As an SMSF Trustee, you have a lot of obligations to manage an SMSF and to understand what is a SMSF and how does it work. As SMSF tax accountants across Perth, we see a common list of mistakes Perth SMSF trustees make for a range of reasons.
The benefits and downsides of an SMSF are many. And when advising a self-managed superannuation fund, trustees commonly make several errors, including:
1. Loans to Members
SMSF trustees often stumble with managing an SMSF is loans to members. This complex aspect of superannuation management demands attention due to its potential to breach the superannuation regulations.
Of course, with SMSF taxation the matter is never simple. Loans to certain related parties might be permissible.
The Prohibition and Its Consequences:
Members, as well as their relatives, are prohibited from borrowing funds from their SMSFs. This strict prohibition aims to safeguard the fund’s integrity and prevent misuse. A breach of this rule is considered a serious error, and the consequences can be severe. Violating this prohibition exposes the SMSF trustees to substantial penalties, which can significantly erode the fund’s value.
The Frequent Offender
Remarkably, breaches concerning loans to members are the most reported violations by SMSF tax advisors to the Australian Taxation Office (ATO) each year. This statistic underscores the prevalence of this issue within the SMSF landscape and the need for SMSF trustees to exercise the utmost caution in their fund management.
The Exception: Loans to Related Parties:
While the general prohibition against loans to members remains steadfast, there are limited circumstances where loans to specific related parties may be permitted. The caveat is that such exceptions must be executed properly and with advice.
- Proper Agreement: A formal binding agreement must be in place for a loan to a related party to be considered permissible. This agreement outlines the terms and conditions of the loan, including interest rates, repayment schedules, and any associated collateral.
- Arm’s Length Transactions: To ensure the transaction’s legitimacy, all dealings related to the loan must be conducted at arm’s length. This means the loan terms and conditions should mirror a typical commercial arrangement, free from any preferential treatment or special arrangements.
- Asset Cap: Loans to related parties should not exceed 5% of the SMSF’s overall assets. Exceeding this limit would constitute a breach of the regulation.
2. Use of SMSF Assets by Members
The SMSF assets acquired by a Self-Managed Superannuation Fund (SMSF) can only be used for the sole purpose of the retirement of the members. There cannot be an ancillary purpose.
SMSF Trustees and the SMSF tax consultants must exercise vigilance and adhere to guidelines that govern the use of SMSF assets.
Here, we explore two common pitfalls SMSF trustees encounter and the specific rules that apply to residential property and collectable assets within SMSFs.
Members of an SMSF cannot reside in residential properties owned by the fund. This restriction remains even if the rental income generated from these properties is at market value.
This prohibition prevents any personal use of assets held within the fund, preserving the superannuation fund’s primary purpose providing financial benefits upon retirement or other specified conditions.
However, it’s worth noting that there is an exception for commercial premises. An SMSF member can occupy commercial premises. Any transactions involving commercial premises should be at arm’s length.
While it is possible to use a SMSF to help your kids buy a house, the critical point to note is that your children cannot live in the house purchased by your SMSF.
Collectables (e.g., artworks, coins, jewellery)
Assets categorised as collectables within an SMSF, such as artworks, coins, and jewellery, must not be used by fund members or their associates for personal enjoyment. This includes keeping them at the member’s house.
The principle behind this rule is to ensure that collectable assets are preserved and maintained for the financial benefit of the fund’s members upon retirement or other qualifying events. To remain compliant with superannuation regulations, the handling of collectable assets is subject to specific requirements:
- Separation from Personal Use: Collectable assets should be maintained separately from the personal possessions of the members and their associates. They should not be stored in a member’s residence or used for personal purposes.
- Leasing to Third Parties: Instead of generating income in line with market value, these collectable assets can be leased to third parties. This arrangement ensures that the assets continue to serve their primary financial purpose.
- Compliance with these rules is essential to protect the integrity of the SMSF and its assets, preserving them for their intended purpose. They will also reduce the tax compliance burden that Perth SMSF tax accountants must follow for end-of-year tax advisory work.
Trustees must be diligent in properly handling residential property and collectable assets to prevent breaches of superannuation regulations and associated penalties.
