SMSF Professional (November 24, 2011)

P R O F E S S I O N A LS M S F

A Money Management supplement November 11, 2011

RISINGCHALLENGE

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INSIDE4 SMSFs: RISING TO THE CHALLENGEThe unfolding SMSF story is an interesting one, according to DAMONTAYLOR. The sector has enjoyed significant growth and success in recentyears and is here to stay, but how will it respond to proposed changes?

10 PLAN BEFORE YOU HOLIDAYWhen a self-managed superannuation fund (SMSF) member or trustee travelsoverseas for an extended period, their SMSF could lose the tax concessions itenjoys. NICHOLAS ALI outlines strategies to avoid this particular consequence.

11 FROM LITTLE THINGSAdvisers need to be wise when recommending insurance options within theirclients’ self-managed super funds. WARRICK HANLEY explains how smallmistakes can lead to big consequences.

12 TIME TO SHIFT INVESTMENT GEARS?The recent interest rate cut by the Reserve Bank of Australia has created anumber of opportunities for self-managed super funds. PETER VAN DERWESTHUYZEN explains.

14 BORROWING IMPROVEMENTS AND REPAIRSThe Australian Taxation Office's (ATO's) recent draft ruling on limitedrecourse borrowing arrangements has clarified its approach, according toPETER BURGESS.

15 PLAY BY THE NEW GEARING RULESMIKE MITCHELL outlines the strategy implications a recent ATO draft rulingcould have for SMSF trustees when deciding whether to borrow to buyproperty in or outside super.

16 SAVVY CAN RIDE MARKET RECOVERYAARON DUNN lists some of the strategies that self-managed super fundmembers should start to think about to help bolster their superannuationsavings in recovering markets.

17 GREATER CONTROL, GREATER SCRUTINYHaving control over investments is the number one reason for switching toself-managed super funds. However, with greater control comes greaterscrutiny, writes ROBIN BOWERMAN.

18 SUCCESSION PLANNING REVIEWIMPORTANCE HIGHLIGHTEDThe ageing population and the ATO’s recent draft pensions ruling highlightthe need to review clients’ overall succession planning, according to DANIEL BUTLER and NATHAN PAPSON.

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Average Net DistributionPeriod ending March '1110,207

M O N E Y M A N A G E M E N T S M S F P r o f e s s i o n a l N o v e m b e r 2 4 , 2 0 1 12

C O N T E N T S

* Source: Macquarie Bank Limited data, ATO Self-Managed Super Fund Statistical Report.

The Macquarie Cash Management Account is a deposit account provided by Macquarie Bank Limited ABN 46 008 583 542 (“Macquarie”). Fees and charges may be payable. Terms and conditions are available upon request. Macquarie Group Limited is regulated by Australian Prudential Regulation Authority (“APRA”), the Australian banking regulator, as the non-operating holding company of an Australian bank (Macquarie, a wholly owned subsidiary of Macquarie Group Limited). As a licensed Australian bank, Macquarie is subject to regulation by APRA. Macquarie also holds Australian Financial Services Licence No. 237502 and is subject to regulation by the Australian Securities and Investments Commission. This information does not take into account your clients’ objectives, financial situation or needs. Therefore, in deciding whether to acquire or continue to hold an investment in the above products, your clients should consider the relevant offer document, which is available from us.

Macquarie Adviser ServicesCall 1800 005 056, talk to your Macquarie BDM or visit macquarie.com.au/cashflow

It’s easier to keep your clients’ SMSFs on course when you have a complete view of their cashflow. With the Macquarie Cash Management Account, you can track each fund’s cash transactions, generate reports and integrate directly with your back office systems.

Plus, consolidated statements take the pain out of accounting, administration, tax returns, end of year auditing and compliance monitoring.

Why do 1 in 4 SMSFs* use the Macquarie Cash Management Account?

F E A T U R E


The unfolding SMSF story is an interesting one, according to DAMON TAYLOR. The sector has enjoyed significant growthand success in recent years and is here to stay, but how will it respond to proposed changes?

RISINGCHALLENGE

TO THE

F E A T U R E

N o v e m b e r 2 4 , 2 0 1 1 S M S F P r o f e s s i o n a l M O N E Y M A N A G E M E N T5

There is little doubt that the self-managed funds sector of super-

annuation has made some significantstrides in recent years. Love it or hate it,the sector now enjoys an enviable posi-tion in terms oof funds under manage-ment, industry acknowledgement, andapparent popularity.

But while it is easy to point to super-annuants’ desire for control as the rea-son for such a trend, principal and headof superannuation audit and consultingfor WHK, Chris Malkin, believes thatposition has been brought about by acombination of factors.

“It’s certainly not confined to thedesire for control,” he said. “I’d saythere’s probably a bit of uncertainty asa result of Europe and the impact thatthat has on the marketplace inAustralia, but I also think people in thevery large funds have probably been alittle bit sceptical about their returnsover a long period of time.”

“So [it is] the fact that they hold sucha view, combined with their ownexpertise and the ability for a self-man-aged fund to diversify away from man-aged investments into property anddirect share investments,” continuedMalkin. “It means they feel that theycan do it as well, if not better, and prob-ably contain the fees a lot as well.”

“There’s no one reason here; it’s def-initely a combination of factors.”

But while Malkin is of the view thatself-managed super fund (SMSF) sec-tor growth goes beyond control, PeterHogan, principal of Plaza Financial anddirector of the Self Managed SuperFund Professionals’ Association ofAustralia (SPAA), said control wascommonly held to be the number onereason.

“When you look at all the surveys oftrustees of self-managed superannua-tion funds, control is clearly the numberone issue that they cite for setting up afund,” he said. “But that arises for anumber of different reasons, and what’shappening in the market has tradition-ally been a catalyst for people settingup their own funds.”

“It’s almost like an inverse reaction;

the worse the markets do, the moreself-managed super funds are set up.”

Beyond control, Hogan said anincrease in the number of self-man-aged super fund trustees holding ontotheir accounts into retirement had alsobeen a factor.

“There are also more people hang-ing onto their SMSF into pensionphase now than there were in thepast,” he said. “A lot of people foundthe whole prospect of running anincome stream out of their SMSFquite daunting, particularly whenthey have to start registering for taxand deducting tax and remitting it tothe tax office, and so on.”

“It was a complex procedure, butit’s less so now, with pensions forover 60s being tax exempt, and gen-erally – provided that the fund is 100per cent in pension phase – it can bea fairly straight forward exercisethese days,” Hogan continued.“Estate planning opportunities andabilities in that space may also bepart of the reason, insomuch as youcan be quite specific about who youleave your money to in the event ofyour death.

“That is clearly another advantageavailable in SMSFs, and just one morepart of their overall attraction.”

Yet while the attraction of an indi-vidual being in control of their own

retirement destiny is clearly telling,one would hope that the SMSFs canattribute their success to improve-ments in the sector’s overall runningas well.

Fortunately, Hogan believes the sec-tor’s professionalism has grown in linewith its superannuation industry mar-ket share.

