When kids and SMSFs go horribly wrong

Founder and Publisher of the Switzer Report
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It’s only natural for parents to want to look out for their kids by including them in their self-managed super fund – protecting your kids is one of the most primal instincts there is. But one of Australia’s top SMSF lawyers says this practice can often be more trouble than it’s worth.

Apart from the peace-of-mind factor, parents often like to include the kids in their SMSF in order to boost the amount of money the fund has to invest. By pooling your super, a family could also possibly save on fees.

Despite this, Dan Butler of DBA Lawyers says including kids in your SMSF could cause a lot of grief. In fact, from a legal perspective, the firm suggests you avoid it. Generally, the more trustees an SMSF has, the greater the chance a dispute may arise.

“Disputes can occur when a child separates from their spouse – even a de facto – and then the SMSF is made party to the dispute in the Family Court,” Butler says.

He says other common disputes arise when parents and children don’t agree on investment decisions.

“Children could outnumber their parents and outvote them unless proper documentation is put in place to protect against this,” he says. “These situations fester when, say, one spouse is gone, or where there is a second spouse.”

To prove his point, Butler spotlights a real-life case study.

The case involved a family of three – a father, mother and son – who were all trustees and members of their Triway Superannuation Fund, which was set up in 2002. The family rolled pretty much all their super benefits into the fund.

Unfortunately, the son developed a drug addiction and over time took almost all the money from the fund. All three trustees concealed the truth about how the money had been lost.

In 2006, the son was declared bankrupt, however, he continued to act as a trustee. In 2008, the trustees made a voluntary disclosure to the Commissioner of Taxation, and in 2009, the fund was declared non-complying because of three reasons: the SMSF had breached the sole-purpose test; the parents, in their role as trustees, had provided financial assistance to a member; and a disqualified person (a bankrupt) was a trustee.

The son accepted responsibility for the losses and associated tax liabilities, but it was noted that he was unlikely to ever repay his parents, and as a result, they would have to start saving for their retirement all over again.

This case clearly highlights the problems that can arise by having multiple people in an SMSF, but it’s perhaps an extreme example. Butler says there are other, more common, reasons to keep the kids out.

Relationship breakdown

One of the most common reasons is marriage break down. The super laws allow for an SMSF’s assets to be split between divorcing couples, and lawyers for your child’s ex-partner might try to claim assets you considered to be your own. It’s a messy situation that’s best avoided entirely.

Succession planning

Having the kids in your SMSF could also get messy when a member dies. Butler points to the case of Katz v Grossman [2005].

The story goes that a father of two appointed his daughter as a trustee of his SMSF, however, he didn’t appoint his son. Instead, he made a non-binding death nomination that his benefits be shared equally between the two children upon his death.

You can probably guess where this is going. When the father died, the daughter had control over the fund and, as a trustee of the SMSF, she chose to ignore the non-binding nomination and pay all the benefits to herself. Butler says it’s very hard to attack a trustee’s discretionary decision.

This situation would likely have been avoided if the daughter was kept out of the fund. The issue can become even more complicated for parents with more than two children, because the super laws stipulate that there can be no more than four trustees of an SMSF.

Butler says parents considering bringing the kids into their SMSF may want to think about succession planning as an alternative. In such a case, the SMSF would be passed down to the kids after both parents have died.

“If the spouse is a second spouse, then it may be appropriate to consider getting a child involved at the time of the death of the natural parent to ensure their interests are looked after in the fund, which would otherwise be controlled by the surviving spouse,” he says.

Butler says planning this well ahead of time is required to make sure the transition is as smooth as possible.

Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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