Superannuation funds that purchase ‘lumpy investments’ need to ensure that they understand the liquidity risks that may come with them. Property is probably the most common lumpy asset, but it could include other fund investments that are difficult to sell or liquidate due to unfavourable market conditions.
Ownership of a property, whether it’s residential or commercial, can have some advantages because of the low tax rates in superannuation, the ability to gear the property if required and that any additional cash flow may be supplemented from contributions being made to the fund.
However, there is a downside which comes with the inability to lease the property, costs of renovations and improvements, death of a fund member and issues if contributions can’t be made to the fund.
Let’s have a look at the extended issues that may arise in a fund with a lumpy asset should one of the members was to die.
Investment strategy considerations
The trustee(s) of an SMSF are required to formulate and give effect to an Investment Strategy, which must be reviewed on a regular basis. When formulating the Investment Strategy, the trustee(s) need to consider “the liquidity of the entity’s investments, having regard to its expected cash flow requirements”.
The Jetstone Superannuation Fund has four members, George and Judy, aged 68 and 63, respectively, George is retired with all his benefits in an account-based pension (ABP), Judy is still working and their adult children, Elroy and Jane, aged 42 and 38, respectively, are both working. The SMSF has a corporate trustee with all members as directors:
Consideration needs to be given to how a member’s benefit will be paid in the event of their death, particularly as more than half of the SMSF’s assets are in relatively illiquid assets, say a commercial property.
A member’s death is a compulsory cashing event. The superannuation regulations say that “a member’s benefits in a regulated superannuation fund must be cashed as soon as practicable after the member dies”.
Consider the following issues if George dies:
Transfer Balance Cap (TBC) issues
George’s benefits, held in his ABP, total $1.8 million. It would be expected that as at 30 June 2017 it was restructured to a retirement phase ABP of $1.6 million and an accumulation account of $200,000. Assuming his ABP reverted to Judy, upon his death the value of his ABP, say it’s still $1.6 million, would count towards Judy’s TBC, but not until 12 months after George’s date of death.
If at the time of George’s death Judy has not ‘retired’, she can receive George’s reversionary pension, provided it was not valued at more than $1.6 million on the date of George’s death. This still leaves the balance of George’s accumulation account to be paid “as soon as practicable” as a lump sum death benefit to a SIS dependant. Based on the makeup of the SMSF’s investments, there should be enough cash or investments that can easily be converted to cash, to make the lump sum benefit payment. However, what if Judy wanted to take all of George’s benefits as a lump sum, in cash?
If, at the time of George’s death, Judy had ‘retired’, it would be expected she had used up a substantial portion of her TBC. Again, consideration needs to be given to what amount of George’s superannuation benefits could be retained within the fund. You would also need to consider if George had completed a binding death benefit nomination, for example, to payout his all his benefits as a lump sum.
Cash flow issues
The introduction and restriction of the TBC means that not all of George’s benefits could be retained by the fund and paid to Judy as a death benefit pension or reversionary pension. Even where Judy had the full use of her TBC at the time of George’s death, a portion of his benefits may need to be paid out of the SMSF as a lump sum death benefit. With nearly more than half the fund in illiquid property, the issue is the payment of the death benefit by selling assets or as an in-specie transfer of assets as a lump sum death benefit.
Contribution issues
Where an amount of George’s benefit is paid out as a lump sum death benefit to Judy, she may wish to contribute this back to the fund. The question will then be, can she do it and if so, how much? The non-concessional cap is now subject to a Total Superannuation Balance (TSB) eligibility test. If Judy’s prior 30 June TSB is at least $1.6 million, her non-concessional contribution cap is nil. If she is under age 65 in the income year of making the non-concessional contribution, she may be able to utilise the bring forward rule, however, this will also depend on her prior 30 June TSB.
Control of the SMSF
The trustee of the Jetstone Superannuation Fund is a company, with all members of the SMSF being directors of the corporate trustee. After the passing of George, there would be three remaining directors, Judy, Elroy and Jane. If the corporate trustee has a standard company constitution, you would expect that each would have 1 vote at director meetings. Consequently, the situation is that Judy would have around 85% of the SMSF, but only has 1 of 3 votes of the directors of the corporate trustee. This could lead to Elroy and Jane out-voting Judy on fund matters.
Consideration may also need to be given to options available if George or Judy dies and for the survivor to retain control of the SMSF. A control issue already exists as it could be possible for Elroy and Jane, siding with one parent, to out-vote the other in any fund matters. Careful consideration should always be given to bringing adult children into the parent’s SMSF which has been confirmed by many court judgements.
Time to review your SMSF’s investment strategy?
A fund’s investment strategy must be reviewed on a regular basis, at least annually. In the event of the death of a member of the fund, there may be cash flow requirements to affect the compulsory death benefit payment, either as a lump sum or pension? What if the property is a commercial property used in the business of one of the members of the fund – will the fund be able to retain ownership, or will the property have to be transferred out?
There’s no rule against the fund having illiquid assets and those assets forming a large portion of the fund, however, the trustee needs to consider the risk to cash flow requirements that such assets present. Consideration of liquidity risk would also be integral to the fund members’ respective individual estate plans.
It is necessary to review the fund’s investment strategy, investment portfolio and for each member to understand their estate plans in relation to the fund’s liquidity should one of them die.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