“The quality in terms of the workthat’s being done for SMSF trusteeshas indeed improved,” he said. “TheATO [Australian Taxation Office],for example – while they’re still say-ing that there are professionals outthere who haven’t done as good ajob as what they should have donefor their SMSF clients, they have amuch greater confidence in thefinancial planners, the accountants,the auditors, and in the work thatthey’re doing in this space alltogether compared to ten years ago.

“There is a higher level of compe-tency in terms of the advice and theassistance being given to trustees ofself-managed super funds, certainly.”

Alternatively, Graeme Colley, super-annuation strategy manager forOnePath, said that based upon the evi-dence available, there was still room forsignificant improvement.

“I think the only objective view you

PETER HOGAN

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can get on this is what the ATO issaying,” he said. “I was on the SMSFworking party for this, and the ATOwas indicating quite clearly thatthere were professionals out therethat weren’t conducting audits ofSMSFs, and the way in which thefunds were conducted was very ad-hoc and very haphazard.

“Now if that’s indicative of a portionof the self-managed fund market, thenthe competencies of advisors certain-ly need to be improved, particularly onthe margins,” added Colley. “So yes,overall, the competency of advisors tothis sector has improved, but it still hasa way to go.

“And you’ll probably see that panout over the next few months once westart to see the legislation for auditors,accountants, financial planners and tosee whether it will actually requireanother bit of a jump to improve thecompetency of those professionalsfurther.”

However, the important point to bemade, according to Hogan, is thatthere are always going to be opportu-nities for improvement.

“That’s just the nature of the beast,”he said. “At the end of the day, this is avery complicated area, and it doesrequire people with a good under-standing of what it is that they’re doingand their role in the area.

“Even to simply start an SMSF, youinitially have lawyers involved in put-ting together the trust documents,you’ve got financial planners with theinvestments, you’ve got your account-ants with annual accounts and theaudits, and so on,” Hogan continued.“So it’s not just a single advisor struc-ture that you’re dealing with and, inthat sense, it’s pretty important thateveryone involved in running the fundis doing their part appropriately.”

But whether you believe that therunning of the SMSF sector is where it

needs to be or feel that it continues tocause concern, a certain amount ofchange has already been flagged interms of service provider requirementand competency.

As Colley has already alluded, theGovernment has made clear its inten-tion to raise service provider profes-sionalism. Top of the list are auditorregistration and independence, andthe removal of the accountants’ licens-ing exemption, but the questionremaining is how the sector is likely torespond.

For Malkin, however, the sector’sresponse is not a concern.

“I think the sector will respond verypositively but, more importantly, Ithink it has responded very positivelyto date,” he said. “As far as auditorsare concerned – which is my area ofinterest – I welcome the increasingcompetency requirements ofapproved auditors, and I welcome thepolicing of the standards requiredwithin the Australian auditing stan-dards, and of course the applicationof a lot of the competency require-ments put on by the accounting pro-fession – particularly the ICAA[Institute of Chartered Accountantsin Australia] and CPA Australia.”

“There’s enough rigour in all of

that in order to satisfy the regulator,”Malkin continued. “I also believethat the further restricting ofaccountants is not a good thing,because I think properly professionaland qualified accountants – andagain I would reference CPAAustralia and the ICAA as being thetwo major bodies – have disciplinesthat are very sound.”

Also speaking to auditor independ-ence specifically, Hogan said that therehad already been strong moves byfirms in setting themselves up solely asSMSF auditors.

“So that’s all they do, and it’s with aview to having that work referred tothem,” he said. “And with the account-ants that are referring the audit tothem, it’s being done on the basis thatthey’re independent of the advicethat’s being given.

“So in the past, accountants havebeen reluctant to refer any client tosomeone else to undertake a functiondue to a concern that that personmight actively try to take over morework from that client,” Hogan contin-ued. “But now what we find is that wehave purely audit firms that can doaudits without having any interest inany of the client’s business outside ofthat space.

“And that’s been a response to thatwhole issue around independence.”

Hogan also predicted that the pro-posed registration of auditors wouldcause a number of current providersto move out of the SMSF spacecompletely.

“They will just see that the amountof time and effort and work involvedin maintaining that registration is notgoing to make it worthwhile to do,” hesaid. “That potentially means thatthere will be fewer auditors availableto audit funds, but on the other hand,the auditors who do continue on inthat area will certainly be people with

a higher degree of capability indoing that work.

“It will be a win for the industryoverall, because what we need isexactly that – that higher degree ofcompetency.”

Changing tack to the proposedremoval of what the Super SystemReview dubbed an artificial licensingexemption for accountants, Hogansaid that the carve out that account-ants currently had, while partiallyeffective, hadn’t actually given themthe scope that they needed to give anappropriate level of advice.

“It seems to me that the positionthey found themselves in, where theycould say that someone should be in aself-managed super fund for certainreasons but couldn’t give them anyadvice about whether they shouldmove any of their existing accountsacross or about what level of contribu-tions they should make or investmentstrategy and so on,” he said, “that posi-tion made it awkward for them tooperate anyway.

“So as to the question of whetherthe requirements come down to hav-ing a full licence or whether there’ssome other interim license arrange-ment for accountants, there's beennothing formally announced in thatway so it’s still a case of ‘wait andsee’,” Hogan continued. “We’ll haveto see what the solution is that theyfinally come up with, whether it’sthat accountants who wish to giveadvice in this area will need a fullAFSL [Australian Financial ServicesLicence] or be an authorised repre-sentative of someone with a fullAFSL or whether there’ll be some in-between licensing regime – it’s justhard to say at this stage.”

“But what you may well find is thatregardless of the result, accountantswho are interested in operating inthis space will license themselves to

F E A T U R E


ANDREA SLATTERY

whatever the law requires in order togive advice in this space - those whogenuinely want to operate in this spacewill just do what's required.”

According to Andrea Slattery, chiefexecutive officer of SPAA, the simplereality for SMSF service providersgenerally is that an understanding ofthe SMSF advice piece well is vital.

“And they have to have the knowl-edge and competency to back that up,”she said. “SPAA is all about raising com-petency, accrediting people to at leastan undergraduate level of experienceand having specialists in the market thatclients or consumers in the market canseek out to get the right kind of advice.”

“Providers should endeavour to gettheir own personal recognition in their

knowledge in this area and shouldseek accreditation,” Slattery contin-ued. “They just need to become morecompetent, get recognition and pro-vide their clients with a very profes-sional service.”

Yet in the wake of the Super SystemReview and the Government’sStronger Super reforms, it seems clearthat the frameworks surroundingSMSFs are set to improve. That areaof development is in line with the sec-tor’s overall growth but what of assetallocation?

The stereotypes of highly conser-vative allocations within SMSFs per-sist, but according to Hogan, suchstereotypes are not necessarilyaccurate.

“When you look at the statistics thatthe ATO puts out with respect to self-managed super fund asset allocations,and if you compare that to the assetallocation decisions of large funds,there’s not a huge difference betweenthe two,” he said. “Perhaps there’s astronger allocation to Aussie sharesversus international shares, but other-wise, the allocation to cash is probablyno more skewed than for biggerfunds.”

