SUPERCentral is an independent online platform provider of SMSFs, advice, legal documentation and wealth management services to accounting and financial planning firms throughout Australia.
Six member SMSF as Pooled Investment Structure
There is currently legislation before Parliament to increase the maximum number of members of SMSFs from four to “not more than six”. When passed, the measure will commence from the start of the first quarter that begins after the Act receives Royal Assent.
In the Explanatory Memorandum to the amendment legislation (Treasury Laws Amendment (Self Managed Super Funds) Bill 2020), it was explained that the new legislation aims to increase choice and flexibility and helps large families to include all their family members in their SMSF.
The pros and cons of a six member SMSF has been extensively discussed since the measure was announced in 2018. It is generally welcome as a means to consolidate family wealth for retirement, save costs, allow younger family members to leverage into more substantial investments and achieve economy of scale. The increase in the number of members may also allow extended family members e.g. grandparents to become part of the family SMSF.
While members have to navigate family dynamics and possible drawbacks such as the possibility of children outvoting parents, transparency of the parents’ balances to the children and vice versa, the general consensus is that in most situations, the benefits outweigh the disadvantages. There is also flexibility in relation to multiple investment strategies, two super arrangements, weighted voting mandate and other checks and balances.
Looking beyond the family SMSF
An SMSF is looked upon primarily as a family super fund. However, the SMSF is by nature a trust fund. It can be advocated that the six member SMSF with an enhanced capital base is also ideal as a structure for a conglomerate of individuals to pool together capital for tailored investments and prospectively, better retirement outcomes. The investments will be subject to superannuation and other relevant laws, notably the SIS investment rules and the sole purpose test.
There are a number of advantages of a six member SMSF as a “collective” investment structure for both related and unrelated individuals.
1. Membership flexibility
SMSF membership is not restricted to family members. Subject to the trust deed, anyone can become a member of an SMSF, except for unrelated employees of the member and disqualified individuals (Section 17A SIS Act). Those who do not meet the age contribution criteria may also become a member if they have benefits in a regulated super fund which they can rollover.
2. Concessional taxation
Tax consideration is significant in the choice of investment structures, especially for long term retirement benefits. In this regard, a SMSF has immense advantages over other commercial structures. The maximum taxation on earnings in the fund is 15% with ECPI for assets supporting income streams. Excess franking credits can also be refunded.
As a comparison, taxable income in a proprietary company is taxed at either 26% or 30% depending on whether the income is over 80% passive (30% tax rate) or not (26% tax rate) (with available imputation credits). Undistributed income accumulated in a fixed or discretionary trust is taxed to the trustee at the highest marginal rate of tax. Income distributed or streamed to trust beneficiaries is taxed at personal marginal tax rates.
The concessional taxation of SMSFs potentially accentuates the compound effect of earnings re-investment.
3. Flexible investments
The underlying investments of an SMSF can be any investments authorised by law for the investment of SMSFs, subject to the investment strategy, superannuation law and the trust deed. This may include listed investments, unlisted investments not available through public offer funds, or projects which require a reasonable amount of capital to be worthwhile such as start-ups, venture capital, innovative investments or real properties.
A group of friends with similar investment objectives decide to combine financial resources to invest in venture capital, especially in the AI and robotic sectors with IPO potential. In addition, they are interested in investing in biomedical and pharmaceutical R & D ventures. They would also hold cash on the side to meet liquidity requirements and to further invest, should other suitable opportunities arise. As their investment and reinvestments would be long term for their eventual retirement, they decide to set up an SMSF as the investment structure.
A group of medical practitioners and their spouses (up to six members) decide to pool together financial resources to purchase a medical centre using an SMSF to enhance their retirement savings. The rooms in the medical centre (business real property) will be leased back to the practitioner members as well as other MDs who may conduct their respective practices through discretionary trusts, sole trader, partnerships or other arrangements. The objective is to sell the medical centre eventually when they approach retirement.
The investments of the SMSF are the medical centre and cash. In the formulation of the investment strategy, the trustees who are also members are aware of the concentration risk. This is addressed as the members either have diversified investments outside super or investment in other super entities. The SMSF will also receive further contributions which will be invested in other asset classes. Rental returns will also provide ample liquidity.
4. Limited Recourse Borrowing
The SMSF may further enhance its capital base through borrowing under the limited recourse borrowing arrangement, subject to appropriateness, the investment strategy and LRBA rules. This can provide the SMSF with greater flexibility to invest in more substantial projects or further diversify investments. Loan interest and borrowing expenses are generally tax deductible to the SMSF.
5. Member balances
In the pooled investment scenario, members may contribute in equal amounts but unequal balances can easily be accommodated. In the SMSF, each member maintains their own member balance (account) to which investment earnings and expenses will be allocated on a fair and reasonable basis, subject to the governing rules.
Where the members are business partners or friends who have combined capital to invest for retirement, they may also have a second SMSF for family members or superannuation with public offer funds eg. for their concessional contributions, including mandatory contributions.
6. Longevity and succession
Superannuation benefits are preserved. Generally, the benefits can only be withdrawn upon the member meeting an unrestricted condition of release eg. retirement or attaining age 65.
However, payment of benefits from superannuation is not mandatory even after a member has met an unrestricted release condition. Cashing of benefits is only compulsory after a member has died. While the member is alive, there is the option to retain benefits in the fund (accumulation phase) with tax on earnings at a maximum 15% rate. In addition, pensions that have commenced can be stopped and rolled back to accumulation. Members can also make withdrawals and at the same time contribute to super in the same financial year, as long as they meet eligibility requirements.
In some circumstances, especially where members have substantial assets and income outside super, it may be advantageous to retain their super in an SMSF (with taxation at maximum 15%) for future withdrawal and upon death to devolve the benefits to dependants free of probate and, possibly, of access by creditors (for lump sum benefits), or to the legal personal representative, including holding in a Super Proceeds Trust.
7. Asset protection
A member’s interest in a regulated super fund is generally protected from the trustee in bankruptcy. Any lump sum paid to the bankrupt person on or after the bankruptcy date is also protected. Super pensions do not receive the same level of protection.
The exception is where the contribution of money or assets to super is made with the intention to defeat creditors; these will not be protected and may be clawed back by the trustee in bankruptcy.
Superannuation benefits are preserved; that is, they are not immediately accessible. This means participants in the SMSF have to be committed to investing over a longer term, although there is always the option to sell underlying assets and rollover benefits.
As we approach a time of rapid product innovation both in Australia and in many other countries, six member SMSFs allow a greater chance for the fund to amass capital, achieve better economy of scale and move into comparatively innovative products as well as maintaining blue chip investments, subject to the investment strategy.
Familiarisation with the SIS investment rules including borrowings, in-house assets, arms-length transactions, related party dealings, and the sole purpose test are essential to the SMSF investment process.
As the members are also the trustees or the directors of the corporate trustee, clear demarcation between services performed as a trustee or in another capacity such as a contractor, is also crucial under the NALI regime.
For further information regarding this article, please contact SUPERCentral on 02 8296 6266.
You might also like ...
- Minimum pension drawdown relief extended to the 2021/22 financial year
- The trifecta of government super changes - Your Future, Your Super changes also passed
- More Flexible Superannuation Bill - passed with benefits
- Six member SMSFs finally arrive
- Not too close but not too far - SMSFs transacting with former spouse, cousins or friends