The ageing of those who operate self-managed super funds raises a new crop of issues for trustees.
Chris Malkin represents the changing face of burgeoning numbers of self-managed superannuation fund (SMSF) members: he is an older baby boomer, receives a super pension, has a multimillion-dollar super balance and pays close attention to estate planning.
Almost 60 per cent of SMSF members are older than 55, with a quarter – like Malkin – being over 64. And SMSFs hold more than half of the total superannuation money invested in retirement products, according to estimates by the actuarial firm Rice Warner.
Malkin, an FCPA and senior consultant auditor for Baumgartner Superannuation, has taken steps to ensure that his SMSF will not cause problems if he suffers a serious illness or predeceases his wife.
For instance, Malkin regularly sends updated details of his super and non-super assets to his brother, his lawyer and a close friend. He has ensured that his fund's core holding – a debt-free office building – produces a solid income so the fund won't have to sell assets to pay a pension to his wife "if I get knocked over by a bus".
Unfortunately, regulators and professional advisers suspect that many older SMSF members are not nearly as well‑prepared as Malkin for their funds to deal with their death or serious illness.
Superannuation, tax and estate-planning lawyer Peter Bobbin, managing principal of Rockwell Oliver in Sydney, believes the ageing of much of the SMSF membership is a time bomb for many unprepared funds.
The age profile of Australia's SMSFs is markedly older than for other types of super funds. Rice Warner statistics show that industry funds, for example, have just 5 per cent of the superannuation money invested in retirement products, compared with more than 50 per cent held by SMSFs.
While older members of SMSFs face many of the same issues as members of big, Australian Prudential Regulation Authority-regulated funds, some crucial differences exist.
All SMSF members must be either individual trustees of their fund or trustee directors if the fund has a corporate trustee.
Aside from the greater legal responsibilities of their members, SMSFs have an average asset value of more than A$1 million with many owning valuable (and relatively illiquid) direct property. And SMSF members are usually much more involved in their super.
The ageing of much of the SMSF membership creates both challenges and opportunities for their members.
One critical issue facing the ageing SMSF membership, says Stuart Forsyth, the Australian Taxation Office's assistant deputy commissioner for superannuation, is that the vast majority are run by couples but with one trustee making most of the decisions. Forsyth warns that if the most-active trustee dies first or becomes seriously ill with something like dementia, the less‑active trustee could be left floundering.
"The investments may not be managed and the returns may not be lodged," Forsyth says. Some ageing trustees, he adds, may just lose interest in running their funds.
The ageing of much of the SMSF membership creates both challenges and opportunities for their members.
Given the flexibility of SMSFs and their high average asset value, many older trustees focus heavily on estate-planning strategies. The potential of these strategies is magnified, because superannuation assets backing the payment of super pensions are exempt from tax on income and capital gains.
Melbourne financial planner Matthew Scholten, a principal of Godfrey Pembroke (part of the MLC group), likes to review his SMSF clients' portfolios every quarter. However, these reviews become "more focused" in the last few years before retirement.
Pre-retirement reviews typically examine whether a fund's asset allocation is still appropriate for the members' retirement lifestyle, expected longevity and risk tolerance.
The reviews often cover whether an SMSF should build up a cash buffer before retirement, to provide enough money to pay pensions during unfavourable market conditions without being forced to sell assets at depressed prices.
Scholten generally suggests that SMSFs have enough in cash and term deposits to make two years of pension payments. Funds often direct their contributions and investment income into cash during the final couple of years before retirement to build their cash buffers.
SMSF administrator and consultant Meg Heffron
When conducting pre-retirement portfolio reviews, Scholten stresses that SMSFs should hold sufficient growth assets to counter inflation during a potentially very long retirement. Some of Scholten's SMSF clients simplify their portfolios as they grow older, in part to make the investments easier to manage – particularly given the possibility that the most-active trustee may die first.
Scholten sometimes recommends that an SMSF sell a valuable direct property after the fund begins to pay pensions. The property might not be producing a satisfactory yield or ageing members might find it more difficult to look after.
Another reason why some pension-paying SMSFs decide to sell a direct property is to ensure the fund has enough liquid assets to pay pensions, as well as super death benefits when necessary.