“Property is also not quite as largeas you might think,” Hogan added.“Then there are investments that areproblem investments, but there alwayswill be.”

“From SPAA’s perspective, trusteesof SMSFs aren’t really that different in

their capacity as trustees as they arein their capacity as an individualinvestor.”

For Malkin, there is nothing insuperannuation legislation that dic-tates a requirement to invest in certainproducts or that certain products arebad investments.

“Yes, there are restrictions as toyour ability to invest in certainproducts, to build some rigouraround those investments andensure you’re not getting a presentday benefit,” he said, “but embed-ded into SIS [the SuperannuationIndustry (Supervision) Act] is therequirement to have an investment

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CONTINUED ON PAGE 8

strategy which considers diversifica-tion and risk, and all of the aspectsof any sound investment strategy,and I think that there’s enough rigouraround the legislation to do withinvestment strategies to allow for awide range of investments.

“Also, as far as investments forSMSFs are concerned, I think simpleis best,” Malkin continued. “So even ifI had the capacity to advise clients –though I don’t, given that I’m an audi-tor – I would never advise them to gointo derivatives that they don’t under-stand or instalment warrants that theydon’t understand or anything complexand of that nature.”

“There’s lots of ways to skin a cat,so I would personally prefer a SMSFto be well diversified with a combi-nation of cash, blue chip listed securi-ties that are paying fully franked divi-dends and, of course, property,because I think property is still a verygood investment for self-managedsuper funds – particularly business realproperty and particularly if you’ve gotan exit strategy for the time at whichyou wish to retire.”

Also stating quite clearly that SMSFallocation stereotypes were mislead-ing, Slattery said the most recent dataavailable from the AustralianPrudential Regulation Authority(APRA) showed that most SMSFs

were actually slightly less conservativethan a number of APRA-regulateddefault funds.

“So while people may believe thatthey’re generally conservative, I thinkthey have matured, and I think all thedifferent sectors are maturing,” shesaid. “You’ll also find that SMSFtrustees are able to make decisions ina sometimes more timely fashion, andthey’re able to be flexible in the way inwhich they manage their fund.

“So the combination is that SMSFtrustees will make decisions basedon their personal circumstancesrather than having to be in a situationwhere a decision has been made inbulk for you and sometimes takes alittle while to turn around, particular-ly when you’re meeting barriers ortargets that you have to set in apooled environment.”

For Hogan, the reality is that allinvestors, whether trustees of a SMSFor individuals, are in the same boat.

“They will always have to makeinvestment decisions,” he said. “Andthe unfortunate reality is that some ofthose decisions will always be betterthan others.”

So, on the back of already signifi-cant growth and reform which the sec-tor acknowledges to be positive, theunfolding SMSF story is an interestingone. And regardless of whether they

become the superannuation vehicle ofchoice into the future (as some have sorecently predicted), Malkin said he hadfew doubts that they would remain aspopular as they are now for some timeto come.

“I personally think that as long asyou’ve got enough money to start afund and you know what you’re doingwith it, they’re the superannuationvehicle of choice now,” he said. “Andthey’re certainly here to stay.”

Similarly, Hogan said there was alsolittle reason to think that recent years’growth – both in terms of number offunds and funds under management –wouldn’t continue.

“That well known average of 2,000SMSF set-ups a month, that’s been a

very long-term average when youthink about it,” he said. “It’s gone backeven to the days of the introduction ofthe super industry’s Supervision Actback in 1993-1994 when it saw adecline foπr a very short period oftime and then bounced back almostimmediately.

“So certainly, I think the attraction isstill there, and I think Cooper was rightwhen he said that the members ofSMSFs are more engaged in theirsuperannuation savings than perhapsare members in other types of funds,”Hogan continued. “But they almost, bydefinition, need to be.”

The reality is, according to Hogan,if a member isn’t terribly interestedin what they’re doing with the fund,how they’re investing the money oreven in taking an active role, then aself-managed super fund simply isn’tthe appropriate superannuationvehicle for them.

“It really is that simple,” he said.“But for those people who feelengaged, and for those who want tohave that control, a self-managedsuper fund gives them one of anynumber of avenues to get involvedwith their super.

“It’s clearly one that’s proved to bepopular so far, and so long as peopleare interested in saving for their retire-ment, I really can't see that changing.”

F E A T U R E


GRAEME COLLEY

T A X

M O N E Y M A N A G E M E N T S M S F P r o f e s s i o n a l N o v e m b e r 2 4 , 2 0 1 110 10

It is important for members andtrustees of self-managed superannu-

ation funds (SMSFs) to considerapppointing an enduring power of attor-ney when they go overseas for anextended period. If this is not doone, it ispossible that the fund may not meet thedefinition of an Australian superannua-tion fund foor the purposes of theIncome Tax Assessment Act 1997.This may mean that the SMSF couldlose the tax concessions it enjoys.

To be considered an 'Australiansuperannuation fund':

• The fund must have been estab-lished in Australia, or any asset of thefund is situated in Australia.

• The central management and con-trol of the fund is ordinarily in Australia.Australian Taxation Office (ATO)Taxation Ruling TR 2008/9 shows theCommissioner's interpretation of whatconstitutes central management andcontrol. This centres on the strategicand high-level decision-makingprocesses, which must be made inAustralia.

• Either the fund had no memberthat is an ‘active member’ or at least 50per cent of:

(i) The total market value of the fund'sassets attributable to superannuationinterests held by active members; or

(ii) The sum of the amounts thatwould be payable to or in respect ofactive members if they voluntarilyceased to be members;

(iii) Is attributable to superannuationinterests held by active members whoare Australian residents. An 'activemember' basically means a memberwho makes contributions to an SMSF.

If any of the above conditions arenot satisfied, the fund will be treatedas non-complying, with potentiallydisastrous tax consequences. If the

fund cannot meet the definition of anAustralian superannuation fund, anamount equal to the market value ofthe fund's total assets (less any contri-butions the fund has received that arenot part of the taxable income of thefund, such as non-concessional orundeducted contributions) will beincluded in the fund's assessableincome and taxed at the highest mar-ginal tax rate.

CASE STUDYRichard and Sandra are trustees andmembers of the Smith FamilySuperannuation Fund, which is anSMSF. Richard is seconded to work foran extended period in Dubai, andRichard and Sandra have no plannedreturn date to Australia.

They earn income in Dubai and areDubai residents for tax purposes.Neither Richard nor Sandra intend con-tributing to superannuation whilst theyare overseas.

However, in this instance, centralmanagement and control – the highlevel and strategic decision making – ofthe Smith Family Superannuation Fundwill most likely be conducted outsideAustralia by Richard and Sandra.

Tasks performed by accountants,administrators or investment managerswould not normally constitute high-level central management and control,but rather operational and day-to-daymanagement of the fund's activities.

The Smith Family SuperannuationFund had the following value and com-ponents at the end of the financial year:

Fund value $1,000,000Less non-concessional contributions $200,000

Total $800,000

Tax at 45% ($360,000)

Therefore the Smith FamilySuperannuation Fund will lose$360,000 in tax.

