The self managed super fund is the strongest performing Superannuation sector in Australia. In a very short time, it has created a space for itself. The amount of flexibility and control it offers to you is next to none. I’m sure we all are aware of the advantages of self managed super funds.
However, it is also critical that you understand the rules governing your self managed super fund or you may end up wasting all the advantages.
Listed below are the most important rules for SMSF funds that you absolutely must know to keep your fund safe and growing. Ignore these and risk potentially hefty fines.
15 SMSF rules you cannot avoid knowing
These are not all….can never be….but they will give you a glimpse of what SMSF is all about…a kind of primer.
1. Rules of borrowing for property
SMSF borrowing has to be meted out keeping arm’s length transactions in mind. In other words, the deals must not favour a related party and transactions should be made keeping in mind what would have been the way forward had no related parties been involved.
2. In-house assets rules to abide by
In-house assets rule clearly declares that the amount of in-house assets held by a fund should be in deficit of 5% of its total assets. Investment in a related trust or loan forwarded to a related party is considered an in-house asset.
3. Arm’s length transaction- the related party model
“Arm’s length” implies all those transactions where no favour is being passed between the two parties because of a possible relation between them. The buyers and sellers have to act independently and only aim to work towards their self-interest. At arm’s length can be beautifully summarized as: on an equal footing.
4. Binding Death Benefit Nomination requirements
This is a signed and attested sheet which guides the Australian Super about the way of disbursing a trustee’s estate in the event of his death. You can nominate your present spouse, your children (adopted ones, step-children and children from a former spouse), those dependent on you, an interdependent (with whom you have a commitment towards shared life) or your will’s executor.
5. Super fund costs and SMSF fees (not a rule but an important guideline nonetheless)
Self managed super funds do not cost a $million. The myth has been busted and how! The false notion had originated from the fact that SMSF fees was calculated as 1% of the total fund value and because the fee came around the $1500 mark, you were expected to enter the market with nothing less than $1.5 million.
This is no more the case as fees have dropped drastically due to high competition and administrative software. Today, they can be as less as $700 and this means you can hit the SMSF market if you have something like $70,000 in your kitty.
6. Sole Purpose Test is a cornerstone legislation
Sole Purpose Test implies that the SMSF funds are to be used for the sole purpose of meeting retirement needs. Its benefits, unless in an exceptional case, must be held for that time of life. While the sole purpose test does not have direct power over the investment decisions of a fund, it is widely regarded as keystone legislation in the Super sector.
7. SMSF Investment strategy must be declared
SMSFs have to declare an investment strategy prior to making investments. This strategy is expected to declare your intent towards your fund’s diversification, ability to pay off benefits, member’s current requirement and situation (at what stage of life they are in) and the fund’s liquidity.
8. SMSF Investment strategy example
SMSF lending can be a key investment strategy. You can use it to leverage and diversify your SMSF. What to keep in mind though- It is that things look good as of now but if a government ban is proposed on SMSF borrowing or reforms come to the SMSF lending sector in future, you may find yourself in deep waters. Such a possibility cannot be ruled out. For instance, imagine what may happen if the Financial System Inquiry’s proposal made to the government goes through?
9. Limited recourse borrowing arrangements
Limited recourse borrowing arrangements are those where the lenders have “limited recourse”. In other words, in the event of a default, they can only attach the property or asset for which the borrowing was made and not the entire asset base of the defaulter.
This is one reason why many SMSF investors fear cross-collateralisation (cross-securitisation) of assets during the purchase of property through their SMSF.
10. ATO audit environment has become sterner
ATO audits have become far sterner especially since the introduction of the new regime. The premier body has taken many auditors to task and asked them to prepare contravention reports diligently.
From its side, ATO is quite willing to understand that SMSF is a new industry and that people need time to get acclimatised to it. To this end, it is taking pains to hold webinars and other events where information can be shared. However, it has also put its foot down and made clear to all that it won’t take contraventions lightly from now on.
11. Bare trust structure needs to be followed
When you want to undertake a limited recourse borrowing arrangement through your SMSF, you need a Bare Trust to see through the proper procurement of asset. It is a trust where the trustees are no more actively involved and the reins are held by beneficiaries who are completely ‘entitled’. A Bare Trustee can be anyone apart from the Super fund trustee.
12. SMSF property traps to avoid
SMSF is a smart vehicle to buy your own property but there are key points you must keep in mind to avoid being trapped. For instance, you must use a Bare Trust structure. You should refrain from related party transactions and indulge only in the arm’s length model; not passing any favours. Of course, the purchase must also be declared as part of your investment strategy.
13. SMSF contributions- voluntary additions to the fund
Members of SMSF can make voluntary contributions to their funds. Of course, there is an upper cap which they cannot breach. This cap is different in cases of concessional and non-concessional contributions. In the event when the contribution cap is being exceeded, members are liable to be imposed additional tax on the extra amount.
14. Concessional contribution cap guidelines
Concessional contributions are those which are a part of your SMSF’s assessable income. These contributions are taxed at a meagerly 15%, much below the marginal tax rate. Common examples of such contributions are employer contributions, salary sacrifice or a personal contribution by the member (for this, he/she is entitled to a tax rebate).
15. Non concessional contribution guidelines
Non-concessional contributions are excluded from your SMSF’s assessable income. If a member makes a personal contribution and does not seek a tax rebate on it, it can be termed as a non-concessional contribution. Since July 2014, the non-concessional contribution cap has been raised to $180,000 per year for members who are at or above 65 years of age but not yet 75.
These are rules you simply cannot ignore
Have you ever tripped over any of these self managed super fund rules and have they cost you dearly in the past? Feel free to share your experiences with us. One experience added is equal to several people enriched!
The above points aim to encapsulate some of the most significant aspects of the current SMSF rules in Australia. If you have any pressing questions, feel free to join us – I am always glad to advise.