Setting up a second SMSF

Question. Would you please advise on potential benefits and pitfalls of opening a second SMSF? I have more than $1.6 million currently in pension phase. I have noted press articles promoting consideration of a second SMSF but these have been supported by generalities such as "provides more flexibility" without any further explanation.

Answer. Like most things financial there will be costs and benefits when it comes to dealing with pension accounts exceeding the $1.6 million pension transfer cap (PTC). Trustees in this situation have the choice of paying out the excess to the members as a partial commutation lump sum, or partially commute the excess and roll this into an accumulation account in the SMSF.

The trustees have the choice, if the accumulation account option has been chosen, to keep the accumulation account in the SMSF, or roll out the accumulation accounts to another super fund.

Just as there were choices for dealing with the excess over the $1.6 million PTC, there is also a choice of either using an SMSF, a commercial fund, or an industry fund.

The cost of setting up a second SMSF with a company acting as trustee can be as little as zero, if you are happy to use a company that ties you to using their administration service. Otherwise it will cost between around $1000 to $1500.

If going with a commercial fund, the only costs should be those charged by the investment adviser that sets up the fund. Opening an accumulation account with an industry fund should not cost anything but time.

In addition to the set-up costs, the ongoing administration and audit costs must be considered. These annual costs for a second SMSF can be as little as $800, and often these are with administration services that have restrictions on what bank accounts, investments or share brokers can be used, or from more advice-oriented service providers it will range from $1500 up to $5500.

The annual administration cost of a commercial superannuation fund or super wrap account differs greatly and can sometimes include service fees from an adviser. When assessing the cost of these commercial superannuation funds, fees charged by the underlying fund managers must also be considered. This is because some administration services offer a very cheap administration fee, but then very high investment management fees.

Most industry super funds have an annual cost that varies between $80 up to $120. Some of the more sophisticated industry funds offer direct share investments and can be very competitive when it comes to investment management fees.

If a decision is made against setting up a second SMSF, many industry funds offer access to an independent comparison service that assesses the administration and investment costs of the industry fund with a wide number of commercial funds.

Deciding to have the accumulation account in another fund separate to the existing SMSF does come at the cost of extra fees related to that second fund, but this choice can have a benefit of maximising the value of the $1.6 million pension account.

If the decision was made to leave the accumulation account in the SMSF, rather than rolling over the accumulation account to another fund, the proportionate method must be used to assess how much income earned by the fund is allocated to accumulation accounts.

This is done by an actuary that calculates what the percentage of the accumulation accounts are of the total value of the fund, and this percentage of the income is allocated to the accumulation accounts and taxed at 15 per cent on the income and 10 per cent on capital gains.

This means if the current SMSF has assets that will increase in value, a proportion of that increase or profit will be split between the accumulation accounts and the pension accounts.

For example, a fund with two members with $3.2 million in pension accounts, $1.6 million in accumulation accounts, that makes a $90,000 capital gain on the sale of an investment, has only $60,000 of the gain allocated to the pension accounts, while $27,000 after capital gains tax (CGT) will be allocated to the accumulation accounts.

If that SMSF only comprised the pension accounts worth 3.2 million, with the same investment remaining in that fund with the same $90,000 capital gain being made, the whole of the $90,000 would be allocated to the pension accounts. This means over time, the entire increase in the value of the investments is attributed to the pension accounts which could result in a higher pension account value than the PTC of $1.6 million.

Question. I have a single member SMSF with a balance exceeding $1.6 million. The new legislation requires, prior to July 1, 2017, excess assets exceeding $1.6 million are transferred to an accumulation fund. Can I use the segregated method to determine those making up the $1.6 million that I want to retain in my pension fund?

Answer. The question about being able to use the segregation method does not apply until after June 30, 2017. A superannuation fund with a member's pension balance exceeding $1.6 million must use the proportional method from July 1, 2017.

Either you or your accountant can use the segregation method, when the excess over the $1.6 million limit is being rolled back to an accumulation account, to choose those assets being allocated to the accumulation account and claim the CGT concessions available.

For the 2018 financial year and those that follow, if the accumulation account remains within the SMSF, any income and capital gains will be allocated using the proportional method. Capital gains on the investments allocated to the accumulation account, where the CGT concessions have been claimed, will be limited to the increase in their market value at the date they were transferred to the accumulation account.

The problem will be that capital gains made on all other investments, including those supporting the pension accounts, will have a portion of the gain allocated to the accumulation accounts.

Question. Could you please explain how the resetting of the purchase cost for shares transferred into accumulation account can be done?

Answer. When a member's pension account exceeds the $1.6 million PTC, and the trustees choose to claim the CGT concession for shares transferred back to the accumulation account, the shares are deemed to have been sold and purchased at their market value at the date of the transfer.

The most accurate time to assess a member's pension account balance will be after the financial transactions have been processed for the 2017 financial year and the income has been allocated to each member's account.

All investments in a super fund must be included at their market value at year end. Where investments are transferred to an accumulation account at June 30, 2017 due to exceeding the $1.6 million limit, the cost of shares chosen for the CGT relief will be reset to their market value at that date.