any of the fund’s other investments.

The LRBA rules limit the types of properties that can be acquired and what can be done to the property. Properties need to be single investments and limits apply to the types of, and how repairs and improvements can be made to the property. These rules are very technical and complex.

The advantage of an SMSF investing in property is the generous tax concessions given to super. Rent from the property investment will be taxed at a maximum of 15%. If you decide to take a pension from your SMSF any rent and capital gains can be tax-free. because of these low tax rates the benefits of negatively gearing (expenses of the property are greater than the rent received) an investment property can be less than if you did this as a personal property investment.

There are many considerations that need to be given to the SMSFs wider circumstances when considering an LRBA. This will include insurance and whether a large illiquid asset like property will suit the SMSF member’s needs for their retirement income. Selling an illiquid asset like property can also take time and involve higher costs than liquid assets such as ASX shares, which can normally be sold very quickly. The sale of the property may also result in a large inflow of funds all at once, rather than a steady stream of income. This needs to be managed carefully if an SMSF on various life events such as property settlements, death and retirement. 

Investing in property to fund your retirement is an option that might be suitable for your SMSF but the complicated factors involved in SMSF property investment means you should seek out specialist SMSF advice to make sure it is done correctly.

Risk Management and Insurance 

You can also hold insurance inside your super fund – generally Income Protection, Total & Permanent Disability Insurance and Death cover. While premiums on the insurance may be low, they have a long-term cost to your final retirement benefits. You should also ensure you understand the tax and other consequences of owning insurance inside super.

Holding your insurance inside super can be a cheaper way to be covered.  Generally, you can purchase Death cover (Term Life), Total and Permanent Disability (TPD) and Income Protection insurance inside Super.

However, there are some important things to consider:

• Premiums will reduce retirement benefits – if you can afford to have the cover outside of Super, this may be better.
• Tax consequences – there may be Tax payable if the Death Benefit is paid to adult non-dependent children or other non-financial dependant 
• There may be tax payable on a TPD payment which reduces the size of the payment at a time when you really need it 

• Death and TPD insurance could be received tax-free if owned outside of super

Let’s break it down!

Income Protection

Most Super Funds are only able to offer a benefit period of two years for Income Protection owned inside super.  If owned out of Super, you can access benefit periods to age 65 or 70.

Total and Permanent Disability (TPD)

This insurance pays if you are totally and permanently disabled from working again.  There is an important distinction in the definition if it is owned in out of super:

Tim is an IT Manager and has worked exclusively in IT for the last 10 years.  If Tim has TPD insurance outside of Super then if he is unable to continue to be an IT Manager, due to illness or accident, then it is likely he will be paid.  If Tim has his Income Protection inside Super, depending on his disability, he may not be paid, if he is able to be re-trained into roles that he may have previously worked in his younger years – bartender, shelf stacker, service station attendant etc.

If Tim can claim his TPD, he then needs to consider what tax he will have to pay.  Tim is 42 at the time of claim and finds out that on his $1million TPD payment he will lose around $85,000 in tax.  Tim had selected an amount of $1million as this is the amount, he requires to clear his mortgage.  Tim is devasted to learn that at a time when he really needs the money, he is losing a chunk to tax.

If you are going to own TPD inside Super, ensure you understand the definition and the tax consequences.

Death

Term Life or Death insurance is the most straightforward as far as definitions go.  However, if owned inside super, once the claim is made the Insurance payment is made to the Super Fund.  The insurance is then included in the total super balance and any payment to a beneficiary is treated as a super death benefit.

So should you hold your insurance inside Super?

While it might be cheaper to hold insurance inside super you should carefully consider the long-term consequences.  Part of the reason it is cheaper is that the benefits are less (e.g. only 2 year benefit period on Income Protection and “Any” Occupation on TPD).  If you hold insurance, you want to be paid in your time of need.

In addition, the insurance premiums are debited from your super balance.  While it is not a direct cost to your pocket, it is a direct cost to your retirement benefits as the premium reduces your Super Fund’s ability to grow.

If the only way you can afford to have insurance is inside super, then this is a good option.  However, if you can afford to have it out of super, that is a better option.

Conclusion

As you can see, self-managed super funds aren't a "set and forget" asset. They require a lot of work to remain compliant, and more work to ensure they're helping you to reach your financial goals. 

However, with the help of a professional Advisor, your SMSF can be a powerful vehicle to exercise more control over your superannuation, explore alternative asset classes, and establish a financial future that aligns with your lifestyle goals in retirement. 

If you'd like to discuss how Ulton can assist you in the professional management of your SMSF, we'd love to help. Our Superannuation team has helped thousands of Australians to realise their financial goals with advice as unique as they are. 

To learn more about how we can help, contact us today.

This communication has been prepared on a general advice basis only. The information has not been prepared to take into account your specific objectives, needs and financial situation. The information may not be appropriate to your individual’s needs and you should seek advice from your financial adviser before making any investment decisions. All Ulton Wealth Managers can provide financial services as Sub-Authorised Representatives of Ulton Wealth Management Pty Ltd. ABN 73 168 815 450 | Corporate Authorised Representative 460875 of Ulton Wealth Services Pty Ltd | ABN 86 614 308 628 | AFSL 497721.