The future of SMSF and property

By Contributor | 03 Feb 2020

The Australian Taxation Office (ATO) recently sent a cautionary letter to 17,700 self-managed superannuation fund (SMSF) trustees – that’s about 3% of them – which was directed at those who had more than 90% of funds invested in one class of asset.

The letter reminds trustees that penalties of $4,200 may apply where fund risk, return, liquidity and diversification are not adequately addressed.

The ATO is concerned that these funds may be in breach of the Superannuation Industry Supervision (SIS) regulation 4.09.

But is the ATO exceeding its authority?

It is interesting that these letters have been sent only to SMSFs with property and limited recourse borrowing arrangements (LRBAs). No warning letters have been sent to funds with 90% or more invested in shares. 

The ATO does not have the legislative backing to force any SMSF to sell assets, nor can it dictate the specifics of an investment strategy. Every fund is required to develop an appropriate investment strategy for its members and to document the same for audit purposes.

Advisors should assist trustees in ensuring that due consideration is given to the issues. In practice, the investment strategy should set out a guideline that determines the percentage of assets invested in asset classes such as shares, property and cash. For example, a fund might set its asset investment goal at 55% Australian shares, 20% property (or property trusts), and 25% cash. 

In arriving at that goal as part of the investment strategy, consideration must be given to factors such as the age of the members, their planned timing of retirement, risk profile, liquidity, insurance options, and non-super investments.

Placing 90% or more of retirement savings in property, according to the ATO, does not meet diversification or investment risk management requirements – yet surely that would depend on the profile of the members, including their age and non-super investments?

SMSF trustees can invest in a single asset class if the fund investment strategy deems it appropriate and the strategy considers the liquidity needs of the fund. SIS regulations and taxation law do not prevent single-asset investment.

SMSF benefits

SMSFs are not for everyone, but in the right circumstances they offer several benefits. 

  • Trustees have a high level of control over the fund, making it possible for investments to be tailored to unique member needs.
  • SMSFs have the ability to invest in a variety of assets, including term deposits, Australian and international shares, residential and commercial property.
  • They are often the most cost-effective superannuation fund for large balances.
  • Fees for superannuation funds do not increase as the balance grows. Public offer funds charge a percentage annual fee based on the funds held, typically between 1% and 4%. For example, a super account balance of $1.5m paying 1% will incur fees in a public offer fund of $15,000 per annum. The same investment in an SMSF might pay $5,000–$10,000 for administration and audit. (This does depend on the complexity of the asset investments, and lower fees are only part of the equation. Inappropriate investments in either fund will likely cost more than the fee differential.)
  • It’s possible to have accumulation and pension funds in one SMSF. This means that, should you decide to draw a super benefit pension, you may be able to continue to contribute to your SMSF, with no need to set up a separate fund.
  • SMSFs can accommodate up to four members.
  • It’s possible to transfer certain assets from your personal name to an SMSF; these are known as ‘in-specie’ contributions. It is important to know that in-specie contributions can lead to a capital gain for the transferor.

Placing 90% or more of retirement savings in property, according to the ATO, does not meet diversification or investment risk management requirements

The popularity of SMSFs

SMSFs make up 30% of all super assets. According to the ATO’s SMSF Quarterly Statistical Report for June 2018, nearly 600,000 funds held $750bn in assets during that period, with over 1.1 million members in 2017.

Contributions to SMSFs have also increased, indicating that this remains a popular retirement savings option.

LRBAs accounted for $39m of the $397m invested, or 10%. That is just 3.3% of total super funds invested. So why all the fuss?

With fewer lenders offering SMSF loans for property purchases, the lending rates have risen considerably above standard

The ATO points to a recent report from the Council of Financial Regulators, which focused on SMSFs with LRBAs. The report stated that “prevalence of property as the main asset purchased under an LRBA, most commonly by low-balance SMSFs (under $500,000) who have little investment diversification and high loan to value ratios (LVRs)” was a concern.

While it may seem that the ATO is looking out for members’ best interests, is it really? Property and share markets have cycles; investors can recall the share market downturn and the financial crisis of 2008. The ATO seems less concerned about share market volatility. Could the sudden interest in property and LRBA be more of an attempt to suffocate property demand as the federal government focuses on housing affordability?

