SMSF strategies in a post-super reform world
The 2017 super reforms have significantly transformed the SMSF space especially for high-net worth clients. Now the dust has settled, it’s time to determine what new strategies need to be implemented to ensure the best outcome for SMSF clients.
Research conducted by Class Ltd (June 2017 SMSF Benchmark Report) showed that 39% of SMSF pension members withdrew at least $5,000 over their required minimum annual pension. Prior to the 2018 financial year, the typical approach by advisers and accountants alike was to treat these amounts over the minimum as additional pension payments. There was no incentive to do otherwise. The game has now changed.
All SMSF clients drawing a pension should have in place a formal drawdown strategy customised to their situation. There are a number of different factors that need to be considered strategically.
For members drawing a pension with a total super balance above $1.6m who have moved monies back into accumulation at 30 June 2017 to stay under the transfer balance cap, the strategy is relatively simple: any additional payments to the member above their required minimum pension should be treated as lump sum withdrawals from their accumulation balance. The outcome of this strategy is that over time, the proportion of assets exempt from tax will increase and the SMSF may even return to its pre-2018 days of being 100% exempt from tax.
For members who are under the $1.6m transfer balance cap, thought still needs to be given to a drawdown strategy. Withdrawals above their mandated minimum % can be treated as a partial commutation of that pension. These partial commutations are credited against their transfer balance cap and enable future amounts to be debited in the future – i.e. the amount they have in retirement phase can be increased or added to (via a separate pension or ‘re-boot’ of an existing pension).
A key consideration is whether the member will have additional monies coming into their SMSF in the future. A single person SMSF where the member is retired and drawing a pension is unlikely to have additional money flowing into their account, but what about couples where there is a reversionary pension? Or members that are still eligible to make non-concessional or downsizer contributions?
Treating the additional payments as partial commutations will future-proof the SMSF and it’s not just for members above or close to their $1.6m cap. Estate planning considerations are also key. Take the example of a fund with husband and wife members with $1m each drawing pensions. On the passing of one member, depending on their estate planning, the surviving member may receive their member benefits.
Retrospectivity is not an option. Decisions must be made prior to (or at the time of) any withdrawals to determine whether the payment is a pension payment or is a lump sum. In addition TBAR reporting puts a hard end date on the categorisation of payments.
Invest Outside an SMSF
The introduction of the $1.6m transfer balance cap now requires a review of how clients hold their assets – especially for those higher net worth clients who have above $1.6m in their SMSF. The default approach for many advisers post 1 July 2017 has been to leave amounts above the $1.6m cap in the SMSF in an accumulation account.
Other options to hold these excess amounts could include simply withdrawing it and holding the monies in joint or individual names or in a discretionary family trust. In addition to tax efficiency, structuring of assets should also take into consideration asset protection and estate planning factors as well as cash flow requirements of the SMSF members.
The introduction of the cap might make some trustees consider bringing estate planning forward and gift excess assets to children while still alive. There are various mechanisms of doing this, some of which can protect the assets from potential family law settlements, so it’s essential appropriate legal advice is obtained before assets are moved out of an SMSF to alternate structures.
Six Member SMSFs
The 2018 Budget contains a proposal to increase the member limit from four to six members. If the proposal becomes legislated, it may become available as a strategy after 1 July 2019.
The overwhelming majority of SMSFs have either 1 or 2 members. Only a small percentage could be considered ‘family’ SMSFs with more than 2 members – which perhaps indicates a lack of desire to intermingle different generations within the same SMSF structure, however it should be considered as a legitimate strategy for the right family or group.
One key benefit for advisers is around intergenerational wealth transfer. I am not talking about strategies that keep specific assets (i.e. business property) within an SMSF, rather a mechanism to help advisers engage with the Gen X and Gen Y children of their existing client base.
By bringing adult children into an SMSF it creates an opportunity for an adviser – either directly or via a younger adviser of the same generation within their business – to build a relationship with the younger members and retain them as clients long term.
There are obviously benefits to the young members themselves. They should have a reduction in superannuation account fees and cost-effective access to an adviser by piggy-backing off the parents SMSF and relationship. They can also still have the freedom to work and travel overseas without needing to move their super monies back into the APRA fund environment like they potentially would if they had their own SMSF (assuming EPoAs are correctly utilised).
There are some very important pre-requisites that need to be in place before expanding the SMSFs membership base beyond mum and dad. Control and governance are critical issues that need to be addressed. As a minimum a corporate trustee needs to be utilised rather than individual trustees, the SMSF trust deed must be high quality and ensure control ultimately resides with the members with the most benefits, and the investments should be structured in such a way that any single member can’t access or withdraw funds without the other members being aware.
Another key aspect would be to utilise segregation of assets for investment (not taxation) purposes. Different groups of members within an SMSF should have their own separate investments and accounts and have the option of running separate investment strategies – either self-directed or with the assistance of an adviser.
This means the different members (or groups of members) would each have their own bank account to receive contributions and income or to pay pensions and expenses, and their own investment accounts and make their own investment decisions. Correct administration is essential to ensure the investments are kept separate and that tax is correctly allocated to the specific members.
If Labor’s proposal to remove the refund of franking credits from most SMSFs become reality, having tax paying accumulation members within an SMSF that was previously 100% tax exempt enables the franking credit benefits to be utilised rather than lost – provided the SMSF administration is correctly handled.
Segregation is still a thing
One of the integrity measures introduced with the introduction of the $1.6m cap is the removal of segregation as a method to calculate ECPI for any SMSFs where any member of that SMSF has a total super balance of above $1.6m and the same member also has a retirement phase income stream (pension).