3. Incorrect Asset Valuation
Accurate asset valuation is fundamental to managing and giving tax advice by tax accountants to a self-managed superannuation fund (SMSF). Trustees must ensure that the assets held within the fund are consistently valued at their market value. This valuation is crucial when a member is in the pension phase as it impacts the minimum pension requirements. Inaccurate or outdated valuations can result in non-compliance and mislead SMSF members. Here’s a more detailed look at this critical aspect of SMSF management:
Market Value Valuation:
The requirement to value assets at market value is designed to maintain transparency and fairness within the SMSF. The market value represents the current price that the asset would fetch if it were sold on an open and competitive market between willing buyers and sellers. The market value is essential for determining the SMSF’s net asset value and calculating minimum pension requirements for members in the pension phase.
While some assets, such as shares and cash, are relatively straightforward to value since their market values are readily available through stock exchanges or financial institutions, others can be more complex. For instance, property and shares in unlisted companies may not have readily available market values. Valuing these assets accurately may require specialised knowledge and assistance:
- Property Valuation: Valuing property assets within an SMSF often necessitates engaging real estate agents or professional valuers with expertise in the local property market. These experts assess factors like location, property condition, recent sales of similar properties, and any other relevant market data to determine a fair market value.
- Unlisted Company Shares: Valuation can be intricate for shares in unlisted companies, particularly those not traded on public stock exchanges. To determine the market value, trustees may need to rely on financial information, such as the company’s financial statements and the advice of financial professionals who specialize in assessing the value of private company shares.
Pension Phase Significance:
The valuation of assets is significant when a member transitions into the SMSF pension phase. The reason is that the market value of the SMSF’s assets at the beginning of the financial year affects the calculation of the minimum pension required for that year. If assets are not accurately valued, it could result in members either receiving insufficient pension payments or unintentionally breaching their pension obligations, which can have financial and regulatory consequences.
In summary, accurate asset valuation is a pivotal aspect of SMSF management. Trustees should obtain professional assistance to assess the market value of assets. Consistent, valuation practices safeguard SMSF members’ interests and maintain the fund’s compliance with superannuation laws.
4. Poor Record-keeping:
Accurate and comprehensive record-keeping is the bedrock of a well-managed, self-managed superannuation fund (SMSF). Trustees have a legal obligation to maintain thorough records, and these records play a pivotal role in ensuring SMSF compliance, transparency, and accountability. Here’s an in-depth look at the significance of record-keeping within SMSFs:
The Legal Requirement:
Trustees of SMSFs are bound by legal requirements to maintain accurate and complete superannuation records. These records are a critical means of documenting the fund’s activities, transactions, and compliance with regulatory requirements. Inadequate record-keeping can lead to regulatory breaches and, potentially, financial penalties.
The legal requirement to maintain accurate SMSF books are records can be reduced by cloud accounting for the SMSF with your tax accountant.
Key Records to Be Maintained:
Trustees are responsible for maintaining a range of records, which vary in their retention period and level of detail. Here are some of the primary categories of records that trustees must keep:
- Accounting Records: These records include financial statements, general ledger entries, and details of all financial transactions within the fund.
- Filed Tax Returns: Copies of all filed tax returns, statements, and associated documentation must be preserved. These are critical for tax compliance and reporting to the tax authorities.
- Trustee Minutes: Minutes of trustee meetings are essential for documenting key decisions, fund investment strategies, and any significant changes or events within the fund.
- Records of Trustee Changes: These documents keep track of changes in the trustee composition, such as appointments or resignations, and ensure a transparent historical record of trustee actions.
- Consent to Be Appointed as Trustee: The consent documents of individual trustees or directors of corporate trustees must be retained, ensuring a documented agreement to serve as a trustee.
- Reports Provided to Members: Any reports or statements shared with fund members should be archived, as they serve as a record of information provided to members.
A recent example is where SMSF members are using the tax system downsizer super contribution to maximise their super fund and not recording the contribution in the books properly or making the correct elections.
The retention period for these records is a critical consideration. Accounting records, financial statements, and filed tax returns must be kept for at least five years from the date they are prepared or obtained. Records of trustee minutes, records of trustee changes, consent to be appointed as trustee, and reports given to members need to be maintained for at least ten years.
