November 23, 2010

The 10 Commandments of SMSF Administration

By Kris Kitto

The 10 Commandments of Good SMSF Administration

There are currently about 430,000 SMSFs in Australia and unfortunately only a very small proportion are actually operated and managed as efficiently as they should be.

This article looks at the top ten ‘commandments’ SMSF trustees and SMSF administrators should abide by to ensure their SMSFs not only comply with the plethora of regulations, but also provide the best possible outcomes for SMSF members throughout their lives.

1. Thou shalt always use a corporate trustee

There are five key reasons while all SMSFs should have a company acting as trustee:

1.       Administrative efficiency

2.       Ability to have a single member SMSF

3.       Enables payment of pensions rather than just lump sums

4.       Access to the 15% pension rebate

5.       Liability protection

I have covered these reasons in detail in the following articles:

–          5 reasons why you need a company as trustee of your SMSF

–          Follow up post: Company as trustee of your SMSF

2. Thou shalt have an up to date trust deed

A good quality updated trust deed is essential to the smooth running of any SMSF.

The following is a quote directly from the ATO in regard having an up to date trust deed:

Your SMSF trust deed is probably the most important document in your arsenal when you are trying to build wealth, save tax and protect your assets.

Many SMSF trustees and their advisers (especially your trusty local accountant) are guilty about approaching what you can and can’t do with your SMSF the wrong way.  It is simply not a case of checking whether it is OK under the relevant superannuation and taxation laws.  You need to ensure that your trust deed allows it – if it is not contained in the rules of the fund then you can’t do it.

Even more importantly, if you do something that is contrary to a rule contained in your SMSF trust deed, then you have also breached the superannuation laws.

3. Thou shalt understand their obligations as trustees

The Australian Taxation Office (ATO) has made a great attempt over the course of the last few years to help educate trustees on what their roles and responsibilities are in the management of a SMSF through the ATO publication “Roles and Responsibilities of Trustees”, and have also attempted to explain their position as regulator and the responsibilities of associated parties such as auditors, tax agents, actuaries, and administrators in the ATO publication “It’s your money…but not yet!”

4. Thou shalt have an investment strategy

Aside from the fact that it is a legislative requirement to have a documented and well considered investment strategy, if the trustees cannot produce the investment strategy document, the auditor of the SMSF has to report the SMSF to the ATO

Any sound business prepares budgets, cash flows projections and sales targets etc… As with investments, this is about planning to achieve a return on investments that satisfies the fund risk profile, liquidity, and determining if the investment yields the trustees seek matches to the investments held by the fund.

In other words how will SMSF trustees be able to assess their performance at year end, if they did not know what they were planning to achieve to begin with?

5. Thou shalt seek out quality advice

SMSFs are all about control.  However, just because SMSF trustees seek control over their retirement investments, doesn’t mean they cannot utilise professional advice.

An accountant is typically the main person SMSF trustees will seek advice from – however most accountants have a broad range of knowledge and have to keep up to date with a variety of taxation laws, so in many instances they might not have specialist SMSF knowledge which trustees will need to get the most out of their SMSF.

Similarly, an experienced financial planner can assist SMSF trustees achieve their investment related goals.  In my experience working with a large number of SMSFs, I would say that in general those SMSFs that utilise financial planners achieve higher and more consistent investment returns compared to those who do everything themselves.

SMSF trustees need to realise that control of investment and utilising specialist professional investment advice are not mutually exclusive activities.

So how do SMSF trustees find a knowledgeable accountant or financial planner who has expert knowledge in SMSFs?  I would suggest searching on the SMSF Professional Association of Australia (SPAA) website here.

6. Thou shalt put in place an estate plan for the SMSF

Estate planning is probably the most overlooked piece of the SMSF puzzle.  What most SMSF trustees (and some advisers) probably don’t realise is that assets contained in a SMSF are not covered by the members Will in the event of their death.

