Tax Smart Blog

One of the most important duties of the trustees of a superannuation fund is to manage the fund’s assets.

To reduce risk and ensure that funds are being maintained for genuine retirement, trustees have a number of duties and responsibilities.  These are summarised as follows:

Investment Objectives and Strategy

As part of managing the fund’s assets, a trustee of a superannuation fund, including a self managed super fund, is required to set an investment objective and strategy for the fund. These should be in writing and kept with the fund’s records.

Investment Objectives

An investment objective is a statement that identifies a fund’s investment goals.  The objective should be measurable and able to be communicated to fund members.  Examples of an investment objective could include the desire to:

1. Generate a specific rate of return;
2. Outperform a recognised investment (or cost of living) index over a specified period of time; and
3. Provide long term capital growth with some tax effective income by investing in certain asset classes.

Comply With Investment Restrictions

Although the superannuation rules require trustees to implement an investment strategy for the fund, they do not state exactly what investments a fund can acquire.  However, the legislation does impose certain restrictions on fund investments in order to protect member benefits.

Arm’s Length Rules

All investments by a SMSF must be made and maintained on a strict commercial (i.e. arm’s length) basis.  In other words, the relevant purchase/sale price of any fund asset should be based on a fair market value regardless of who the parties to the transaction are.  Similarly, any rental or lease amounts paid for the use of any fund asset should reflect a fair market rate of return.

Loans to Members and Relatives

The trustees of a SMSF are prohibited from lending money (or providing any form of financial assistance) to a member of the fund or their relatives.

Borrowing

SMSFs are prohibited from borrowing money with some limited exceptions.  These include short term borrowings:

1. For up to 90 days to pay a benefit or surcharge liability; and
2. For a maximum of 7 days to cover the settlement of certain security transactions.

In both these situations the amount of the borrowing must not exceed 10% of the fund’s total assets.

Although a super fund cannot borrow, it is worth noting that they are not prevented from investing in assets that do incorporate borrowings, such as geared managed investment funds or installment warrants.

Acquisition of Assets from Related Parties Rule

The trustees of a Super Fund, including a self managed super fund, are prohibited from intentionally acquiring assets from a ‘related party’ of the fund.  This not only refers to funds purchasing assets from related parties but also includes such parties contributing assets “in kind” (e.g. in-specie contributions).

However, there are some important limited exceptions to the above rule for acquiring related party assets, including:

1. Listed securities (i.e. Shares, units or bonds listed on an approved stock exchange);
2. Business real property (i.e. Freehold or leasehold property interests used exclusively in one or more businesses) acquired at market value;
3. An in-house asset where the acquisition would not result in the level of the fund’s in-house assets exceeding 5%; and
4. Units in a widely held unit trust, such as a retail managed fund.

The definition of related party is very broad and includes:

1. All members of the fund and their associates, and
2. All standard employer sponsors of the fund and their associates

An associate includes a member’s relatives, business partners (and their spouse and children), or any companies or trusts a member controls or that control the employer sponsor.

A standard employer sponsor is an employer who contributes to the fund on behalf of members as part of an agreement between the employer and the trustees of the fund.  Standard employer sponsors are usually employers who make employee contributions to their own corporate fund or to a relevant industry fund.

Breaching the acquisition of assets from related party rules is considered a serious breach and can incur severe penalties.  It is therefore important for a trustee to ensure that any investment the fund makes will not breach these rules.  If there is any doubt a trustee should seek clarification from their professional service provider or seek guidance from the ATO.

The in-house asset rules limit a superannuation fund from undertaking certain transactions with related parties in order to limit risk and to ensure that funds are being maintained for genuine retirement purposes.  In-house assets are defined as:

1. An investment of a fund in a related or trust (i.e. a fund owns shares in a company or units in a trust);
2. An asset of a fund that is leased to a related party; and
3. A loan made by a fund to a related company or trust.

An investment, lease or loan that is an in-house asset is not prohibited but is limited to 5% of the market value of a fund’s assets.  That is, if a fund leased an asset to a related party, the value of that asset (combined with any other in-house assets) must not exceed 5% of the total value of the fund’s assets.

In recognition of certain legitimate business arrangements the superannuation rules exempt certain assets, such as business real property, from being an in-house asset.  This allows a fund to lease certain assets to related parties, or to invest in certain related entities without being limited to 5%.

In certain situations, assets that would otherwise be an in-house asset are exempt from these rules under transitional provisions announced on 11 August 1999.

Pay Benefits In Accordance With Preservation Rules

To ensure that superannuation savings are used for retirement and other permitted purposes, special rules apply to limit when members can access their superannuation.  These are called preservation rules.  Trustees of superannuation funds are responsible for ensuring that their fund complies with these rules at all times.

Superannuation benefits consist of one or more of the following preservation components:

1. A preserved benefit;
2. A restricted non-preserved benefit; and
3. An unrestricted non-preserved benefit.

Preserved Benefits

Preserved benefits can only be paid out as a lump sum or pension where a member has satisfied one of the following conditions of release:

1. Permanent retirement from the workforce on the member reaching their preservation age.  Preservation age is determined according to date of birth as shown in the following table:

1. Termination of employment after turning 60 years of age;
2. Permanent incapacity;
3. Reaching age 65;
4. Death;
5. Compassionate grounds (situations approved by the ATO); or
6. Financial hardship

If a person has reached preservation age but not yet permanently retired, they can access their super in the form of a transaction to retirement pension (but they cannot make lump sum withdrawals).

Restricted Non-Preserved Benefits

Restricted non-preserved benefits must remain in a superannuation fund until a member:

1. Satisfies a condition of release for preserved benefits; or
2. Has terminated employment with an employer who contributed to fund on their behalf.

Unrestricted Non-Preserved Benefit

Unrestricted non-preserved benefits can be cashed at any time.

Breaching the preservation rules is considered a serious offence and can result in severe penalties for both the trustees of a fund and the member improperly obtaining access to their benefits.  Trustees should ensure they comply with the preservation rules at all times.

Once a member has satisfied a condition of release they can access their benefit, depending on the fund’s rules, as either a lump sum or pension, or as a combination of both.

Pension That A SMSF Can Pay From 1 July 2007

Under the reforms a SMSF can now only pay two types of pensions.  These are:

1. Account-based pensions
2. The transition to retirement income stream

Prior to the reforms SMSFs were able to commence to pay other types of pensions including:

1. Market linked pensions
2. Allocated pensions
3. Lifetime complying pensions

In cases where a SMSF had already started paying one of these pensions, the SMSF is allowed to continue paying it.

As Allocated Pensions were formerly the pension of choice, it is important to understand how these differ from Account Based Pensions:

1. Account-based pensions have no maximum limits, whereas allocated pensions do;
2. Account-based pensions usually have lower minimums than allocated pensions; and
3. Account-based pension payment factors are simpler and easily understood.