Written Form and Language:
These records should be maintained in a written form, ensuring that the information is documented and preserved clearly and tangibly. Furthermore, these records must be in English, as this facilitates regulatory oversight and compliance verification.
In today’s digital age, electronic record-keeping has become common. If trustees choose to keep records in electronic form, they must ensure that they are verifiable by the Australian Taxation Office (ATO. This means that electronic records should be easily accessible, secure, and in a format that can be provided to authorities for scrutiny.
In conclusion, maintaining accurate and complete records is a non-negotiable element of responsible SMSF management. These records ensure compliance with superannuation regulations and promote transparency, accountability, and good governance. Trustees should take their record-keeping responsibilities seriously, understanding that it’s not just a regulatory requirement but also a crucial safeguard for the interests of SMSF members.
5. Incorrect Investment Strategy
One of the core principles of self-managed superannuation fund (SMSF) management is ensuring that the investments held within the fund align with the established investment strategy. This strategy is a roadmap to guide investment decisions and should reflect the fund’s objectives, risk tolerance, and financial goals. Here, we explore the importance of maintaining alignment between the investment strategy and the fund’s asset portfolio, along with the implications of adding new asset classes to the mix:
The investment strategy of an SMSF is a vital document that outlines the parameters for investment decisions. It typically details the fund’s objectives, risk tolerance, asset allocation, and the desired mix of investments. It is developed to ensure the fund’s investments are well-suited to achieve the members’ retirement and financial goals.
Regular Strategy Reviews:
An investment strategy is not static; it’s dynamic and should be regularly reviewed to ensure it meets the fund’s objectives. Periodic reviews with your investment advisor are necessary because financial markets, economic conditions, and the members’ circumstances can change over time. When the investment mix does not agree with the investment strategy, the fund’s investments may be necessary (an investment advisor is handy for these situations).
Adding New Asset Classes:
One common scenario where misalignment can occur is when SMSF trustees introduce a new asset class into the fund. For example, the decision to include international shares or commercial property within the SMSF may arise. However, the existing investment strategy may not have accounted for these specific asset classes.
The Need for an Update:
When a new class of asset is contemplated, evaluating the investment strategy’s compatibility with this addition is crucial. If the strategy doesn’t already permit the inclusion of such assets, an update is necessary. This update should be made after carefully reviewing how the new asset aligns with the fund’s long-term objectives, risk tolerance, and overall investment approach. Trustees should consider potential risks, return expectations, and diversification benefits.
Compliance and Regulatory Considerations:
In addition to maintaining alignment with the investment strategy, trustees must ensure that any changes to the strategy or investments comply with superannuation regulations. Misalignment between the strategy and the asset portfolio can result in non-compliance, which may lead to regulatory issues and financial penalties.
The Balance of Flexibility and Discipline:
Ultimately, successful SMSF management requires balancing the flexibility to adapt and the discipline to adhere to the investment strategy. Trustees must be vigilant about reviewing and updating the strategy to accommodate new asset classes or changing markets. These decisions should be made in consultation with financial advisors and be driven by a clear understanding of the fund’s long-term goals, risk tolerance, and the interests of its members.
In conclusion, maintaining alignment between the investment strategy and the SMSF’s asset portfolio is crucial for prudent and compliant management. Regular reviews with your investment advisor, proactive adjustments, and careful consideration of new asset classes are essential to ensuring that the fund continues to work towards its members’ financial security and retirement objectives.
6. Assets Registered in the Wrong Name
Ownership of assets is a fundamental aspect of managing an SMSF. To ensure compliance with superannuation regulations and protect the fund’s integrity, all assets must be correctly registered in the fund’s name. Unfortunately, one of the common pitfalls that SMSF trustees encounter is assets being registered under the names of individual members or other parties rather than in the name of the fund.
The Ownership Principle
One of the principles of SMSF management is that the SMSF itself should own all assets held within the fund. This principle is essential to maintain the separation of fund assets from members’ personal assets and safeguard the integrity of the fund’s financial resources.
