SMSF Alert: September 2015

The Tax Office is wary of life insurance in DIY funds where it may advantage a related party, but don’t let that – or the many emotional barriers – put you off thinking about adequate risk cover. Also, two surveys show where SMSFs are invested and explore their concerns about expected returns.

Key Points

  • Tax Office tracks related party life insurance
  • The emotional hurdles of risk cover
  • Is your SMSF better than average?
  • Trustees scratch their heads when it comes to investing

Nothing cosy about related party risk deals

Life insurance is never a hot topic at the dinner table but within self-managed super funds (SMSFs) it's barely discussed at all. The government’s Cooper Report in 2008 found only 13 per cent of SMSFs had some form of life cover.

Members of most regular super funds have life cover and may not even realise it. Their policies are negotiated in bulk and the premiums are low. For self-managed super funds, an insurer may require that members submit to medical examinations and declare pre-existing conditions. It can sound like a bit of a rigmarole, until you consider the outcome for a dependent spouse who is suddenly widowed.

Insurance within an SMSF is certainly worth a discussion.

But the Australian Taxation Office is conscious that some trustees may feel tempted to divert the cost of cover when a fund member is in a business partnership outside the fund.

It has given an example of how this can happen in Interpretive Decision 2015/10.

Case study

John and Robin are married and are the only members of an SMSF. John runs a company with Kate, his sister. So far, so good.

John and Kate then enter into a buy-sell agreement, but John buys a life insurance policy within the SMSF. He bases the insured amount on an agreed market value of his share of the company he runs with Kate. The company contributes amounts to the fund which are used to pay the premiums on the policy.

If John dies, the terms of the policy state that proceeds are paid to the SMSF and paid to Robin as benefits. Then his shareholding in the company is transferred to Kate. Robin relinquishes all claims on the company.

It sounds as though Kate gets John’s share of the business at no cost. But in the ATO’s eyes this is a clear case of a DIY fund managing its affairs while at the same time favouring a related party, in this case John’s sister.

Kate gets total ownership of the company without having paid any of the life cover premiums or a direct sum to Robin for the share of the company she would otherwise have inherited on John’s death.

'It is our view that because some of the benefits of the arrangement flow to Kate, financial assistance has been provided to a relative of a member of the SMSF and a contravention of section 65 of the SISA has occurred,' the Tax Office says.

Trustees who realise they’ve put similar mechanisms in place should think about undoing the arrangement. An appropriate time would likely be during the annual visit to an auditor. A breach of the sole purpose test is regarded by the ATO as a pretty serious infraction.

The national numbers of self-managed funds

Trustees of self-managed super funds have to track how they’re going if they want to be sure of meeting retirement targets or maintaining sustainable pension strategies, but it’s also interesting now and then to have a look at how all the other funds around the country are doing.

In its survey of 65,000 SMSFs over the 2013-14 financial year, actuarial services firm Accurium found most couples in DIY funds are likely to achieve comfortable retirement lifestyle standards (as defined by the Association of Superannuation Funds of Australia) of $58,444 in disposable income per year.

The median SMSF balance grew by 5.2% to $1,091,000 in the year to June 30, 2014. The increase was helped along by strong investment returns of 8.2%, after accounting for contributions and withdrawals. The S&P/ASX200 gained more than 13% over the period.

Older trustees are on average well within the savings band required for a comfortable retirement (see Chart 1), and a trustee who was 60 in 2014 had 'reasonable confidence of achieving the comfortable standard', Accurium says. By contrast, in 2013 the relevant age was 62.

Members of DIY funds who aspire to a more comfortable lifestyle in retirement but have not met savings targets may have to keep up contributions later into life, increase current contributions or revise their objectives. The survey found if they retired today only 28% of couples aged 55 to 70 would be confident of achieving savings to generate $100,000 a year for life.

The actuary found the average trustee has taxable income 84% higher than the average Australian. SMSF members are also working later into life, with 36% of respondents in accumulation phase aged over 65.

What do SMSFs expect for their investments

A survey of self-managed super funds shows trustees are split between defending the capital they have or taking more risk in the hope of higher returns. In aggregate, however, expectations for returns are low. In March this year, SMSF investors were expecting portfolio returns of 4% for the next 12 months.

The data were collected by researcher Investment Trends in a survey of more than 3,900 SMSF investors in March and April.

Over the preceding year 39% of respondents had decided on a more defensive stance when making revisions to asset allocation (by focussing on income to reflect a negative outlook on shares); and 26% had decided to take a more aggressive position (having decreased cash holdings to back a positive outlook on shares).

Holdings in direct shares are still very high, at 41%. This heavy reliance on risk assets is balanced by a 24% allocation to the most defensive asset class of all, cash (see Chart 2).

Choosing what to invest in was deemed the hardest part of running a self-managed super fund, but 64% of respondents said they plan to invest in blue chip shares over the following 12 months, outside of any already held in managed funds.

Whether they know which blue chip shares are already held within those managed funds wasn’t explored. Fund managers are not compelled to reveal holdings.

The chance of trustees doubling up on stocks they already own within a managed fund would be high, unless an active manager is chosen for their skill picking investments in international markets or in the small companies part of the share market.

Exchange-traded funds are gaining favour as a cheap way to diversify holdings offshore: in October last year, 60% of the sample said they use ETFs to access global markets; in 2011 only 40% of the sample used ETFs that way.

Direct share portfolios are hard to manage, and the 9% of SMSFs with more than half their share portfolios in resource stocks will have felt pain as that sector struggles. In the year to August 29, the S&P/ASX200 Resources index had lost 29% in value. The 22% who admitted that more than half their share portfolios were comprised of banks / financials will have also been hurt; that sector has lost 4% in the year to August 29.

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