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A six-member SMSF trap

When considering six-member SMSFs, the Senate Economics Legislation Committee has hinted at an important trap advisers must remember.

On 27 April 2018, then-revenue and financial services minister Kelly O’Dwyer announced the federal government would expand the limit on the maximum number of members in SMSFs from four to six.

In O’Dwyer’s media release, she described the purpose of the change as follows: “The change will allow for greater flexibility and, given the growth in the sector to date, will ensure SMSFs remain compelling retirement savings vehicles into the future.”

The next month, the government handed down the 2018/19 budget with the document confirming this change, stating: “The government will increase the maximum number of allowable members in new and existing self-managed superannuation funds and small APRA (Australian Prudential Regulation Authority) funds from four to six, from 1 July 2019. This will provide greater flexibility for joint management of retirement savings, in particular for large families.

However, the measure then languished until earlier this year when the Treasury Laws Amendment (Self Managed Superannuation Funds) Bill 2020 was introduced.

The explanatory memorandum described the change as follows: “Increasing the allowable size of these funds increases choice and flexibility for members. SMSFs are often used by families as a vehicle for controlling their own superannuation savings and investment strategies. For families with more than four members, currently the only real options are to create two SMSFs (which would incur extra costs) or place their superannuation in a large fund. This change will help large families to include all their family members in their SMSF.”

The Senate referred the bill to the Economics Legislation Committee and, earlier this month, the committee delivered its report.

In short the committee found that: “The changes provide families managing joint superannuation funds with greater control and reduced costs, which in turn will increase the need for greater financial literacy and accountability to effectively manage those investments as trustees. The committee is broadly supportive of measures that increase individuals’ engagement with their retirement saving and encourage improved financial literacy.”

Accordingly, the committee recommended the bill be passed. Presumably it will be passed soon.

The hint of a trap

However, the committee did hint at a trap.

The committee’s report summarised the various submissions it received. Some of those submissions referred to common problems with increased membership, such as the “ability for the majority of members to override the wishes of the minority”.

Furthermore, there were dissenting senators who wished for the bill not to be passed. Those individuals made several unsuccessful recommendations, including the following: “Given the potential for increased conflict in the effective governance of SMSFs by trustees, especially if they are family members, the government should ensure a minimum standard of protections are in place for each member of the SMSF, especially with regard to mandatory education and dispute resolution to balance the interests of the increase in the numbers of trustees and members.”

Again, the above recommendation was unsuccessful. However, there already exists an important minimum standard of protection that may be even more significant in any future five or six-member SMSFs.

Namely, under regulation 6.29 of the Superannuation Industry (Supervision) (SIS) Regulations 1994, “a member’s benefits in a fund must not be transferred from the fund unless: (a) the member has given to the trustee the member’s consent to the transfer…”

Consent in this context means written consent (SIS regulation 6.27B).

There are limited exceptions to this rule, such as if implementing a successor fund transfer. However, for technical reasons, successor fund transfers are not broadly possible in respect of SMSFs.

Therefore, if admitting additional members to an SMSF, one must remember members cannot later be rolled out unless the member has first given to the trustee the member’s consent to the transfer. This is the case regardless of how small or seemingly insignificant a member’s balance might be.

Case study

Consider, for example, Charles and Alexandra. They admit their children into their SMSF because Charles and Alexandra feel that:

  • the SMSF’s fees (as a percentage of total assets) are very low and very transparent, and
  • it will be a good way for their children to gain practical ‘hands-on’ financial management experience.

Initially all goes well. However, after several years, there is an estrangement in respect of one child. That child then relishes the power he has as a member (and therefore as a trustee) of the fund. He insists on being invited to trustee meetings, only to then veto each vote and slow down all matters concerning the fund.

The other trustees – who incidentally have 99 per cent of the member balances – soon become fed up and wish to roll that child out.

However, regulation 6.29 of the SIS Regulations effectively prohibits this.

Solutions

Several potential solutions exist. One potential solution is as follows.

Before Charles and Alexandra admit their children to the SMSF, they arrange for ‘conditional membership’ documentation to be prepared. Essentially, this involves the new members providing – upon admission of membership – their consent to be rolled out upon certain contingent events occurring. One such contingent event is that member(s) with the majority account balance determine the conditional member should leave.

Conclusion

The Senate Economics Legislation Committee’s report in respect of six-member SMSFs has hinted at an important trap. Namely, it alludes to the potential for disputes within an SMSF as well as minimum standards of protection. One existing protection is the prohibition on transferring a member’s benefits out of a superannuation fund unless that member’s written consent is first received. This is an issue whenever admitting new members to an SMSF. However, there are a number of potential solutions available, such as admitting the new member as a conditional member.

Bryce Figot is special counsel and Daniel Butler is director at DBA Lawyers.

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