All in the family

Including one’s children in an SMSF can be a very effective plan on many fronts. Darin Tyson-Chan examines the reasons to consider this strategy, but also the pitfalls that can be involved.

SMSFs are often set up to look after the retirement needs of a husband and wife. It stands to reason then that some trustees see the extension to include their children in the fund as a logical next step. As with any SMSF strategy, there can be benefits and drawbacks to all parties concerned and each element must be carefully considered before embarking on the move.

One of the prime motivating factors driving parents to include their children in their SMSF is to give them a degree of financial assistance in their early years, especially when the time comes for the kids to join the workforce.

SMSF Strategies and NowInfinity principal Grant Abbott says the move can really help when it comes to reducing the amount of fees the children are faced with when nominating where their initial super guarantee contributions are directed. “The more people in the fund, the lower the cost per member and that is really crucial for parents with gen X or gen Y kids who are going into retail or industry funds and being charged the fees associated with those funds. If they’re in their parents’ fund, then obviously there is a significant cost saving there,” Abbott explains.

The financial benefit in mind may not necessarily be as immediate as the situation above. For example, it can be to retain a most valuable asset that the next generation can continue to gain advantage from in future years. “Including children in an SMSF can give them access and preserve grandfathered structures you wouldn’t get access to again, like pre-1999 unit trusts,” Heffron SMSF Solutions head of technical services Meg Heffron says.

“I guess an extension of that is the ability to leave assets in the fund for more than one generation. We had a couple of clients where they have got particular properties and another that had a whole lot of cranes they leased to a related party.

“They are great assets to have in this fund because they produce a heap of income, the family does not need the income, and they get it in a tax-free environment.”

DBA Lawyers director Daniel Butler says there can be specific situations that make the inclusion of children in the fund very prudent.

“One scenario where it is quite a favourable move is where there is a disabled child who has received a settlement payment,” Butler says.

“Here you may want to include the child in the parents’ SMSF because it might be a suitable vehicle for the parent who is managing those funds on behalf of the incapacitated child.”

But often the financial aspect considered when including the children in the SMSF is not purely about the dollars and cents. Many parents go down this path as an introductory form of financial education for the next generation.

HLB Mann Judd wealth management and superannuation partner Michael Hutton supports this mindset. “I think it’s a good way to bring young people into the fold and have them be responsible for some investment decisions. It’s also a good way to encourage them to have some understanding about tax, investments, financial planning and contributions,” he says.

Abbott says this aspect can definitely help the children later in life, especially if the current levels of general financial knowledge are any indication. “I’d say that’s pretty good strategy when you have a look at it. Someone who is 35 or 40 these days, if they’re in a retail or industry fund, they’re probably pretty clueless about their super,” he says.

“For parents who have been wanting to give financial guidance to their kids throughout their lives, it is not a bad idea to sit down and go through the process and motions of saying this is what super is about and now these are the things you can do, like borrowing to purchase a property.”

While Heffron acknowledges this thought process, she is not entirely wedded to the concept. “That was the Jeremy Cooper rationale. One of the very first things he said in an early Cooper review meeting was: why does a SMSF have only four members when I’ve got three kids? I really want them all in my fund so I can make them take their super seriously,” she says.

“But my personal view is that is just one way of achieving that outcome and there are many other ways.”

The financial benefits of including children in the SMSF are not a one-way street either as some rewards can flow back to the parents.

“One of things we’ve done recently involves situations where the older generation is taking pensions out of the fund and don’t necessarily need all of the cash and they can’t re-contribute because they are too old,” Hutton says.

“We are pointing out they can re-contribute in the name of the kids so it keeps money within the fund, keeps the superannuation entity building up and keeps it going.”

Financial considerations are not the only elements driving the initiative to include the next of kin in the parents’ SMSF. One issue most people running their own retirement savings vehicles need to be mindful of is the point in time when they become incapable of continuing this process. Having the children as members of the SMSF can be a viable solution in these situations.