The Tax Commissioner is not able toexercise any discretionary powerswhere a fund is made non-complyingdue to it failing to meet the definition ofan 'Australian superannuation fund'. Ascan be seen from the above example,this is a disastrous outcome for Richardand Sandra's retirement savings.

One effective way to ensure centralmanagement and control remains inAustralia is for members to execute anenduring power of attorney in favour of

someone who will remain in Australiaand be able to make decisions aboutthe operation of the fund.

An enduring power of attorney issimply an instrument that enables aperson (the donor) to empower anoth-er person (the attorney) to make finan-cial and property decisions on theirbehalf.

Therefore, whilst fund members andtrustees are outside Australia, they mayestablish Enduring Powers of Attorney infavour of someone else to ensure centralmanagement and control remains inAustralia and maintain the fund as acomplying superannuation fund.

The attorney stands in the non-resi-dent trustee's place and can act as indi-vidual trustee or director of the corpo-rate trustee, undertaking the high leveland strategic decision making inAustralia.

As outlined in TR 2008/9, it isimportant the central management andcontrol is being made by the attorney,and they are not acting on instructionfrom the trustee/member whilst theyare overseas.

If this is the case, central manage-ment and control may be considered toreside with the trustee/member who isnot in Australia, and the SMSF may notsatisfy the definition of an 'Australiansuperannuation fund'.

Implementing an enduring power ofattorney is a crucial consideration forthose who have their own SMSF andare considering working or residingoverseas. Planning prior to thetrustees/members leaving overseascan mitigate against the fund becomingnon-complying and the adverse taxconsequences that come with it.

Nicholas Ali is a technical services special-ist at Super Concepts.

Plan before you holidayWhen a self-managed superannuation fund (SMSF) member or trustee travels overseas for an extended period, their SMSF couldlose the tax concessions it enjoys. NICHOLAS ALI outlines strategies to avoid this particular consequence.

I N S U R A N C E


There are many reasons to rec-ommend that insurance for a

self-managed super fund (SMSF)member is heeld in their super fund.However, very careful considerationis required with respect to the pur-posee and the premium payments ifthe insurance is to fulfil its functionproperly. This is most topical wwhennon-related parties are in the sameSMSF (such as in the case of busi-ness partners) and there iis a largedisparity in premiums between theparties. It can also be tricky if youare not in control oof the SMSFadministration.

Take, for example, two businesspartners (Bill and Ted) who formedan SMSF and leveraged the purchaseof their business premises. Theirintention was for the property to staywithin the fund and continue as thebusiness premises.

To protect the asset, they areadvised to take out insurance. Theyonly want to insure for the value of

their member benefits. Bill is 40years old and Ted is 57 and theirpremiums are $1200 and $6700respectively. Because of the costdifferential, they decide that eachmember will be responsible formeeting their own insurance cost(premiums credited to each mem-ber’ss account). See Table 1.

What happens if Ted dies?Because the insurance premiumswere paid directly, the proceeds mustalso be allocated to his memberaccount. The result is that his bal-ance now becomes $800,000 andthis has to be paid out as a deathbenefit. The amount exceeds thecash in the fund by $300,000 andthere is a good chance that a lot ofplanning will need to be unwound atgreat expense and anguish.

If instead of treating the insur-ance individually, Bill and Ted hadviewed the cost holistically as thecost of protecting their long-termplans, the result would be quite

different. See Table 2.Here the fund paid the premiums,

not the member. Assuming (don’tassume, you must check the deed)the trust deed does not require insur-ance proceeds to be allocated to themember, when Ted dies the moneycould go to a reserve. Ted’s memberbalance remains $400,000 but thefund has $500,000 in cash. Ted’sdeath benefit can be paid out and thelong-term planning remains in place.

The reason it can also be tricky ifyou are not in control of the fundadministration is because your plansmay not be reflected in theaccounts. You will need to check thefinancials of the fund each year toensure that the fund – rather thanthe members – paid the premiums.It’s a small mistake from an admin-istrator’s perspective, but it has verybig consequences.

Warrick Hanley is the chairman of onlinetraining resource SMSF Education.

From little things Advisers need to be wise when recommending insurance options within their clients’ self-managed super funds. WARRICK HANLEYexplains how small mistakes can lead to big consequences.

TABLE 1

Fund Assets $1,500,000Property $1,400,000Debt $800,000Cash at bank $100,000Net Assets $700,000

Bill’s Balance $301,200Insurance ($1,200 for $300k)Bill’s Net Balance $300,000

Ted’s Balance $406,700Insurance ($6,700 for $400k)Ted’s Net Balance $400,000

TABLE 2

Fund Assets $1,500,000Property $1,400,000Debt $800,000Cash at bank $100,000Net Assets $700,000

Bill’s Balance $300,000Ted’s Balance $400,000

Unallocated Income $7,900Insurance cost ($7,900)

With the Reserve Bank ofAustralia (RBA) cutting the

cash rate recently, and the possibilityof further rate cuts in the near term,self-managed super fund (SMSF)investors now have the opportunityto chaange gear in their investmentstrategy to make the move out ofcash. A leveraged solution may helpSMSSFs get the most out ofAustralian equities which right noware delivering attractive dividendreturnns and franking credits.

While leveraging into shares canmagnify losses if the market falls, itcan also help diversify your portfolioand generate long-term returns,even if equity markets remain flatfor the next three to five years. Withhistorically high dividend yields andfranking credits, there is currently anopportunity for SMSF investors withthe right set of circumstances togenerate returns by leveraging intosome of Australia’s largest listedcompanies.

INVESTMENT ANDRETURNS FROM CASH ARENOW SLOWINGOn 1 November, the RBA loweredthe cash rate for the first time in overtwo years from 4.75 to 4.50 per cent.This shift in RBA monetary policycomes at a time when deposits onthe Australian books of individualbanks had increased by over 16 percent in the two years to September2011, rising from $1.23 trillion toover $1.43 trillion. During that time,the average Australian householdsaving rate had also been on theincrease, with the average Australiansaving almost twice as much oftheir household income than they

were five years ago.This recent attraction to cash has

been quite appealing for investors.Many investors are shifting theirinvestments into cash to take advan-tage of its perceived safety, andreturns from term deposits that arebeing offered by some with interestrate premiums of greater than 1.50per cent over the RBA cash rate.

However, the RBA’s Novemberrate cut has potentially put an end tothat party. In addition, two-yearAustralian bond yields are pointingtoward further interest rate cuts overthe next 24 months. It is likely thatthis expectation has contributed to anoticeable slowdown in the rate ofgrowth of deposits held on theAustralian books of individual banksin September 2011, compared tothe previous two months. With sucha large amount of cash sitting on thesidelines, it is worthwhile reconsid-ering Australian equities as aninvestment class.

WHY CONSIDER A SHIFT ININVESTMENT STRATEGY?The stock price declines in many ofAustralia’s largest listed blue chipcompanies over the past 18 monthshave seen dividend yields on anumber of ASX top 10 listed com-panies increase to levels not seensince the early 1990s and immedi-ately after the global financial cri-sis. In fact, the average dividendyield on the ‘big four’ Australianbanking stocks has recently tradedat a premium of over 5 per cent rel-ative to the rate of return on two-year Australian government bonds,for only the third time in the last 20 years (see Chart 1).

