Should your super be a family affair?

Should kids be part of a DIY super fund?

The pros and cons of including children in your SMSF.

By Alia McMullen

Investment gurus, self-help books and just about any market pundit you can find will assure you that one of the fundamental rules of investing is not to let your emotions run away with your money.

That's easier said than done, given money is so intrinsically linked to our everyday lives and our happiness. Controlling your emotions becomes an even greater challenge when dealing with superannuation.

Try telling someone in their mid-60s, who has postponed retirement because their super was eroded by the global financial crisis, that they shouldn't worry about their quality of life in their “golden years”.

Now, let's raise the emotional bar by adding in kids.

It's possible to include children as members of your self-managed super fund (SMSF) and as the number of SMSFs surges, the number of kids in family super funds has been increasing.

Up to four members can join an SMSF and children under the age of 18 are allowed as members as long as someone is appointed to represent them as trustee.

But should kids be part of a DIY super fund? And since the "sole purpose" of an SMSF must be to provide for your retirement, can emotions and family pressures be put aside? Given the number of family arguments caused over a board game of Monopoly, many may quickly answer “no”. But the answer is not so black and white and there are staunch supporters on either side.

Let's start by exploring the positives

The inclusion of working adult children in a family SMSF can help preserve family wealth due to a number of financial benefits, including:

•    Access to better investment opportunities because of a larger pool of funds
•    Easier succession planning, such as the seamless ability to keep valuable assets, like a business property, in the family over generations
•    The potential cost savings of running a single fund

Some like to point out that having a family SMSF gives parents the opportunity to teach children about the importance of saving for retirement.

Keeping it in the family

The ability to easily transfer high-value assets – particularly business assets – between generations is an important aspect for many families. When a large asset, like a business property, is transferred outside super, the transaction may trigger capital gains tax and stamp duty obligations.

However, if the property is held in an SMSF that includes the parents and children as members, the transfer happens gradually over time. This is because as the parents retire and start to draw a pension (assuming there are other assets in the SMSF to cover the pension payments), their share of the SMSF's wealth decreases; on the other hand, as the children are presumably still in the workforce and contributing to super, their share of the wealth in the fund increases.

It's a slow process, but the children's share of the wealth will eventually grow large enough to cover the value of the business property. This strategy is often referred to as the “intergenerational transfer of assets”.

Potential risks

The potential risks vary greatly due to the fact humans are unpredictable and emotional creatures and, while many families start out with good intentions and trust, family SMSFs have been a boon for superannuation lawyers.

Before choosing to bring your children into your SMSF, it's important to understand that the laws that govern the various aspects of SMSFs are open to interpretation. This means what you “think” you see is not always what you get if forced before a court. The good news is that many of the risks can be avoided by carefully working through your fund's trust deed and succession plan with not just all members of the family, but a specialist SMSF lawyer.

Here are some problems an SMSF with children as members may encounter:

Relationship breakdown – not just between the members of the SMSF, but the relationships of an adult child's family. For instance, if a child who is part of a family SMSF divorces their spouse, even if that spouse is not a member of the fund, the family's SMSF may become party to a legal dispute.

Investment decisions – disputes may arise regarding how the money in the fund should be invested. In some cases where only one parent remains in the fund, the children may outnumber the parent and outvote them on issues regarding how the assets are managed. This may become messy if a parent has remarried, particularly if the children are left to run a fund with a step-parent.

Family pressures – a family may feel under pressure to use the fund to provide assistance to a member who has met with financial difficulty. This is against the law.

Large families – family disputes may arise in families where there are more than four members. It's important to understand that a child included in an SMSF generally has greater claim on the money in the fund than a child who isn't involved – even if you've written a will.

This problem was highlighted in the well-known case of Katz v Grossman, in which a father included his daughter in his SMSF but not his son. Despite his request in a non-binding death benefit nomination that upon his death, his benefits be split equally between his two children, this wish was ignored. This was because the daughter was a trustee of the fund and therefore had the power to determine what happened to the benefit, despite the father having written down his legal wishes. She instead appointed her husband as a new member and trustee of the fund and they claimed the benefits for themselves.

Another extreme case that demonstrates the potential risk of a family SMSF was Triway Superannuation Fund v FCT. This case involved a fund established at the urging of a drug-addicted son.

The case involved a family of three – a father, mother and son – who were all trustees and members of the Triway Superannuation Fund. In June 2002, about A$40,000 was rolled into the fund and by September that year the son had bled the fund dry. The parents concealed the truth about how the money had been lost in order to protect their son – even when he was declared bankrupt a few years later. But with the fund in difficulty, the trustees eventually made a voluntary disclosure to the Commissioner of Taxation in 2007.

This resulted in the fund being declared non-complying because it was found to have broken three rules:

1.    It had breached the sole-purpose test
2.    The parents in their role as trustees had provided financial assistance to a member
3.    A disqualified person (a bankrupt) was a trustee

Fortunately, most parents will never find themselves in as grave a situation as those in this example, but what the case does highlight is that the more people in an SMSF – particularly people of different ages and agendas – the greater the chance that the SMSF will not always run to your liking. It is therefore important to make sure SMSFs with multiple members are established with a solid legal framework.

And remember, if you're concerned about your children's welfare in the event of your death, you have a number of other options available to you other than including them in your DIY super fund. It would be wise to seek legal advice from a lawyer that specialises in SMSFs and succession planning to discuss your situation and plans for the distribution of your estate.

Alia McMullen is the former editor of the Switzer Super Report as well as former Economics Reporter at the National Post.