Many people establish an SMSF for greater control over their retirement savings. But Peter Burgess details another powerful reason for running one’s own superannuation fund.
The SMSF sector has grown enormously over the past 10 years from a mere $100 billion in assets a decade ago to over $570 billion in assets today. Equally impressive has been the sector’s growing exposure to commercial property, which, according to the latest ATO statistics, currently stands at $67 billion.
There have been many articles written about the growth of the SMSF sector and most point to the important benefits of investment flexibility and control as being the key drivers behind a decision to establish an SMSF. And for the vast majority of SMSF members, there is no doubt the ability to make their own investment decisions and to choose from a wider range of investment options were absolutely the reasons why they chose to establish an SMSF.
But for many small business owners the benefits of an SMSF, and their reason for establishing an SMSF, were not driven by a desire for more investment flexibility or control over the day-to-day investment decisions of their fund.
For these individuals, the combined benefits of asset protection and taxation concessions provided the most compelling reason to establish an SMSF. At its core, a superannuation fund, including an SMSF, is simply a trust fund that enables individuals to accumulate assets in a tax concessional environment for the sole purpose of paying retirement benefits to trust beneficiaries or their dependants if the trust beneficiary dies.
For many small business owners, an SMSF is just one of many legal structures that make up their integrated wealth and asset protection strategy. An SMSF typically sits alongside one or more family trusts and other legal entities, such as a family business. The trust and legislative structure of an SMSF provides the ability to protect assets, such as a business premises, while at the same time growing their retirement savings in a tax concessional environment.
Being able to invest in a broader range of listed and unlisted investments, being in control of things like corporate actions, and even being able to benefit from lower fees if their super balance is large enough, are all secondary considerations for many small business owners. What matters most is the ability to protect assets against creditors, law suits and hostile beneficiaries, while at the same time minimising their taxation liabilities and growing their retirement savings. This is where an SMSF can play an important and unique role.
Asset protection benefits of an SMSF
One of the age-old benefits of superannuation is asset protection. As a trust, the assets are owned by the trustee, rather than the members themselves. This means the assets of the trust cannot generally be called on by creditors in the event of a fund member’s bankruptcy or in the event someone wins a lawsuit against one of the members.
For many small business owners, the asset protection benefits of an SMSF stem from the ability of an SMSF to acquire a business premises owned by a member or a related party of the SMSF. From an asset protection perspective, this strategy involves repositioning the legal ownership of the business premises and putting it out of reach of creditors.
In its simplest form, this strategy involves transferring a business premises a member may already own into their SMSF. The SMSF essentially becomes the landlord of the premises and the member’s business then leases the premises by paying a commercial rate of rent to the SMSF. Subject to the contribution caps, and the work test rules if the member is over 65, the premises can be transferred to the SMSF by way of an in-specie contribution.
If the SMSF has the necessary liquid funds available, another option would be for the SMSF to acquire the business premises outright via an in-specie acquisition. These days, where an SMSF doesn’t have the required liquid funds, a variation to the in-specie transfer approach could involve an SMSF borrowing funds under a limited recourse borrowing arrangement.
Importantly, transferring a business premises into an SMSF is a capital gains tax (CGT) event and may also have stamp duty implications. However, in some situations, the small business CGT concessions can be used to reduce or eliminate CGT and stamp duty concessions may also apply.
But why an SMSF?
As discussed, an SMSF is merely a trust with the sole objective of providing retirement benefits to trust members or their dependants on the death of the member. Arguably, as a trust, it provides no more or no less asset protection then other types of trusts. This raises the question – why use an SMSF as your preferred asset protection vehicle?
The answer lies in the tax-favoured status of superannuation, which, when compared to most other trust and investment structures, means superannuation typically offers the most tax-effective structure to accumulate and grow retirement savings.
Investment income, including realised capital gains, derived by superannuation funds is subject to concessional rates of tax. Similarly, benefits paid from a superannuation fund to the members personally are also subject to concessional tax rates.
In the context of an SMSF owning a business premises, the tax benefits can be considerable when compared to other trust structures. For example, lease payments received by the SMSF are taxed in the fund at a maximum rate of 15 per cent or exempt from tax if the business premises is being used to support the payment of a pension from the fund. Similarly, if the business premises is sold by the SMSF, any capital gains are subject to a maximum effective rate of 10 per cent tax, or again exempt from tax if the premises was being used to support the payment of a pension from the fund.
Furthermore, the requirement in these situations to pay lease payments to an SMSF provides another avenue to fund retirement benefits that are not subject to the contribution limits. For individuals who are already fully using their contribution caps, this can be an appealing strategy to maximise retirement savings and ultimately the payment of tax-free benefits in retirement.
However, there are some important points to consider. While the amount of lease income paid to the fund is required to be no less than what the fund would have received if the parties were dealing at arm’s length, it is also important to ensure it is no more than a commercial market rate.
Income received by the fund that is higher than commercial rates, referred to as non-arm’s-length income, is not taxed at concessional rates, but rather is subject to tax in the fund at the highest marginal tax rate plus the budget repair levy.
Additionally, it is important the SMSF treats the related-party tenant as it would a third-party tenant. This means rental payments need to be made in accordance with a written lease agreement and any lease breaks or reductions need to be consistent with an arm’s-length dealing.
There are also some disadvantages of an SMSF when compared to other trusts and investment structures. The availability of the superannuation tax concessions is contingent on the fund complying with a raft of rules that are essentially designed to ensure the fund is maintained solely for the purpose of providing retirement benefits to members and dependants on the death of the member.
For example, it is generally not possible for the members to derive a personal benefit from the fund assets prior to satisfying a condition of release, and there are record-keeping and reporting obligations imposed on SMSF trustees that don’t apply to other types of investment trusts.
So regardless of the reasons for wanting to establish an SMSF, it is always a good idea at the outset to spend time understanding the roles and responsibilities of being an SMSF trustee. This includes assessing the extra administration workload and deciding on a provider to help manage the administration of your fund if appropriate.
The importance of planning
When it comes to asset protection, a common mistake is starting the asset protection planning too late. For example, there are laws that protect creditors from actions designed to hinder or defraud creditors.
The laws that apply to SMSFs are no different, so waiting until legal proceedings have commenced, or even in anticipation of legal proceedings commencing, is likely to result in your asset protection plan being unwound by the courts and your assets exposed.
This demonstrates the importance of seeking advice early to devise a strategy that not only meets financial objectives, but provides adequate levels of wealth protection. And given there are more than 2 million small businesses in Australia, the importance of securing personal wealth for this group cannot be understated.
For many years we’ve seen examples of how SMSFs play an important role in providing an integrated wealth and asset protection strategy. This is particularly the case for many small business owners, who have been a key driver behind the growth of the SMSF sector. An SMSF can provide the benefit of asset protection within a tax concessional environment, but the key to realising these benefits and peace of mind for our clients is early planning.