“As the generations move on we are going to see a lot of mental infirmity, especially in the funds run by baby boomers,” Abbott warns.

“If someone experiences mental incapacity, and they’re the last person standing, it is a bit of a nightmare in terms of what to do with their fund, unless you are left with instructions. But if you’ve got children inside the fund to keep it going, it can be handed over to the next generation and I think that’s actually crucial.”

Hutton supports this notion, but with some qualifications. “You can get around that in other ways, but I don’t think that’s a bad way to go as long the kids are on the same page in terms of how to run the fund,” he says.

Heffron says the inclusion of children in the fund to address this matter is sound in theory, but not all that important in practice.

“The key thing you need to deal with incapacity is you’ve got to have a power of attorney in place before it happens. As long as you’ve got that in place, it doesn’t really matter whether they’re members or trustees because they can become a trustee any time they like,” she says.

For all of the positives of setting up a family super fund, there are plenty of drawbacks as well. One would be the situation where the parents become somewhat accountable to their children regarding the running of the fund.

“If the kids are in, you now have to account to them. And let’s say they are a director, then you are beholden to your children because now they are a director or a trustee who have sway,” Butler says.

He also points out there can potentially be added complexity when it comes to running the fund. “Often the parents will be chasing down their kids because they want some documents signed and the kids couldn’t care less because they’re on holiday or something like that,” he says.

Abbott agrees accountability and having to be more transparent about the family finances can be problematic.

“Some parents don’t want their kids to know how much they’ve got, which the trustees and directors and corporate trustees are going to need to know, so then again it depends on the level of openness with the family and the level of communication within the family. The ones that are really open and communicative work truly well,” he says.

Another issue Butler highlights is the potential to open the super fund up to other areas of the legal process. “De facto relationships are governed by the Family Law Act. So let’s say you introduce one of your children to the fund and go through a separation and they’re not even married. The former spouse to your child could make a claim through the Family Court to claw back assets of their former spouse,” he says.

“In effect it means the SMSF is now a party to a family law action and has to deliver numerous court documents and disclose all sorts of information.”

Another potential disadvantage in trying to set up the family super fund is that an SMSF is restricted to four members only. It means a family with more than two children will be required to establish multiple funds. This in turn can have an adverse financial impact.

“Having to have more than one fund increases the underlying costs because the asset pool has been reduced so the percentage of costs are going to be a lot higher,” Abbott says.

“Also setting up another fund can be quite costly in itself.”

Butler agrees with this point, emphasising other costs can also arise.

“By separating you may not get the volume discounts you might otherwise get. The financial institutions offer lower management expense ratios if you have a higher level of funds under management, so it can come back to bite you on that front,” he says.

Heffron feels it can sometimes diminish some of the primary objectives of investing together as a family unit. “The rationale for combining in the first place is to give you a bigger pool of assets to allow you to buy lumpy things without compromising on your diversification,” she says.

“And that’s not necessarily destroyed if you have to put it into two separate funds. It just gets slightly more complicated.”

With the additional complexity involved with the inclusion of children, there are also implications for the trust deed.

“A deed that actually has one trustee, one vote is not going to work. You need to have the ability to have separate investment strategies. You need to have the ability to manage all of that. The thing with many employer funds is the right to terminate membership with one of the children if you are not getting on with them or the child is from a divorce, and the deed probably needs to cover this,” Abbott says.

“You want to have a really strong deed and some really strong membership rules.

“You also want to look at setting down some preset rules and guidelines in the event of what may happen if someone was to lose their mental capacity. Do you want to put a guardian inside the fund to look after that person’s needs or do you want it up in the air.”

Hutton says the estate planning side also needs to be securely bedded down. “The estate planning aspect has to be solid in these circumstances. We’ve usually found binding death benefit nominations are pretty satisfactory. But you are trying to be more careful with the deed in this regard,” he says.

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