Stepping back: SMSF wind-up options for trustees
The latest research shows that over 12,000 self-managed superannuation funds (SMSFs) are wound up each year. There are many reasons, or triggers, as to why a client and their adviser may decide to wind up an SMSF. These include death, relationship breakdown, trustee capacity and disability concerns, disinterest, disqualification or non-residency.
It’s common for SMSF clients to lose interest in managing their SMSF as they get older or they simply find it becomes too onerous. Others may become ineligible to be a trustee due to disqualification through bankruptcy and disqualification by the regulator, the Australian Taxation Office (ATO), non-residency, and, more recently, capacity concerns.
The most recent data from the ATO shows the number of SMSF establishments and wind-ups each year, as shown in table one. While there has been plenty of commentary about new SMSF establishments, there is less discussion about SMSF wind-ups.
WHAT ARE THE TRIGGERS?
There are seven common trigger events that can require a client who is a trustee of an SMSF to need an SMSF exit strategy. These are death, divorce, dementia, disability, disinterest, disqualification, and departure.
Death
Death is a significant trigger event for a review of the viability of an SMSF. SMSF trustees are jointly and severally responsible for the running of the SMSF, but in practice there are occasions when some trustees are more responsible than others. In the event that a ‘more responsible’ trustee dies, the remaining trustees may not be willing or able to continue in the role of trustee.
The payment of a death benefit also becomes an important issue if indivisible or illiquid assets are involved, or if there are assets, such as business real property, that the family unit wishes to retain.
Divorce
If a relationship breakdown occurs between a couple who are trustees of an SMSF, it is often highly desirable for each member to make their own future superannuation arrangements. While the former couple may maintain a cordial and constructive relationship, it is not always the case. Running an SMSF with trustees who are not on good terms becomes difficult at best and can be impossible.
Additionally, if a family law split is being made from an SMSF, it is possible to take advantage of the capital gains tax (CGT) exemptions when moving one of the parties to a small Australian Prudential Regulation Authority (APRA) fund (SAF) or a new SMSF. This is generally not available if the family law split is paid to a public offer fund.
Dementia and disablement
As clients age, the loss of capacity because of dementia or other illnesses is an growing source of concern for SMSF trustees. The prevalence of dementia is projected to increase, so these concerns will escalate.
There are currently more than 413,000 Australians living with dementia. By 2056 this number is expected to reach 1.1 million. According to Dementia Australia, dementia is the second leading cause of death for Australians and in 2016 overtook heart disease as the leading cause of death for Australian women.
If an SMSF trustee loses mental capacity, they cannot continue in the role of trustee and so are unable to be a member of an SMSF. There are no legal issues with a person who lacks mental capacity being a member of a public offer fund or a SAF.
There may, however, be practical impediments to such a person becoming a member of a public offer fund or a SAF if they do not have an enduring power of attorney. Accordingly, ensuring SMSF trustees have an enduring power of attorney is an essential part of the SMSF establishment process.
Disinterest
Loss of interest can be a driving force behind an SMSF exit strategy. Many SMSF trustees are skilled and committed when they commence their SMSF journey but may become less interested and able as they age.
Disqualification
A disqualified person is a person who:
- has been convicted of an offence involving dishonesty;
- is an undischarged bankrupt; or
- has been disqualified by a Regulator of a civil penalty.
If an SMSF trustee becomes an undischarged bankrupt, they must notify the ATO immediately and make alternative arrangements for their SMSF within six months of declaring bankruptcy. If alternative arrangements are not made within the six months, the fund will fail the definition of an SMSF and will not be eligible for tax concessions.
A disqualified person cannot legally be a trustee and, as in the case of a loss of mental capacity, are therefore unable to be a member of an SMSF. There are, however, no legal issues with disqualified persons being members of a public offer fund or a SAF.
Departed
To be eligible for concessional tax treatment, a super fund must meet the definition of an Australian super fund. If a fund fails to meet the test below at any time during the income year, they do not meet the definition of an Australian super fund and are not entitled to tax concessions.
A super fund is classified as an Australian super fund if:
- the fund was established in Australia, or any asset of the fund is situated in Australia;
- the central management and control of the fund is ordinarily in Australia; and
- active members who are Australian residents hold at least 50 per cent of the fund’s value.
For SMSF trustees, the residency test is particularly important. As the trustee is responsible for the central management and control of a fund, their physical location is paramount.
If an SMSF trustee becomes a non-resident, the fund will generally fail to meet the definition as high-level decisions relating to the fund will be made wherever the trustees reside.
There is a grace period where the trustees can be temporarily outside Australia for a period of no more than two years and can still meet the definition of an Australian superannuation fund. Absences beyond two years, however, or permanent residence overseas will generally see the fund fail the definition.
