Grim Reaper threat to SMSF property

Death can be rather inconvenient, particularly if poorly timed.

And I’m not talking about the impact on the deceased. Sure, mostly, they aren’t going to be thrilled with the event. But it tends to be rather final and today we’re going to assume that the deceased can’t buy their way back to life.

When it comes to super, the price of death has gained a whole new value in recent years, particularly as it relates to the purchasing of property inside SMSFs.

While SMSFs have always been allowed to buy direct property, the issue of gearing for property inside super has introduced risks that previously didn’t really exist.

The crux of the problem

Let’s take a husband and wife (Jim and Jane, both aged 50) and a super fund worth $600,000. Of that, Jane’s balance is $400,000 and Jim’s is $200,000.

They purchase a property worth $500,000. After stamp duties and other purchase costs, they have $70,000 left in cash (plus any incoming contributions and earnings of the fund). Assume, briefly, that there is no gearing.

Not long after the purchase, Jane dies. Her death causes a cashing event for the super fund.

Under a wide variety of circumstances, Jim now has a major problem.

As two-thirds of the super fund is Jane’s – and we’re assuming there’s no automatic reversionary pension in place because of their ages – the super fund will need to pay out Jane’s portion of the super fund as a death benefit.

In the vast majority of cases, in order to meet the death benefit, the property is going to have to be sold.

There are many reasons why this could be an awful result for Jim. Predominantly, this is because the super fund doesn’t have a big enough cash balance to pay out Jane’s death benefit, which is likely to be slightly less than $400,000.

These other problems include:

1. Costs of selling the property (assume about 3-4% for agent’s fees and advertising)
2. Being a forced seller. Never great if your property might need some time to attract a buyer at the right price.
3. Selling into a flooded or depressed market.

It wouldn’t be in the realms of the ridiculous that Jim could lose the vast majority of his $200,000 in super. Potentially, if gearing was included and the stars weren’t aligned, he could potentially lose all of it.

For example, if, due to a property market downturn, the property had dropped by 20%, then it is now only worth $400,000. There were $15,000 in sales costs (and $30,000 was already blown up in stamp duties on purchase). Jim could suddenly have to pay out nearly $400,000 (probably to himself as dependant), but a good portion of his $200,000 could have been lost in the transaction fees.

Imagine then, if the whole thing had have been magnified by gearing. Instead of it being a $600,000 super fund on which $500,000 was spent on a property, take a $300,000 super fund on which $200,000 was spent on the deposit of a super fund that, with a loan, had purchased the $500,000 property.

And then, the property market had collapsed and Jane had died. There may be no equity left in the investment property itself.

Jim might be paying himself out something, but there would be little to nothing left of his own super.

The solution

Insurance that is structured and owned correctly.

Please note: This is a particularly complex area. And anyone seeing some danger signs in their own circumstances from today’s column is advised to seek independent financial advice.

A solution is for Jim to own some life insurance on Jane’s life in the SMSF to ensure liquidity in the event of her death. That is, an insurance contract for $400,000 on Jane’s life, owned by Jim, would then be payable to the SMSF, specifically to Jim’s superannuation account.

The insurance is then used to, in effect, swap the property ownership that Jane had for the insurance sum. This may allow her super account death benefit to be paid out in the event of her death, without the property being sold.

It will come down to the ownership of the insurance policy itself and potentially the flexibility of the rules of the trust deed, in whether it will allow ownership of the insurance premium by another member over another member’s life.

Check your trust deed

You will also need to check the rules for your super fund trust deed, as to what they allow for when it comes to insurance, various ownership options and the allowability, potentially, for liquidity reserves. In some cases, for insurance strategies to work properly, the trust deed will need to allow for the segregation of assets between members.

In any case, the huge surge in interest in property ownership in super is, undoubtedly, a good thing. However, it brings with it many risks. The increased risks associated with gearing is a major new issue.

But even if you get all of those things right, with the right intentions, a badly timed call from the heavens could send your best laid plans into a tailspin.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au.

• The Institute of Public Accountants (IPA) says Australians need to think about how the compulsory superannuation guarantee charge (SGC) rate, due to increase from 9% to 9.25% on July 1, will be funded when it comes into effect. “There are only two possible avenues for funding the increase in the SGC; one, employers will do so, adding to their cost structure or two, employees must sacrifice some of their pay packet,” said Andrew Conway, chief executive of the IPA.
• Self-managed super fund (SMSF) administrator SuperGuardian has launched a second SMSF product in a bid to attract investors looking to take control of their investments. “Called Xpress Super, it will provide an SMSF service to rival the top end of the market with fees positioned at the lower end,” said chief executive officer Olivia Long.

• La Trobe Financial has announced the winners of its annual CIO/COO awards, with a presentation at Melbourne’s Eureka Tower. Chief Investment Officer of the Year went to Gerard Parlevliet, chief investment officer of Commonwealth Bank Group Super, while Graeme Arnott of First State Super took home the award for Chief Operating Officer of the Year.