For some of Australia’s largestblue chip companies, dividendyields when grossed-up for frankingcredits are trading at levels above 10per cent, providing SMSF investorswith the ability to use leverage as anopportunity to generate returnseven if stock prices remain flat overthe next five years (see Chart 1).

Incidentally, if one had purchasedshares in any of the ‘big four’ bank-ing stocks over the last 20 years on

a day in which the stock traded on adividend yield with a premium offive per cent or more over the two-year government bond rate and heldthe investment for five years, theaverage annual capital return(unleveraged, and excluding divi-dends) would have been 21.5 percent. On all 548 occasions in whichthat investment opportunity wasavailable (ie between 1991 and2006), a positive return would have

G E A R I N G


Time to shift investment The recent interest rate cut by the Reserve Bank of Australia has created a number of opportunities for self-managed superfunds. PETER VAN DER WESTHUYZEN explains.

been returned 100 per cent of thetime. Of course, it is important toremember three important invest-ment principles: past performance isnot necessarily an indicator offuture performance and should notbe relied upon as such; there are noguarantees when investing; and anyinvestment decisions must considernot only the potential for gain butalso the risk of loss.

CASE STUDYTan and her husband Philip aretrustees of their family SMSF.They, like many investors, have ahistorically high percentage oftheir total SMSF assets allocatedto cash. Anticipating further cuts to

the official cash rate, Tan andPhilip would like to take advantageof the high dividend yields current-ly available in Australian bankingstocks. After assessing their riskprofile, they are comfortable takingon the risk of leveraging into equi-ties through the use of a leveragedinvestment product. They alsounderstand that the use of leveragecan potentially magnify gains aswell as losses.

Tan and Philip use an instalmentreceipt to leverage half the amountof a $100,000 investment into ‘bigfour’ Australian banking stocks.They determine that they are pre-pared to invest on the assumption

that the underlying share portfolioachieves zero capital growth overthe next five years. Other key detailsincluded in Table 1.

THE RETURNS ANALYSISBy using an instalment receipt, theSMSF is entitled to the dividends andassociated franking credits (subject tothe SMSF’s particular circumstances)based on the entire investmentamount (ie $100,000) and not just onthe cash contributed.

In Philip and Tan’s case, theirinvestment strategy immediately gen-erates income for their SMSF. Theincome earned from the dividendsand the franking credits results in theinvestment being cash-flow positivewithin the first year. Over a five-yearterm, the SMSF has during that timegenerated more than $71,000 worthof dividend income and frankingcredits for an interest outlay of a littlemore than $20,000.

When measured net of cashflowsand tax after five years, the value ofthe investment into banking shares tothe SMSF is worth over $92,000, sig-nificantly higher than the $50,000 cashinitially contributed. This return hasbeen achieved assuming a flat equitymarket providing zero capital growth.

Conversely, assuming negative cap-ital growth each year over the five-yearperiod, the underlying prices of theshares purchased would have to fall by12 per cent per annum (or roughlyhalve in value during that time) for thefinal value of the leveraged investmentin equities to be worth roughly thesame as the initial $50,000 cash con-tributed. This provides a significantdownside buffer if Tan and Philip areconcerned about a falling share priceenvironment. However, it will exposethem to increased losses if shareprices fall by greater than that amount(see Table 2).

SO, WHICH PRODUCT DO IBUY?A number of leveraged SMSF productsoffer ‘built-in protection’ features, suchas loan protection or put option fees.While these may appeal to some, pro-tection comes at a cost. In someinstances, loan protection premiums,often paid in advance, can cost as muchas $4,600 on a $50,000 leveragedamount, requiring the underlying port-folio to generate a positive return just toearn back that ‘protection premium’.

Instalment receipts, on the otherhand, can offer SMSFs a lower-costalternative to use leverage in theirinvestment strategy. Instalmentreceipts generally have a loan-to-value-based early repayment triggerand may not protect the starting valueof the underlying investment portfolio.However, they are generally limitedrecourse obligations, meaning that theSMSF’s exposure is limited to the ini-tial amounts invested and any addi-tional amounts that the SMSF electsto pay in response to an early repay-ment trigger.

Instalment receipts may not comewith all the bells and whistles of someother leveraged SMSF products.However they can provide the SMSFwith a high degree of transparencyand liquidity, and access to the bene-fits of leveraged investing (such as div-idends and franking credits). At thesame time, they also have the poten-tial to fulfil the investment objective ofgetting from A to B without the highexpense.

When it comes to investing, beingable to arrive at your destinationshould be the primary consideration.After all, there is no point shiftinggears if it isn’t going to get you towhere you want to be.

Peter van der Westhuyzen is the headof Macquarie Specialist Investments.

G E A R I N G


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Chart 1: Spread Differential – Big four average dividend yield versus two-year Government bond rate

Source: Bloomberg, Macquarie

*Figures immaterially rounded up for ease of reference

*The franking credit and dividend assumptions arebased on public statements by the listed entities andsourced from Bloomberg consensus data as at 3November 2011. The share portfolio is assumed to havean equal weighting (in dollar terms) to NAB, WBC,ANZ and CBA purchased using share prices availableon 3 November 2011.

Table 1

SMSF cash contribution $50,000Outstanding instalment balance $50,000*Total investment $100,000*Leverage to value ratio 50%SMSF tax rate 15%Investment term 5 yearsVariable interest rate 9.95% paEstimated deductible rate 8.80% pa

Table 2: Returns comparison – final value ofinvestment, net of cashflows and tax*

Initial If share prices If share prices Contribution remain flat fall by 12% pa$50,000 $92,000 $49,854

On 14 September 2011, theAustralian Taxation Office

(ATO) released Draft Self ManagedSuperannuation Fuunds RulingSMSFR 2011/D1. The draft rulingexplains key concepts relevant tolimited recourse borrowiing arrange-ments (LRBAs) put in place on orafter 7 July 2010.

Importantly, the draft ruling clarifiesthe ATO’s previous preliminary viewon asset improvements and provides anumber of examples to illustrate theextent to which improvements oralternations can be made to an assetacquired under a LRBA without con-travening the asset replacement rulesin section 67B of the SuperannuationIndustry (Supervision) Act 1993.

The draft ruling states that an assetacquired under a LRBA can beimproved as long as the improvementis not funded by a borrowing under theLRBA, and the improvement does notresult in a new asset being created.

In the draft ruling, the ATOdefines an improvement as a changeto the asset which provides a greaterefficiency of function. This usuallyinvolves changing the asset in a waywhich increases the value or desir-able form, state or condition of theasset. In other words, an improve-ment involves the addition of newand substantial features or rights toan acquirable asset that substantiallyincrease the asset’s value or func-tional efficiency.

The ruling provides an example ofa SMSF which purchases a three-bed-room residential property under aLRBA. After the acquisition, the SMSFrenovates the property by adding abathroom. As the addition of the bath-room has increased the value of the

property and its functional efficiency,the renovation is considered to be animprovement.