Scholten says the tax exemption for assets backing the payment of a pension may make retirement an appropriate time to make adjustments to a portfolio, including the sale of assets liable for capital gains tax.
Many professional advisers suggest that individual trustees or trustee directors grant enduring powers of attorney as part of their planning for possible serious illness and old age.
It grants authority to another person to make financial decisions on their behalf, including if a fund member loses mental capacity.
Meg Heffron, co-principal of SMSF administrator and consultancy Heffron, holds enduring powers of attorney for her parents and expects to become a trustee director of their SMSF when they reach their 80s.
“The key point is that I hold the enduring powers of attorney now in case anything unexpected happens,” she says. “But I don’t expect to use them for a long time.”
Bryce Figot, a director of DBA Lawyers, says the first step trustees should take to prepare for the possible illness or death of a trustee is to ensure their trust deed reflects what they want to achieve.
Figot suggests that other key steps include having enduring powers of attorney and thinking about who will control the SMSF following your death or disability – and whether you trust that individual. He says a member may decide to make a binding death benefit nomination if trust is lacking.
As part of their estate planning, Figot strongly recommends that SMSFs have a corporate trustee rather than individual trustees. Consider the example of a two-person SMSF when one of the trustees dies. SMSFs with individual trustees must have at least two trustees. Therefore, the deceased trustee in this example must b ereplaced for the fund to continue as an SMSF.
However, a SMSF with a corporate trustee can continue with a single corporate trustee if a trustee director of the two-person fund dies.
There are other reasons why professionals such as Figot favour corporate trustees. Under superannuation law, an SMSF with individual trustees must hold its assets in the name of all those individuals as trustees of the fund. If a trustee dies, the names on the fund’s ownership documents must change.
In contrast, with a corporate trustee assets are held in the name of a company acting as trustee. If one of the trustee directors dies, the assets remain in the name of the company.
Other things to think about during estate planning for an SMSF include who is eligible to receive super death benefits, the tax treatment of those benefits in the hands of different beneficiaries and the limitation of a will in regard to super.
An SMSF with a corporate trustee can continue with a single corporate trustee if a trustee director of the two-person fund dies.
Super death benefits are generally only payable to deceased members’ dependants, as defined in superannuation law, or to their estates.
Eligible dependants are the deceased’s spouse, children of any age and a person who had an “interdependency” relationship with the deceased. Financially independent adult children are subject to tax on the taxable component of inherited super benefits – estate-planning strategies can be adopted to minimise it – whereas spouses, for instance, are not liable for any tax.
Significantly, super death benefits do not automatically form part of a deceased estate. And unless a fund member makes a valid binding death benefit nomination, a super fund’s trustees have full discretion about which eligible dependants will receive the super death benefits.
While Heffron says that binding nominations are effective in some circumstances, she has some reservations about them for SMSFs. One of her main concerns is that by issuing a binding set of instructions to a trustee, any flexibility is removed for the trustee to make decisions given the circumstances at the time of death. For instance tax laws or family circumstances may change.
Chris Malkin's approach is an example of how best to manage an SMSF.
A binding nomination stipulating, say, that super death benefits be paid half to a surviving spouse and half to a now financially independent adult child may have unexpected and unwanted tax consequences. While the spouse would receive the benefit tax-free, the financially independent child will likely pay tax on a portion of the benefit.
Heffron says an SMSF member can manage the distribution of super benefits following death without a binding death benefit nomination by ensuring that the favoured beneficiary is left in control of the SMSF.
“You are then effectively giving that person total control over the money and leaving them to work out how best to take it out of the system.”
SMSF administrator and consultant Meg Heffron is receiving many more inquiries from elderly trustees about whether their adult children should join their SMSF to help manage the fund.
This article is from the February 2014 issue of INTHEBLACK.
Inter-generational SMSFs may operate smoothly in some circumstances, Heffron says, such as when the parents and adult children are already in business together. Perhaps the parents may want particular assets, such as the premises of a family business, to pass between generations through their SMSF.
However, she has reservations about parents and their adult children being members of the same SMSFs in most circumstances. Parents have different time horizons for investments, different tax positions and, perhaps, different financial objectives. "And potentially, there is a loss of control over the fund. You will have a committee making decisions."
Heffron says there are ways to allow your adult children to become involved in running your SMSF without becoming members. These include using an enduring power of attorney.