Bigger might be better for self-managed funds

Changed rules that allow a maximum of six members in a Self Managed Super Fund – rather than four – have the capacity to create a range of new opportunities for families.

If you still want to add your children as members of your SMSF, there are a few practical steps that you can take to mitigate risks.

Australian parents have an average of 1.8 children, so when thinking about self-managed super funds and keeping retirement assets within the family, it makes sense that SMSFs have traditionally been limited to a maximum of four members.

However, in recent years the federal government decided to expand this to six. Former revenue and financial services minister Kelly O’Dwyer said the change would increase choice and flexibility for members. After an extended parliamentary journey it has finally been passed into law as of July 1.

In reality most SMSFs only have two trustees so this is a big change, allowing SMSFs to become considerably larger vehicles than the traditional units. In particular it allows many families to widen the fund to another generation or to in-laws.

Before you make any moves there are administrative and legal considerations to get right.

Timothy Ricardo, director and SMSF specialist from Bishop Collins Chartered Accountants says: “Getting the right advice when setting up your fund is important, especially when considering multiple members. Pooling assets might seem a great idea at first but individual circumstances inevitably change, which adds another dimension of risk and consideration when adding more members.”

But for those thinking about adding more members to their SMSF, the attractions include having greater family involvement in financial decision making, potential cost savings with the consolidation of individual super balances into the SMSF, greater diversification flexibility for the new SMSF members, and help with succession planning for future generations with both parents and children in the same super fund.

There is of course a flip side bearing some significant disadvantages. A major one is where an adult child member of the SMSF gets divorced and then sucks the whole SMSF into a messy and expensive family law dispute.

Further problems can arise when parents and children have differing views about investment selection due to different stages of life. The children may want more growth-orientated investments, reflecting their long time frame to retirement, whereas parents may prefer defensive cash and bond investments to support their upcoming retirement income needs.

In terms of ongoing management, having more trustees can mean more work for the SMSF trustees and lead to delays in investment execution. In most cases, investment providers require all SMSF trustees to sign application forms and contracts. However, in some instances not all SMSF trustees are required to sign documents, such as the annual financial accounts. For SMSFs with more than two members, only 50 per cent of trustees are required to sign.

In extreme cases, opening the door to give more control of your retirement assets to your children can lead to catastrophic consequences. Take the case involving Triway Superannuation Fund and the Commissioner of Taxation (2011 AATA 302) where a drug-addicted child was admitted to the parents’ SMSF and then proceeded to misappropriate SMSF funds to fuel his drug habit. The parents decided to try and cover up the mess. However, the SMSF auditor unravelled the situation and reported it to the ATO, which had consequences for not just the child, but the parents also.

Even where there is an amicable agreement for a child to leave the SMSF at a later stage, liquidity issues can come into play if the child’s funds have been used to help purchase an illiquid asset such as a physical property.

If you still want to add your children as members of your SMSF, there are a few practical steps that you can take to mitigate risks.

There is a little-known method of adding a SMSF member as a ‘‘conditional member’’. What this means is that upon certain agreed trigger events, the member can be forcibly evicted from the SMSF. The trigger events are commonly separation or divorce.

As a conditional member, this makes it easier for the parents to remove the child in the future, to avoid dragging the SMSF into the child’s family law issues.

Another way to assist with the smooth running of the SMSF is to give the parents an Enduring Power of Attorney for the child members of the SMSF.

In other words, the children appoint their parents as directors of the SMSF in their place, so ongoing decision-making can still be conducted via the normal method through the parents.

At some stage in the future when the children are ready, they can take their seat at the table as a SMSF director.

It is difficult to forecast how the new rules will pan out. However, for those considering it, there are many considerations to work through to make sure it is going to work.

Seeking expert legal and accounting advice will also help plan for unexpected situations that could damage the SMSF as a whole. So in this instance getting advice really should be the starting point, given SMSFs are likely to have to update their trust deeds to admit up to six members.

James Gerrard is principal and director of Sydney financial planning firm financialadvisor.com.au