On the other hand, a new asset iscreated if the character or purpose ofthe original asset has changed as aresult of the improvement or alter-ation. In the above example, the reno-vation has not changed the characteror purpose of the property originallyacquired under the LRBA and there-fore it is not considered to be a newasset.

Importantly, in a LRBA context, thedistinction between a repair and animprovement is only relevant if therepair is being financed by a borrowingunder the LRBA. This distinction is notrelevant if the repair is being financedby the SMSF directly or by some othersource. All that matters in these situa-tions is that the change to theacquirable asset does not fundamen-tally change the character or purpose

of the asset such that it becomes a dif-ferent asset.

This approach also enables theuse of insurance proceeds to rebuilda property destroyed or damaged byan insurable event such as a fire orcyclone. Because the reconstructionor repair is not being financed by aborrowing under the LRBA, it is irrel-evant whether or not the construc-tion merely repairs or improves theproperty.

However, it is important that therepair or reconstruction does notresult in a different asset to the originalasset acquired under the LRBA. Animportant consideration would bewhether the asset has been entirelyreplaced by another asset, as thiswould constitute a new asset undersection 67B of the Act.

The draft ruling uses the example ofa house which is destroyed by fire andis subsequently rebuilt using the insur-ance proceeds. As rebuilding thehouse is restoring the asset to what itwas at the time of entering into theLRBA, it does not result in a new assetfor the purposes of section 67B of theAct. Although the house has beenentirely replaced, the acquirable assetitself has not been entirely replacedbecause it has been constructed onthe same land as the previous house.

In contrast, if the acquirable assetwas a piece of artwork which wasbeing stored in a professional galleryand the gallery and the artwork wasdestroyed by fire, replacing the art-work with a similar piece of artworkwould be in breach of section 67B.The artwork in this situation has beenreplaced in its entirety, and thereplacement piece of artwork is notcovered by section 67B.

Whether or not the asset has beenimproved or replaced in a LRBA con-text requires an assessment of theextent of the improvements to deter-mine whether the improvements havefundamentally changed the characterof the asset such that it becomes a dif-ferent asset.

In some situations, it may be diffi-cult to determine whether theimprovements have resulted in a newasset being created.

For example, what if whenrebuilding a house destroyed by firean additional shed is also addedwhich will be used for commercialpurposes? In this situation, a furtherassessment would need to be under-taken to determine whether or notthe acquirable asset is now serving adifferent function and purpose tothat previously served by the assetoriginally acquired under the LRBA.

The draft ruling suggests there is asignificant amount of scope toimprove or alter an asset withoutthat asset being considered a newasset for the purposes of section67B. The draft ruling uses the exam-ple of a property which is damagedby a cyclone and states that the addi-tion of a second storey to the houseat the time the house is repairedwould constitute an improvementbut not a new asset for the purposeof section 67B.

Similarly, the addition of a new poolor a new garage to that asset would bean improvement but not a new assetfor the purposes of section 67B.

Peter Burgess is the national technicaldirector of the Self Managed SuperFund Professionals’ Association ofAustralia.

B O R R O W I N G


Borrowing improvements and repairsThe Australian Taxation Office's (ATO's) recent draft ruling on limited recourse borrowing arrangements has clarified itsapproach, according to PETER BURGESS.

B O R R O W I N G


On 14 September 2011, theAustralian Taxation Office

released its Draft Tax Ruling SMSFR2011/D1 to proovide some clarity onhow the limited recourse borrowingarrangement (LRBA) provisions in sec-tion 667A of the SuperannuationIndustry Supervision (SIS) Act shouldoperate.

Since section 67A received RoyalAssent in July 2010, there has beensome confusion regarding the applica-tion of certain elements and a need forsome provisions to be relaxed to makeLRBAs more workable.

KEY IMPLICATIONSThe more significant announcementsare:

• Super fund trustees can now useother funds (but not borrowings) toimprove the asset, provided it is not seenas a different asset. When making thisassessment, trustees will need to consid-er if there has been a substantial increasein the features or rights and hencewhether the structure has been alteredinto a more valuable or desirable formthan a repair would do.

• An asset that straddles morethan one land title that cannot bedealt with separately will now beseen as a 'single' asset and can beacquired using an LRBA. Where anasset is divided or can be dealt withseparately, it will generally fail thesingle acquirable asset definition.

• If an asset is destroyed, insuranceproceeds may now be used in certaincircumstances to replace the assetwithout contravening the LRBA rules.

Once finalised, these and otherchanges will provide more certaintyand flexibility for self-managedsuperannuation fund (SMSF)trustees. They are also likely to make

borrowing to buy a property in supermore attractive than was previouslythe case. However, the new rulesdon't necessarily mean that using anLRBA to acquire property in superwill suit all SMSF clients.

ADVICE ISSUESWhen advising SMSF clients, someof the key issues to consider include:

1. Are alternative sources of financeavailable?For example, could the trustees bor-row in their own names or via anentity such as a company? If noother finance options are available,then borrowing in super may be theonly solution.

2. Does the SMSF have the capacity tofund the borrowing arrangement? Not only will the fund need to meetloan interest payments, there will beinsurance premiums and other relat-ed expenses. Cashflow problemscould arise if the rental incomedoesn't cover the expenses and:

• There are limited liquid assets(such as cash) in the fund that couldbe drawn on, and/or

• The members have limitedcapacity to make additional contri-butions (which are subject to caps).

Cashflow problems could be fur-ther magnified if the property is nottenanted for a significant period,and/or the fund is in pension phase,where pension payments will need tobe met.

3. Will the asset be positively or nega-tively geared?It's important to assess the startingtax position, and whether this is like-ly to change for a significant part ofthe anticipated holding period.

4. What marginal (or other) tax ratewould be payable if the property waspurchased outside super?As a general rule, borrowing in supercan be more tax-effective if theinvestment is positively geared andthe alternative tax rate payable onsurplus investment income is greaterthan the maximum rate of 15 percent that is payable in super.

Conversely, negatively gearedinvestments can be more tax effec-tive if held outside super when thealternative tax rate is more than thesuper tax rate. In this scenario, theindividual (or company) will receivemore value for the excess tax deduc-tions than a super fund would.

But even if an investment is nega-tively geared at the outset, borrowingin super may still be a better option.This is because negatively gearedinvestments can become positivelygeared over time. Also, regardless ofthe gearing position, less capitalgains tax will generally be paid onthe sale of the investment if it's heldin a super fund.

5. Is buying property in super suitable for(and reflected in) the fund's investmentstrategy?Under the general SIS covenants thatapply to SMSFs, trustees must for-mulate and give effect to an invest-ment strategy that has regard to thewhole circumstances of the fund.This means the assets acquired mustsuit the entire operations of the fundand the investment strategy shouldconsider matters such as:

• Diversification and the impact alarge single asset could have on thefund's performance;

• The potential risks and returnsfrom the property and other poten-tial investments, and

• The capacity to meet currentand future fund expenses, such asoperating costs, tax liabilities, pen-sion and death benefit payments.

When assessing whether SMSFclients should use an LRBA toacquire property in their super fund,it's important to consider a range ofissues such as taxation, diversifica-tion and liquidity. If buying a prop-erty is what they really want, insome cases financing the acquisi-tion outside super can be a bettersolution.