Alternatively, perhaps this is part of a government attempt to improve the standard of advice in the SMSF space? Frequently we see investment strategies crafted by advisors with investment goals of 0–100% for all asset classes. While such an investment strategy may be strictly compliant with the current rules, it’s little wonder that the ATO is taking such an interest.

Fund auditors are required to review the investment strategy and ensure that the fund assets are invested according to the investment percentages assigned. The trustees should regularly review the strategy to ensure that it meets the changing needs of members.

The ATO relies on fund auditors to assess and report on SMSFs’ compliance with regulations. Non-compliance may be reported to the ATO in an Auditor Contravention Report.

Members also rely on auditors, and two recent cases have seen members successfully claim significant damages from fund auditors (Cam & Bear Pty Ltd McGoldrick and Ryan Wealth Holdings Pty Ltd v Baumgartner). In both cases the auditor did not adequately verify asset values, and members successfully sued for damages for negligence.

Could the sudden interest in property and LRBA be more of an attempt to suffocate property demand as the federal government focuses on housing affordability?

Increasing regulation and litigation of auditors will result in more stringent evaluation of investment strategies. Trustees and advisors should review their investment strategies ahead of their next audit.

The future of LRBAs

All four major banks have decided to stop providing SMSF property loans. In April 2019, Macquarie Group also announced it would no longer offer SMSF residential loans. Its public announcement stated that it wanted to “streamline its core home loan offering”.

The absence of banks offering SMSF property loans has caused the non-bank alternative providers to profiteer. With fewer lenders offering SMSF loans for property purchases, the lending rates have risen considerably above standard. The increased cost of lending adversely affects the feasibility of some property investments. 

The ATO is also causing difficulties due to new measures that will impact a member’s total superannuation balance (TSB): any LRBAs entered into after 1 July 2018 will add to a member’s TSB. This will adversely impact their ability to access non-concessional contributions, government cocontributions, and the catch-up contribution concessions.

The new measures will also impact the tax status of funds in pension mode with LRBAs. The transfer balance cap (TBC) of $1.6m is generally a cap placed on the maximum pension account balance permitted for each member in a super fund at retirement. 

The implications are not yet clear, but it seems that where one’s TSB exceeds the TBC because of an LRBA, a fund may not attain a 100% tax-free status. This significantly disadvantages retiring members and those turning 65.

What next for SMSF trustees?

The ATO’s interest in certain SMSFs, particularly those with LRBAs, is not going away. Trustees should take time to review important aspects of their SMSFs, including:

  1.  The Sole Purpose Test: Be sure there’s no ancillary purpose for your fund. The fund must exist only for the purpose of providing retirement benefits.
  2. No lending of funds to members is permitted.
  3. No acquiring of assets from members is allowed, except for business real property and listed investments such as shares.
  4. The fund cannot borrow except for under an LRBA.
  5. All assets of the fund must be held in the correct SMSF name.
  6. Cryptocurrency is a difficult investment in SMSF. Check with your advisor about the specific rules

Increasing regulation and litigation of auditors will result in more stringent evaluation of investment strategies

Where to from here?

Investors should develop an investment strategy with their advisor that complies with investment standards and SMSF rules.

Not all accountants are licensed to provide SMSF advice, so first ensure that your advisor has the required Australian Securities and Investments Commission (ASIC) licence. Ask about fees, and be careful of commissionbased services where the advisor earns a commission based on the investments placed. Be sure to ask about the costs and find a ‘fee-for-service’ advisor if you want to avoid hefty commissions.

The best investment plan will consider your overall investment portfolio, not just your super.
SMSFs will continue to play an important role in the retirement savings landscape. The continued benefits of potentially lower fees for large balances, and member control, make SMSFs an attractive alternative for many investors. In the current environment, SMSFs remain a great option for those currently holding LRBAs, and those with non-geared investments in both shares and property with balances over $200,000.

With the current state of play, consider all possibilities. Additional property investments might be better placed in a property trust outside of your superannuation – do the math or ask your advisor.

With concessional contributions set at a low $25,000 per year, the annual tax saving for most investors is about $6,000. Alternatively, the flexibility and gearing opportunities of a property trust are certainly worth considering.

Most importantly, don’t stop investing in growth assets. As Robert Allen famously said, “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”

Janelle Bartlett is a chartered accountant and partner at Chan & Naylor Redlands.
She has over 20 years of experience in taxation and the implementation of business improvement strategies.

 

 

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