If the current frenzy in property prices is anything to go by, there’s no doubt we’re a property loving country. Purchasing a property directly or indirectly via an SMSF can be one of the significant factors in establishing a self-managed fund.
Around 24% of the value of all SMSFs surveyed have an investment which incorporates property. For some SMSFs, property may represent the vast majority of the fund’s assets and the only other asset is the fund’s bank account1. However, because the payment of some super fund benefits, such as a death benefit pensions, can’t be made in bricks and mortar, the liquidity of the fund should be seriously considered.
To comply with the superannuation laws, all SMSFs must have an investment strategy, which is reviewed regularly and at least annually. When putting the investment strategy together, the fund needs to consider “the liquidity of the entity's investments, having regard to its expected cash flow requirements”.
Let’s consider the ABC Superannuation Fund. Its members include a retired member, who is 68 years of age and receiving an account-based pension (ABP). The other members of the fund who are all in employment are the member’s partner who is aged 63; and the couple’s adult children, aged 42 and 38. The SMSF has a corporate trustee with all members as directors.
More than half of the fund is invested in a commercial property, which makes it relatively illiquid. The trustees need to consider how the assets, such as the commercial property, are able to pay member benefits. This would apply particularly to any death benefit lump sums, which must be paid as soon as practicable after the member dies. Liquidity may not be as important if death benefit pensions are paid from the fund as the capital supporting the pension remains in the fund.
Members should consider the following issues should the retired member dies.
Transfer balance cap (TBC) issues
The retired member’s benefits, held in his ABP, total $2 million. Assuming the retired member’s ABP reverted to their partner, the value at the time of death would count towards the partner’s Transfer Balance Cap (TBC), but not until 12 months after the retired member’s date of death.
If the partner is still working…
If at the time of the death of the partner of the retired member has not retired, they will receive the reversion from the retired member’s ABP. However, they may need to commute (convert) part of the ABP to a lump sum to ensure they don’t exceed their TBC on the anniversary of the retired member’s death. This will still leave any lump sum from the commutation of the ABP to be paid ‘as soon as practicable’ as a lump sum death benefit to a SIS dependent. Based on the makeup of the SMSF’s investments, there should be enough cash (about $400,000) or investments that could be transferred to satisfy payment of the lump sum. But what if the partner wished to receive all of the death benefit lump sum in cash?
…and if the partner retired…
If at the time of the member’s death their partner had ‘retired’, it could be expected that they may have used some of their TBC. Again, consideration needs to be given to the amount of the death benefit, if any, could be retained within the fund and paid as a pension. Consideration should be given to whether the deceased member had a binding death benefit nomination and if it required that all of the death benefits be paid as a lump sum.
Cash flow issues
The impact of the TBC means that not all of the member’s death benefits could be retained in the fund and paid to their partner as a death benefit pension or reversionary pension. Even where the partner had full use of their TBC at the time of the retired person’s death, there could still be part of their benefits that need to be paid as a lump sum death benefit. With over half the fund in an illiquid property investment, the challenge for the trustee is how the fund can pay the death benefit payment? By the sale of assets? Or via an in-specie asset transfer?
Where the death benefit is paid as a lump sum, the partner may wish to contribute some of it back to the fund. The question will be, can they contribute, and if so to what amount? Non-concessional contributions are limited by a person’s total super balance on 30 June in the previous year, their age and is the amount is capped.
Control of the SMSF
The trustee of the ABC Superannuation Fund is a company, with all members of the SMSF being directors of the corporate trustee. After the death of the retired member, there would be three remaining directors, consisting of the partner and the two children. If the corporate trustee has a standard company constitution, it would be reasonable to expect that each would have one vote at trustee meetings. Consequently, the fund now has a situation where the partner would have the majority share of the value of the SMSF, but only has one of vote out of the three directors of the corporate trustee. This could lead to the children outvoting the partner on fund matters.
It may be worth considering the options available while all members are alive to ensure that, in the event of one of them passing, control of the SMSF is vested in the member with the largest balance by value.
Careful consideration should always be given to bringing adult children into the parent’s SMSF as illustrated by many court and tribunal cases.
When to review the fund’s investment strategy?
It’s important to regularly review your fund’s investment strategy, particularly in light of changed circumstances. A review is required at least annually.
In the event of the death of a fund member there are a number of issues to be considered:
- review the fund’s investments to make sure adjustments are made to the investment strategy to ensure they are consistent;
- review the cash flow requirements if a death benefit lump sum or pension will be made, either as a lump sum or pension;
- if an asset of the fund is a commercial property used in the business of one of the members of the fund – does the fund retain ownership, or will the property have to be transferred out?
There’s no rule against the fund having illiquid assets and those assets forming a large portion of the fund. However, the trustees should consider the risk to the fund’s cash flow requirements. Consideration of liquidity risk would also be integral to the fund members’ respective individual estate plans.
So, get out the fund’s investment strategy, review the fund’s investment portfolio, understand the estate plans of each member and consider the liquidity requirements if one of the members was to pass away.
Subscribe below Market Watch to receive my latest articlesGraeme Colley, Executive Manager, SMSF Technical and Private Wealth SuperConcepts
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