Mike Mitchell is a senior technical consult-ant at MLC Technical Services.

Play by the new gearing rulesMIKE MITCHELL outlines the strategy implications a recent ATO Draft Ruling could have for SMSF trustees when deciding whether toborrow to buy property in or outside super.

The last month has seen theAustralian Stock Exchange (ASX)

recover strongly after a disastrousstart to the new financial year. Whilewe are well short of the ASX highs ofmid-2007, we may start to see soomestability with recent positive newsfrom Europe and other parts of theworld.

From a strategic point of view, it isimportant to start thinking about somekey strategies that will bolster yourclients' superannuation savings in amarket recovery:

1. BOOST THE 10 PER CENTPENSION LIMIT WITH ATRANSITION TO RETIRE-MENT 'REBOOT' This transition-to-retirement strategy,effectively implemented, can add tensof thousands of dollars to a member'sretirement savings. For some clientswho regularly take a 10 per cent max-imum pension, recovering marketscan provide the ability to roll back theexisting income stream and reset thepension with a higher balance.Conversely, if clients are looking totake the smallest pension possible,especially in light of the 25 per centreduced minimum for the 2011/12financial year, now may be an oppor-tune time to roll back their pension to

reduce the amount required to betaken for the financial year.

2. LOCKING IN TAX-FREEPROPORTIONS The use of recontribution strategies isstill one of the most effective tools tobuild greater tax efficiency in incomestreams under age 60 and for estateplanning purposes. The creation ofmultiple pensions with additional con-tributions or recontributions allows amember to potentially benefit from ahigher tax-free proportion when draw-ing an income stream from the fund.Subject to the level of pension takeneach financial year, you can continueto grow the higher tax-free super bal-ance when markets rebound.

In poor markets, there are some sig-nificant tax savings that can beobtained by rolling back pension toaccumulation phase to 'absorb' thenegative returns against the member'staxable component, rather than pro-portionately against their tax-free andtaxable components. At an appropri-ate time in response to recoveringmarkets, the ability to recommencethe pension allows for the member tolock a higher tax-free component, sav-ing tax on pensions taken prior to 60and providing long-term benefits fornon-dependent beneficiaries.

3. HAVE YOU CONSIDEREDSEGREGATION?To further benefit the use of multiplepensions, trustees have the ability tosegregate specific assets to differentmembers, pools of members or differ-ent superannuation interests. Forexample, by applying the fund'sgrowth assets to a member's superinterest with a 100 per cent tax-freeproportion, it can potentially:

• Accelerate the growth of theaccount balance;

• Provide a greater pension amountthat can be withdrawn under a transi-tion-to-retirement income stream; and

• Decrease the fund's potentialfuture exposure to death benefits taxfor non-dependants.

Segregation may also be usefulwhere the fund is not 100 per cent inpension phase (ie one member inaccumulation, one in pension). Itcould be used to assist in the realisa-tion of a particular asset which hasrisen significantly off a low cost base.By applying segregation, the particu-lar asset(s) with a significant capitalgain is fully exempt from tax, ratherthan partially exempt by having anunsegregated fund. It is importantthat any segregation strategy isappropriately documented by thetrustees to show specific assets being

applied to a particular member, inter-est or pool of members.

4. TIME TO BUILDRESERVES?Reserves within a self-managed superfund can play an important current-day and longer-term estate planningrole. For the majority of self-managedsuperannuation funds (SMSFs), youtypically see any positive returnsapplied towards each member's bal-ance. However, it is important to con-sider whether, to capture some ofthese positive earnings into fundreserves, to look at implementing arange of strategies including futureanti-detriment payments, self-insuringmembers, enabling future crediting of100 per cent tax-free pensions, etc.

Fund reserves can play an integralrole in any SMSF and are typically gen-erated by earnings over time. Planningto capitalise on recovering marketsallows for SMSFs to implement many ofthese reserving strategies effectively.

These are just some strategies thatyou can start to plan with your clientsto help bolster your clients’ superannu-ation savings in recovering markets.

Aaron Dunn is the managing director ofThe SMSF Academy and author of the-dunnthing blog.

S T R A T E G Y


Savvy can ridemarket recoveryAARON DUNN lists some of the strategies that self-managed super fund members should start to think about to help bolster theirsuperannuation savings in recovering markets.

C O M P L I A N C E


There are many good reasons toset up a self-managed super fund

(SMSF), with greater control overinvesstments and lower costs toppingthe lists of most investor researchreports.

However, shouldering the compli-ance burden of a superannuationtrustee or responding to an auditrequest from the tax office perhapsdoes not have quite the same popu-lar appeal.

But they are just as real, and SMSFtrustees should be aware that the taxoffice – in its role as SMSF regulator– is stepping up its efforts over thenext 12 months to ensure that morefunds comply with superannuationand tax law.

The Australian Taxation Office’s(ATO’s) compliance program for thenext financial year (released thisweek) indicates a clear willingness tostrip wayward funds of their comply-ing status for breaches rangingupwards from repeatedly failing tolodge annual returns.

It’s interesting that the compliance

program notes that 70 SMSFs weredeclared non-complying in 2010-11.At first glance, 70 funds may not seemmany, considering that over 445,000funds are in existence.

However, a non-complying fundcan lose almost half its assets inpenalty tax. If a fund is made non-complying, the market value of itsassets – less any non-concessionalor undeducted contributions – istaxed at the highest marginal rate.In wealth creation terms, that is thenuclear strike option, and to be fair,one the ATO does not exerciselightly.

In other words, the penalty forbeing declared non-complying is typ-ically devastating for all members ofan SMSF, including those who do nottake an active role in their fund’saffairs.

So being declared a non-complyingfund is the one thing you really wantto avoid as an SMSF trustee.

The latest compliance programwarns that the ATO’s SMSF focus in2011-12 includes:

• New funds to check whether theirtrustees are participating in illegalschemes to gain early access to supersavings.

• Related-party transactions – inpart, to ensure compliance with the 5 per cent limit on in-house assets.

• Unrectified contraventions ofsuperannuation law which had beenbrought to the attention of fundtrustees by a fund’s approved auditor.

• The performance of approvedauditors of SMSFs – the regulatorthreatens to disqualify auditors that“pose an ongoing risk”.

The tax office is right to focus ontrustees participating in scams to getearly access to super – that is a bla-tant abuse of the system. Last year,the ATO audited more than 920 indi-viduals and 31 scheme promoters,and as a result raised almost $14 million.

However, the other area of focus forthe ATO in regards to superannuationin the year ahead is likely to have amuch broader impact on ordinaryemployees. The tax office also has a

role to play in protecting super fundmember rights by checking that com-panies are paying the correctamounts as super contributions.

A number of businesses will strug-gle with cashflow or other financialpressures at various times, which cansometimes result in withholding supercontributions. Employees will typical-ly notice if salary doesn’t turn up intheir bank account, but it may take alot longer for someone to notice thatmoney has not been paid into a superfund – the long-term nature of superand the fact it is locked away does notencourage close monitoring.

