When it comes to running a self-managed super fund, the good news is that most people are doing the right thing, but there are so many rules and regulations concerning SMSFs, which can make some aspects a little tricky to keep on top of. While SMSF regulations exist to keep things in line, we’re all human, so mistakes are always bound to happen. Awareness is key to prevention, so here are the top five mistakes made when running an SMSF.
Separation of Assets
The ATO reported in their 2020 update of SMSF issues that contraventions relating to separation of assets amounted to 12.7% of the total regulatory breaches, making it one of the most common mistakes made.
As trustee of an SMSF, it is a legislative requirement that super fund assets are kept separate from your own personal assets. This means all SMSF assets must be clearly owned by the SMSF. When we say “assets”, we don’t just mean investment assets. This relates to all assets, investments, accounts and policies relating to the super fund — including bank accounts and life insurance policies.
All assets must be in the name of the corporate or individual trustees, as trustee for (ATF) the SMSF. They are not allowed to be held in the name of a member or trustee as an individual.
This rule is more than just a legislative requirement though — it acts to protect individual members from financial issues in their personal life, such as protection from creditors and relationship breakdowns. For example, an ex romantic partner has no legal right to the assets in the SMSF unless they are also a member. While an ex-partner may be entitled to a portion of your individually held assets, they do not have the same rights with assets held under the SMSF.
Mistakes with in-house assets make up 18.5% of the most common SMSF mistakes — so take note of this one. An in-house asset arises when the fund’s assets are involved with a related party. Situations that bring about an in-house asset are loaning money to, or investing in, a related party, or leasing an asset (such as property) of the fund to a related party (this rule does not apply to commercial property held by an SMSF and leased to a related business on an arms-length basis). In-house assets cannot be more than 5% of the fund’s total assets. So, for example, consider machinery owned by the SMSF and leased to a business owned by the members. This equipment is classed as an in-house asset — which is fine as long as the value of the equipment is less than 5% of the total assets.
This seems simple enough, but it’s very easy for the ratio to be thrown out with something like a stock market crash or property boom.
Generally, when in-house assets exceed 5% of the total fund value at the end of the financial year, the trustees must prepare a written plan by the end of the next financial year to reduce the ratio of the in-house assets back to the allowed level. Because COVID-19 brought about a lot of market volatility, the ATO has stated that they will not be taking compliance action against any funds that have been unable to implement their plan as a result of the market having not recovered. This applies to in-house assets being in excess of 5% as at 30th June 2019 and 30th June 2020. To learn more about how COVID-19 brought about in-house assets through rent relief to tenants and the stock market crash, see the Impact of Coronavirus on SMSF’s.
Insurance Policies and Succession Planning
When you think of your SMSF, your main focus is probably on retirement planning, but sometimes life gets in the way, and people don’t make it to retirement as planned. This is where appropriate succession planning and insurance are absolutely vital for an SMSF. A succession plan means that if you were to die or lose legal capacity, you could rest assured that your SMSF will be in the control of someone who will manage it as per your wishes.
Insurance is a great way to plan for the unexpected. As mentioned in point one regarding the separation of assets, insurance policies must be appropriately owned by the SMSF. To ensure your policies comply, the title of fund assets (including insurance policies) must be in the name of the trustees. To help with separation and ownership, the premiums should be paid by the SMSF’s bank account. Issues arise when members organise insurance under their own name with the premiums being paid by the SMSF. The policy needs to be taken out under the member’s capacity as trustee for the fund, and not as an individual.
If you discover your insurance policy is in the name of an individual and not ATF for SMSF, you will need to make some changes to ensure you are no longer breaking any laws. Regulations do not allow for a change of ownership as this is taken to be an acquisition of assets from a related party — which is not permitted. To remedy the incorrect holding of insurance by the super fund, the policy needs to be either cancelled and reinstated under the individual’s name, as trustee for the fund or, the individual can simply have the premiums debited from their own private bank account. The latter would result in the insurance policy being held directly by the individual and unrelated to the SMSF.
Further to the ownership of policies, mistakes arise regarding the type of policies allowed in SMSFs. As of 1st July 2014, Trauma and Own-occupation TPD insurance is not allowed. Any policy purchased before this date is still valid.
Paying the minimum pension
One of the significant benefits of investing in a super fund is the favourable tax concessions. To maintain the tax concessions, it is essential to ensure the minimum amount of pension is being paid.
Any income generated by an SMSF in retirement phase is tax-free — providing the fund is paying the minimum pension to the members to stay compliant. If your fund is not paying out the minimum pension, it essentially has more assets available to earn tax-free income, so you can probably see why people might prefer not to pay a pension. Failing to pay out the appropriate amount can result in a large tax bill and compliance action — which completely defeats the purpose of having an SMSF for tax concessions! Earning a tax-free income is such a great feature, so you’ll want to make sure your fund is doing things correctly. If you do not make the right pension payments, you’ll end up paying a lot of tax on what should have been tax-free.
If you’re considering an SMSF loan with a pension fund, the capital value of the pension account, nor the pension payments can be used as security for a loan. If you are considering an SMSF loan, we offer a free SMSF finance session to help you understand the ins and outs of SMSF lending and the options available to you.
Using Assets for Personal Reasons
As discussed earlier, it’s essential to keep all assets and bank accounts of the SMSF separate from business and personal accounts. Withdrawing money from your super fund without meeting conditions of release can result in heavy consequences including fines and disqualification of the trustees.
To access money, you need to meet a condition of release as follows:
- • Reach preservation age and;
- • Retire, or
- • Begin transition-to-retirement income stream
- • Ceases employment from age 60.
- • Is 65 years old (regardless of retirement).
- • death
If you need your money sooner than meeting the conditions above, there are exceptional circumstances where you can access funds. These include:
- • Incapacity (either temporary or permanent)
- • Diagnosis of a terminal medical condition
- • Compassionate grounds
- • Financial hardship
- • First home super saver scheme
- • COVID-19 early release of super
Using assets for personal reasons can be more than just withdrawing money before a condition of release is met. The rule applies to other assets too. For example, a holiday home owned by your SMSF is not able to be used by members or related parties of the fund, regardless of whether it’s leased at market rates.
Regarding the use of property, it is generally only possible for a related party to use a commercial property owned by the SMSF. A member’s business is able to lease commercial property from the SMSF, but mates rates are not allowed. The cost must be similar to what any unrelated party would pay for the lease.
With the various types of assets held in SMSF’s, it’s easy to see how using SMSF assets for personal reasons is a common mistake! There are conditions of release, rules regarding the naming of assets, and legislation determining who can use an asset. It can be a lot to get your head around.
While some careful planning can keep you from making any of these mistakes with your SMSF, it’s not the end of the world if an error was to occur. The ATO has reported that over the last five years, of the SMSFs who had advised they had made an error, almost half of them corrected this error prior to lodging their tax return. On average only two per cent of SMSFs who lodged a tax return were reported as contravening regulatory provisions. So if you do happen to find an error, chances are you won’t be facing any harsh penalties if you’re able to rectify the oversight.