Strategic advice has resonated well with SMSF trustees, but the ability to provide it is challenging. An SMSF strategy system can make the process easier, writes Grant Abbott.
I love SMSF strategy, as do thousands of accountants, financial planners, mortgage brokers and lawyers. And why wouldn’t they love creating tax-effective and long-lasting wealth-creation strategies for clients. After all, who would have ever thought from nowhere 20 years ago that SMSFs would be the biggest game in town. And it’s all because members of SMSFs have chosen to control their own super destiny rather than leave the investment, administration and strategy to the big end of town.
Now the big end of town is having to change its game plan to meet the huge shift of assets into SMSFs. With over $500 billion in assets and more than 1 million members, SMSFs can no longer be ignored by anyone in the financial services industry.
But with all the new advisory entrants into the market and SMSF professionals getting ever younger, making strategies work consistently and compliantly is tough. That is why experienced strategists are worth their high price because it takes years of strategy development at the coalface and understanding the inner workings of the law before a professional really knows their stuff. It is a hard wall to climb over and doing one or two courses helps, but it does not create the grey matter that builds strategies. That comes with time or does it really?
For those of you who have been reading my columns, particularly the business articles, you will know I am a big fan of Michael Gerber of ‘E-Myth’ fame. And his story fits well with SMSFs. It is systems that create success, not technical supremacy. Too many professionals get into the SMSF advising game and get frustrated – they know it is a big booming industry and they know the strategies that work for clients, but they don’t know how to put the strategies into action. They have no system.
This costs them dearly as they spend time focusing on SMSFs and letting their other business interests slide around them chasing the dream. But without systems and processes built around one or more strategies, trial and error is going to take a long time. And if you leave a step out, the auditor or Australian Taxation Office (ATO) steps in.
SMSF strategy systems
So after reading Gerber earlier this year, I went to work making an SMSF strategy system. The first I rolled out as an experiment was the infographic you see on these pages. It maps out the first year in the life of an SMSF. In short, it sets up a system for the transfer of superannuation money from retail, company or industry-based funds for the purpose of setting up an SMSF and acquiring a property. The flowchart is self-explanatory, but what really surprised me when mapping it out in detail was how many steps and side steps were involved and how many compliance traps and pitfalls could befall an adviser without the flowchart. The next step is to build the auto-generated documentation trail for the limited recourse borrowing arrangement (LRBA) strategy.
There are obviously a lot of benefits in having a strategy system:
1. It lays out a step-by-step map, making the strategy simple to follow so a new entrant to the SMSF industry can learn a strategy quickly and effectively without having to trial, learn and experiment for years.
2. It provides a compliance trail and guide for the fund’s audit files, auditor and also the ATO. For accountants, this is crucial and ensures every step is considered along the way. If you look closely at the LRBA system, you will see there is a range of laws – the Corporations Act 2001, the Superannuation Industry (Supervision) (SIS) Act 1993 and the Income Tax Assessment Act 1997 – covered, each with its own compliance rules and regimes. For the SMSF auditor, it provides a definitive guide on how an LRBA works – a guide that can be tested against other LRBAs they review. For Australian financial services licensees, it enables a check on their authorised representatives that are completing LRBAs.
3. Add the documentation and a difficult strategy suddenly becomes simple and an SMSF business is born. This is the Gerber way and allows continuous improvement as the systems work time and time again to produce a particular result.
Some SMSF strategy keys
Building any system takes time, particularly where auto-generation of documentation is involved. As a result, the LRBA system must be limited to plain vanilla SMSF lending, although with the base built there is plenty of scope to diverge into side strategies, such as the transfer of business real property into an SMSF by a related party. Some of the important things to know about the LRBA strategy system are outlined below.
Corporations Act
The LRBA strategy system is comprehensive and covers numerous facets of the strategy. For a licensed financial planner or authorised representative of an Australian financial services licence (AFSL) holder, they will need to prepare a statement of advice covering the transfer of money from a retail or industry super fund to an SMSF. At this time, the establishment of an LRBA over property is not a financial product, however, the risks associated with any leverage must be carefully laid out for the client. The investment strategy and insurance requirements are vital and covering the life or disability of the borrower is a critical and vital part of the advice process.
For an accountant without a limited licence, they can advise on establishing the SMSF and also the LRBA, but the investment strategy, writing any insurance (although they can suggest insurance to cover the liability) and the recommendation of the transfer of money from a retail or industry-based fund to the SMSF are off limits. For limited-licence accountants, they must pay heed to the licensed financial planner model above, but will not be able to give specific advice around any insurance product.
For the mortgage broker not operating under the licensing regime, they can advise on the lending and LRBA side, but not on establishing an SMSF or rolling over superannuation to the SMSF.
The borrowing arrangement
The strategy system maps out a simple purchase of a residential or commercial property. However, there are a number of side scenarios that we are currently mapping out and documenting, including the following:
The acquisition of commercial property to be used by a related party. This strategy follows the same process, however, a market value leasing agreement will need to be inserted into the flowchart. This is not a big issue and another simple compliance step.
The transfer of a commercial or business real property into an SMSF takes a few more steps and the mapping for this will be released in early 2014. However, some of the key issues include
- section 67A of the SIS Act provides that the trustee of a super fund can borrow money to acquire a single acquirable asset. So the transfer of a property into a holding trust without money being transferred has been a talked about compliance issue by a number of SMSF auditors. As such, any transfer would need to include some money, cheque or promissory note.
- he transfer of the property – subject to the strategy above, it may be made up of concessional contributions, non-concessional contributions and related-party loans. It is clearly a step up from the basic LRBA arrangement considered in this article.
- estate planning needs to take into account where there is a related-party loan as it may result in the beneficiaries of the estate being pitted against the ongoing trustees of the fund and beneficiaries of the SMSF estate. This will particularly be the case if the related-party loan agreement is for a long period – 20 or more years – and does not terminate on the death of the member.
An off-the-plan arrangement, which is popular at the moment and has been given sign off by the commissioner of taxation. It requires much the same documentation, but will be over a longer period of time, which entails some inherent risks, such as a change in legislation between contract and settlement.
Improvements to the property as allowed under the commissioner’s LRBA ruling will require a more detailed investment strategy considering the potential pitfalls of renovating and improving a property.
Multi-holding trust strategy for share or managed fund acquisitions. This is where each holding trust holds a collection of shares. The SMSF lending laws allow a trustee to borrow provided that it is a single acquirable asset. Share or managed funds with the same market value and characteristics are to be considered a collection of assets. For example, 1000 BHP shares bought at the same time would be a collection of assets with the same characteristics and thus a single acquirable asset under the laws. But 500 BHP shares acquired today and 500 in December 2013 would be two collections.
Summary
It has taken me a long time to understand why so many people don’t provide advice on strategy and why many are scared of it (because there is no set format to follow that guarantees success and compliance at the same time). The LRBA flowchart in this article will make life easier and with our auto-generation documentation tool, effortless.