Some powerful estate planning strategies that can be used are:

  • Utilising a company as trustee of the SMSF to reduce administrative hassles in relation to the ownership of the assets (covered in commandment #7)
  • If a pension is commenced, ensure that it is revisionary to the members spouse
  • Put in place non-lapsing binding death benefit nomination which directs where the members balance will go in the event of their death
  • Add customised rules into the SMSF to effectively ‘hard-wire’ an estate plan into the trust deed of the SMSF
  • Re-contribution and pension ‘stop-start’ strategies that reduce or eliminate the tax payable when benefits are paid to non-dependent beneficiary such as an adult child (i.e. reduce the ‘death tax’ payable)
  • Ensure that the estate plan for the SMSF works together with the members Will to ensure consistency, flexibility and reduce the chances of the members Will being challenged
  • Utilise reserves to either create massive tax deductions within the SMSF that can be utilised by future generations or simply to keep certain assets within the SMSF without the need for them to be transferred and incur stamp duty and legal costs

Estate planning with SMSFs is a complex area where SMSF trustees and administrators definitely need to seek competent specialist advice to ensure they are protected and their family is looked after.

7. Thou shalt ensure all member components are tracked accurately

Tracking the member components within a SMSF is probably just as important, if not more important as tracking the financial and taxation reporting.

So what are the member components?  Member components are made up of the preservation benefits which determine what amount (%) of a members account can be accessed / withdrawn from the SMSF, while the taxable and tax free components how they benefits are taxed when they are withdrawn from the SMSF.

Correctly accounting for these components is essential – especially when it comes to the following:

  • Commencement of a pension (especially transition to retirement pensions)
  • Payment of lump sums
  • Payment of death benefits

The components basically determine when the benefits within the SMSF can be accessed, and how much tax (if any) will be payable by the SMSF member or their beneficiary.

8. Thou shalt ensure assets are in the name of the trustee

Investments and assets not being legally held in the name of the trustee(s) of the SMSF is one of the most common breaches reported to the ATO by SMSF auditors.

Aside from the fact that this is a reportable breach under the legislative provisions, when assets are not held in the name of trustees they are put at risk in the event of bankruptcy, divorce or any number of other circumstances.

The trustee then has the major issue of having to fight through the courts to have them separated away from their personal assets and back into the name of the SMSF. This is an expensive exercise, when a bit of care could avoid the issue altogether.

This is yet another reason why a special purpose SMSF trustee company should be used as trustee of all SMSFs as it completely avoids the above issues.

9. Thou shalt utilise technology

When it comes to the administration of SMSFs, both trustees and advisers need to maximise the use of technology to ensure that the SMSF is operated in the most cost effective method possible.  The days of bringing a file (or shoebox!) to the accountant at the end of each financial year are on the way out.

Leveraging technology which allows SMSF transactions to be uploaded directly into a web-based accounting package provides the following advantages:

  • Both SMSF trustees and their advisers can see up to date information at any time – they don’t have to rely upon SMSF accounts that can be months out of date
  • Accountants and advisers can spend less time doing the compliance work and more time providing valuable strategic advice – and they can do so with up to date information!
  • Compliance issues can be monitored easily – for example ensuring that contribution caps are not exceeded and minimum pension drawings are made
  • Reduction in costs

10. Thou shalt deal with related parties at arm’s length

Last but not least is the key commandment that requires SMSF trustees to deal with any related parties at ‘arm’s length’ – which basically means to ensure any transactions that involve related parties are conducted in a transparent way at market value.

Examples of transactions that deal with related parties include:

  • Transfer of listed shares or business real property from a member into the SMSF – must be transferred at market value
  • Lease of a commercial property owned by the SMSF to a business operated by the member – lease amount and conditions much be that same for the related party as for an unrelated party
  • Member-financed limited recourse borrowing made to a SMSF – a market interest rate needs to be charged

All transactions with related parties are always high on the list of the ATO when they conduct audits – so SMSF trustees and their advisers need to ensure that everything is conducted on an arm’s length basis and appropriately documented.