Yet in the past five years, the ATOsays its compliance activities haveresulted in about $1.3 billion in extrasuper contributions being collectedon behalf of employees.

That is a significant amount ofmoney, but it also points to the needto be vigilant with super contributions.

Robin Bowerman is the head of corpo-rate affairs and market development atVanguard Investments.

Greater control,greater scrutiny

Having control over investments is the number one reason for switching to self-managed super funds. However, with greatercontrol comes greater scrutiny, according to ROBIN BOWERMAN.

With the recent release of theAustralian Taxation Office’s

(ATO) controversial draft rulingregarding auto-reversionary pen-sions (TR 2011/D3), the aware-ness of effective succession plan-ning has beenn highlighted.Advisers should take this as anopportunity to review their currentsuccession planninng practices.This article aims to give some gen-eral guidance to advisers as towhat aspects of succession plan-ning may impact their clients, aswell as outlining some of the prac-tical tools and doccuments that mayassist advisers.

COMPREHENSIVE SUCCESSION PLANNINGFOR CLIENTSAdvisers are frequently asked toassist with self-managed superfunds (SMSF) succession planningassignments for their clients. Moreoften than not, they will beapproached by advisers with thequery, “I’d like to update Mr X’spensions to make them reversion-ary”, or “Mrs Y needs a BindingDeath Benefit Nomination (BDBN)drafted”. However, in order toappropriately plan for Mr X andMrs Y’s SMSF succession upontheir death or loss of capacity,there are a number of things thatmust be considered.

THINGS TO BE CONSIDEREDAs a first port of call, the SMSF’sdeed will need to allow for othersupporting documentation to be

put into place. The SMSF mem-bers should then consider having asole-purpose corporate trusteeappointed, with mechanisms in thecompany constitution that allowfor the smooth succession ofdirectors.

Thereafter, things such as wills,enduring powers of attorney, pen-sion documentation and BDBNsshould all be reviewed and consid-ered. They should first be checkedto ensure that they are consistentwith one another and are in accor-dance with their clients’ goals. Forexample, a BDBN may state that amember’s superannuation benefitsare to be paid to their legal per-sonal representative. However, thatmember’s will may not take theirsuperannuation benefits intoaccount.

When an adviser’s client asksthem to start a pension or BDBN,the adviser should be thinkingabout a range of other aspects.The reversionary nomination isnow an important decision andhas an impact on clients’ estateplanning — it affects every pen-sion. Advisers such as account-ants, financial planners andlawyers should hopefully be ableto formulate strategies that can beapplied across all of their clients.Such a strategy should not neces-sarily restrict clients’ successionplanning choices, but ratherensure that:

• The adviser is demonstratingto the client that they have theclient’s best interests at heart bythinking outside the square; and

• The client will have a ‘rocksolid’ SMSF succession planningposition at the completion of theengagement.

CHECKLISTA checklist (see Table page 19) hasbeen included as a general guide toassist advisers with a range ofSMSF succession queries that theirclients may have.

The first question in the check-list is arguably the most impor-tant. Once a client has decidedwhere they wish their death bene-fits to be paid, then considerationcan be given to the other ques-tions in the table.

RECENT SUCCESSIONPLANNING ISSUESSome of the recent issues to dowith pensions highlight the impor-tance of having the right docu-mentation in place.

In recent months, advisers havebeen divided as to whether aBDBN takes precedence over an‘auto-reversionary’ pension, orvice versa.

The BDBN/auto-reversionary pen-sion controversy arises where, forexample, a BDBN stipulates that themember’s benefits are to be paid tothe member’s children from a previ-ous marriage, but the pension docu-mentation requests the trustee to pay

S U C C E S S I O NP L A N N I N G


Succession planning grabs The ageing population and the ATO’s recent draft pensionsruling highlights the need to review clients’ overall successionplanning, according to DANIEL BUTLER and NATHAN PAPSON.

the member’s benefits to the mem-ber’s second spouse. With blendedfamilies becoming more common inmodern society, this inconsistency isalso more common.

The correct position is as follows:• A BDBN will usually validly

bind a trustee (ie, it is a fettering orlimiting of a trustee’s discretionthat is usually authorised by thegoverning rules of the SMSF); and

• An auto-reversionary pension,under most SMSF deeds, is merely arequest by the member of the SMSFtrustee or a trustee resolution.

Therefore, if there was a conflict,the BDBN would ordinarily win.

However, the conflict can easily be

avoided. BDBNs and auto-reversion-ary pensions should be consistent, aswell as align with the SMSF mem-ber’s other estate planning documen-tation (eg, wills, enduring power ofattorney, etc.).

TR 2011/D3The ATO TR 2011/D3 outlines itsview of when a superannuationincome stream (eg, a pension) willcease upon a member’s death.

The ATO’s view is that a pensionwill generally instantly cease uponthe SMSF member’s death. However,the pension will continue if a‘dependent beneficiary’ is automati-cally entitled to receive the pension.

There are a number of adverse taxrisks that may arise as a result of apension ceasing — if only for a day— upon a member’s death. Theseconsequences include a ‘blending’ oftax-free and taxable componentswithin the SMSF, as well as losing the‘exempt’ status of income derivedfrom assets supporting the pension.

As such, TR 2011/D3 highlightsthe need for appropriate successiondocumentation to be in place foreach pension.

CONCLUSIONAdvisers should urgently review allclients with pensions following therelease of TR 2011/D3 to see if theyare exposed by not having an autoreversionary pension.

Typically, a conversion to an auto-reversionary pension will not addressall of that client’s succession plan-ning needs. By utilising the materialoutlined above, advisers should beable to design comprehensivereviews that will benefit all theirclients’ interests.

Daniel Butler is director and NathanPapson a lawyer at DBA Lawyers.

S U C C E S S I O NP L A N N I N G


the spotlight

SMSF Succession Planning Checklist

Question/ItemHas the SMSF member considered how they wish their superannuation benefits to be paid upon their deathor loss of capacity? Have the tax consequences of this also been considered?Does the SMSF have a corporate trustee? (there are a number of succession planning advantages withhaving a corporate trustee)How is the shareholding of the SMSF’s corporate trustee structured and who will take control of the sharesof the corporate trustee on a member’s death or loss of capacity? (this aspect can affect an SMSFmember’s succession planning)Does the SMSF member have any enduring powers of attorney (‘EPoA’) in place to deal with their loss ofcapacity? An EPoA allows a person to represent a member on loss of capacity in an SMSF.Does the SMSF member have a pension? If so, do they have a reversionary pension or BDBN in place thatprovides for an automatic reversion? Are these consistent with the SMSF deed and with each other?Does the SMSF member have a current will? Does it adequately take into account how they wish theirsuperannuation benefits to be paid (if applicable)? A will can also be a useful fallback if a BDBN fails.Does the SMSF member require a ‘hard wired deed’ or death benefit rule in order to achieve their desiredoutcome? These seek to enshrine the client’s estate planning directions in an SMSF deed.Depending on the clients’ requirements, do I have access to other professionals that can draft the abovedocumentation?

Documents

SMSF Professional (November 24, 2011)