Active members are members who contribute, or for whom contributions are made, to a fund. For the purpose of the residency test, contributions include rollovers to a fund.
Public offer funds may have many non-resident members who contribute, however it is unlikely that the non-resident members would hold at least 50 per cent of the fund assets. Accordingly, the active member test is usually not an issue in a public offer fund.
In a SAF, however, the active member test can be an issue as membership is limited to a maximum of four members. A SAF can only meet the active member test if non-resident members don’t contribute or if contributory resident members hold greater than 50 per cent of the fund’s assets.
THE SMALL APRA FUND ALTERNATIVE
A SAF is an SMSF with a professional trustee. This means the critical role of trustee and the responsibility of managing the super fund on behalf of the members is passed onto a licensed trustee company. The trustee company is also responsible for the compliance, regulatory reporting and administration for the fund.
When it comes to winding up an SMSF there are several options available including:
- a rollover to another APRA regulated fund (retail or industry fund);
- a member benefit withdrawal payment out of the superannuation system; or
- a change of trustee to a SAF.
A change of trustee to a SAF is often overlooked but should be considered as a logical alternative, as it can provide additional benefits to members that are not otherwise available.
BENEFITS OF A SAF
Understanding the different exit strategy options as well as the benefits to members that a change of trustee to a SAF is increasingly important. These are some of the key factors that members should consider.
Investments options
A change of trustee to a SAF may help members who wish to retain unique, illiquid and lumpy investments such as property, private company shares and collectables. The professional trustee of the SAF may accept the types of assets that would typically not be accepted by a retail or industry fund.
This could prove most important to members with business-real property used to run a family business or a property which is currently in a capital loss position.
Capital gains tax requirements
In accumulation phase, if a client actions a rollover to another superannuation fund or a member benefit withdrawal there may be a significant capital gains tax (CGT) liability.
Alternatively, converting an SMSF to a SAF is simply the removal of the SMSF trustee and the appointment of the professional trustee. There is no disposal of the investments held within the super fund as the fund is the tax-paying entity and it continues uninterrupted.
A recent example highlighting this benefit is that of a senior executive manager, with a top-200 ASX listed company, who was required to move to New Zealand as part of their employment. A change of trustee from their SMSF to a SAF ensured no CGT event occurred within his accumulation superannuation benefit.
In addition, any carried-forward capital losses will be retained in the SAF whereas they would be lost if the SMSF wind-up was a rollover or withdrawal.
Centrelink implications
A change of trustee to a SAF does not have any implications for the grandfathering of Centrelink deeming on pensions. The SAF will continue the existing pension arrangement that was initially established within the SMSF. On the other hand, a rollover or member benefit withdrawal payment from an SMSF may have Centrelink implications.
Insurance policy arrangements
If a member rolls over to a retail fund they will generally need to arrange for their insurance policy to be cancelled and reissued. This may result in underwriting requirements. In addition, some historic policies offer benefits that are no longer available in current day policies.
Clients who choose to change the trustee to a SAF can retain their existing insurance arrangements. This means that they do not have to go through the underwriting process and can retain any policy benefits that may not be available in newer policies.
The importance of continual cover should not be underestimated, as the inability to regain cover when applying for new a new policy could prove stressful for members.
Estate planning opportunities
Through special purpose trust deeds, a SAF can provide unique estate planning opportunities compared to a retail or industry fund, particularly for blended families and intellectually disabled members.
Super versus non-super investments
A member benefit withdrawal payment from superannuation requires a careful comparison of the tax-effective concessional environment of superannuation to other forms of structures outside superannuation. This decision is often balanced by the expense of running a superannuation product, as opposed to managing personal investments.
CONCLUSION
There are many triggers for winding up an SMSF, namely death, divorce, trustee capacity and disability concerns, disinterest, disqualification or non-residency.
A SAF can continue the member’s superannuation strategy and achieve their retirement goals, even when they encounter life-changing events.
Luke Costa as Australian Executor Trustees’ national specialist – SMSF solutions.
AUTHOR
Industry Expert
Recommended for you
When entering paid employment, it’s not long before we are told that we’ll need to lodge a tax return but there are times when a person will be excepted.
Anna Mirzoyan examines how grandfathering affects income support payments and how factors such as paying for aged care can impact them.
There are specific requirements that only apply to trustees of self-managed superannuation funds, writes Tim Howard, including the allocation in their investment strategy.
Investments bonds offer a number of flexible, tax-advantaged benefits, writes Emma Sakellaris, but these are often overlooked as old fashioned when it comes to portfolio allocations.