So although for many higher value SMSFs utilising segregation to calculate ECPI is no longer available, segregating for investment strategies purposes is still very much a viable and underutilised strategy.
Segregating for investment purposes enables an SMSF to execute multiple investment strategies within the same fund. For example where there are members with different demographics (as mentioned above with 6 member SMSFs) or for high account balance members that have both pension phase and accumulation interests.
An extension of the investment segregation strategy is going as far as using multiple SMSFs for the same members. Although the ATO has rightly cautioned members against this strategy to gain a tax advantage, as regulator they’ve clarified that it’s not the existence of a second SMSF that is in itself a concern, it’s what occurs after the second SMSF is established which may draw their attention.
There may be legitimate circumstances that make multiple SMSFs a viable option including specific estate planning needs with blended families of separating higher risk assets from more vanilla conservative assets held to produce steady income and support pension payments.
Removal of the 10% Rule
Prior to 1 July 2017, for an individual to make personal concessional contributions to super, they needed to meet the 10% rule – i.e. they needed to effectively be self-employed with less than 10% of their income coming from employment.
This restriction no longer applies which brings into play an additional tax saving strategy for savvy advisers and their clients. Rather than having to plan contributions well in advance via a salary sacrifice arrangement, an individual can make additional contributions from after tax monies up to their annual $25,000 cap and claim a tax deduction.
This strategy is extremely useful for clients who have had increased income from a business, bonus or a realised capital gains during the financial year.
For example an individual earning $150,000 per annum would have SGC contributions of $14,250 and an ability to make an additional $10,750 in contributions and claim a deduction. This would save them tax overall of 24 cents in the dollar (39% tax and Medicare less 15% contributions tax) or more if additional income or capital gains pushed their total taxable income over $180,000.
The amount claimed as a deduction could also potentially be increased above the annual $25,000 concessional contribution cap if an SMSF was utilised with a contributions reserving strategy to push some of the contributions made in year one to be allocated against the member year two cap. Ideal for clients who have a one-off spike in taxable income – for example from a realised gain on a property or other asset.
Catch-Up Concessional Contributions
Starting from the current 2019 financial year (from 1 July 2018) an individual with a total superannuation balance of under $500,000 can ‘catch up’ unused amounts of their concessional contribution cap over a rolling five year period.
For example if someone made $15,000 in contributions in the 2019 and 2020 financial years, their available concessional contribution cap would be $45,000 in the 2021 financial year ($25,000 plus $10,000 x 2).
The key criteria is the individuals total superannuation balance which needs to be under $500,000.
The catch-up of unused concessional contributions has been designed for individuals who may have uneven income or broken work patterns to make additional contributions to better enable a self-funded retirement.
When combined with the removal of the 10% rule, catch up contributions will be a powerful tool for advisers to assist their clients to quickly build their super balance while reducing additional tax from the realisation of capital gains for example from the sale of an investment property.
Super Splitting Reborn
Super Splitting enables 85% of concessional contributions made by one individual to be transferred to their spouse in the financial year after the contributions were made.
Super splitting is one of the primary mechanisms for evening the balances between members in an SMSF (typically husband and wife style SMSFs) with the other being a re-contribution strategy utilising the receiving members non-concessional contribution cap ($100,000 per annum of $300,000 when the bring-forward is used).
Many advisers employed a super splitting strategy in the years prior to 2017 when it became apparent that the Government’s intention was to better target superannuation tax concessions and that is was most likely any changes would occur on an individual level.
There are two primary scenarios where super splitting will be useful. Firstly, where a member wants to keep their total superannuation balance under $500,000 to use the unused concessional contribution cap strategy as detailed above, or secondly to keep their balance under $1.6m to avoid exceeding the transfer balance cap when they commence drawing a pension when eligible.
Attempting to keep balances between a couple even can be difficult as investment returns allocated proportionately will always skew towards members with higher initial balances and higher ongoing contributions. A contributions splitting strategy can help move an SMSF towards the ideal retirement scenario where both members have $1.6m each and therefore maximising tax free income through retirement.
From 1 July 2018, an individual 65 years or older may be able to choose to make a downsizer contribution into their SMSF of up to $300,000 (per person) from the proceeds of selling their home.
Key criteria and features of this opportunity are:
The downsizer contribution is available regardless of an individual’s total superannuation balance
The property sold must be the main residence of the individual and exempt from CGT
The contract for the sale of the property must be on or after 1 July 2018
The individual or their spouse must have owned the property for at least 10 years prior to the sale
The downsizer contribution must be made within 90 days of receiving settlement proceeds
The individual making the contribution must be above the age of 65 at the time of making the contribution
Importantly, both members of a couple are able to make the contribution (regardless of the ownership structure of the sold property) meaning an additional $600,000 amount could potentially find its way into the SMSF. There is no requirement for individuals to meet the work test.
The underlying motivation for this policy is to encourage retired property owners to free up housing stock that may be too large for their requirements. Despite the name, there is no actual need for the individuals to downsize (i.e. buy a smaller lower value property) – they can sell a $2m property and then re-purchase a $2.1m property and still be eligible to utilise the downsizer contribution strategy to deposit additional monies into super.
Taking advantage of new strategies
The SMSF space in 2018 and beyond has changed dramatically. The game has changed and advisers need to partner with an SMSF administrator who can handle the increased compliance burden that comes with monitoring funds for events-based reporting as well as implementing value-added strategies outlined above.
Intello works with over 150 advice businesses around Australia looking after more than 2,500 SMSF and non-SMSF entities on their behalf. Our team is 100% onshore and provide technical and strategic support to all advisers we work with.
We have the technology, systems and people to ensure you and your clients are well supported in this new SMSF world.