Assets such as bank accounts, shares, and other investments are frequently incorrectly registered under individual members’ names. This can occur due to administrative oversights, misunderstanding, or lack of attention to the proper registration procedures. Sometimes, life insurance policies or invoices related to property expenses may also bear the wrong names.
The Need for Prompt Rectification
Rectifying assets registered in the wrong name is a crucial step for SMSF trustees. Correcting these documentation errors is not merely a formality; it’s a regulatory requirement. Failure to do so can result in breaches of superannuation laws and may have severe consequences for both trustees and the fund itself.
- Bank Accounts: Bank accounts in the fund’s name should have the SMSF’s name on the account, indicating its ownership. Any income or expenses related to the fund should flow through these accounts.
- Shares and Investments: Shares, managed funds, and other investments should also be registered in the name of the SMSF. This ensures that the income and any capital gains generated from these investments are attributed to the fund, not to individual members.
- Life Insurance Policies: When life insurance policies are held within the SMSF, they should be properly documented and registered in the fund’s name. This helps ensure that insurance benefits are administered according to the fund’s terms.
- Property Expenses Invoices: In cases where the SMSF owns property, invoices for property maintenance or management expenses must be addressed to the fund, reflecting the proper ownership structure.
Failure to rectify these ownership issues can result in a breach of superannuation regulations. Such breaches may lead to financial penalties, potential taxation issues, and challenges when winding up the SMSF or transferring assets to beneficiaries.
7. Outdated Trust Deed
The trust deed is the foundational legal document governing self-managed superannuation fund (SMSF) operations. It outlines the fund’s rules, obligations, and objectives, serving as the guiding framework for trustees. Trustees often encounter an issue with the trust deed becoming outdated, failing to accommodate legislative changes and evolving fund-related developments. Here, we delve into the significance of ensuring the trust deed remains current:
The Importance of the Trust Deed:
The trust deed is the constitution of the SMSF. It specifies the fund’s rules, including its objectives, how contributions and benefits are managed, and the trustees’ powers. To maintain compliance with superannuation laws and regulations, it is imperative that the trust deed accurately reflects the legal framework governing SMSFs.
Dynamic Nature of Superannuation Laws:
Superannuation laws are not static but subject to ongoing changes, amendments, and legislative updates. Given the dynamic nature of these laws, SMSF trustees must remain vigilant and adapt to stay in compliance. Changes can affect contribution limits, pension rules, tax benefits, and other aspects of SMSF management.
An example where our Perth SMSF Tax Accounting advisors are focussing on now is the tax change to super balances over $3m and if SMSF trust deeds need alteration.
Keeping Pace with Legislative Changes:
When legislative changes occur, the trust deed must be updated to reflect these changes. Trustees should ensure that the SMSF’s operations align with the new legal requirements. Neglecting to update the trust deed can lead to non-compliance and potential regulatory issues.
Besides legislative changes, trust deeds should be adapted to accommodate fund-related developments. For instance, when a member initiates a pension, it triggers specific requirements and considerations related to the management of assets and pension payments. In such cases, the trust deed should be reviewed and updated to provide clear guidance and adhere to the updated regulations.
Maintaining an up-to-date trust deed requires an understanding of changing superannuation laws. SMSF trustees should seek professional guidance from their Perth tax accountants or investment advisors.
Neglecting to update the trust deed to reflect legislative changes can have serious consequences. Non-compliance can result in penalties, taxation issues, and legal complications that can negatively impact the SMSF and its members.
In summary, ensuring that the trust deed remains current is fundamental for the responsible management of an SMSF. Trustees should proactively monitor legislative changes and regularly review the trust deed to ensure it reflects the latest legal requirements. This maintains compliance with superannuation laws and safeguards the fund’s members’ long-term financial security and objectives.
Managing SMSF assets is a critical part of a family’s wealth planning. Prudent tax advisory on an SMSF’s succession, management, growth and administration is essential for a family looking to their retirement and succession. At Westcourt, we are leading tax advisors for SMSF tax advisors and SMSF administration, and we manage funds from a starting value to over $100m in assets. Given our focus on taxation and strategy, our global network, and our independence of advice, we are a natural choice – so why not call us today?