Yes, a self-managed super fund (SMSF) can purchase life insurance cover on behalf of members (see our article SMSFs and life insurance), but life insurance policies held outside a super fund cannot be transferred within a SMSF.

No transfers of personal life insurance policies

In the past, the ATO has specifically stated that you cannot transfer an existing life policy held by a member outside a SMSF, into the SMSF. The rules are clear on this position: a SMSF cannot purchase/transfer a life insurance policy held by a member. If such a transaction took place, the SMSF trustee would be in breach of subsection 66 (2A) of the Superannuation Industry (Supervision) Act 1993.

If, however, the SMSF buys the policy from a related party of the SMSF (other than a fund member or relative of the fund member), then it appears such a transaction is within the rules. You will need to confirm this view with the ATO.

The question regarding transferring personal life insurance policies into a SMSF has caused a lot of confusion over the years. In some cases, the ATO has retrospectively permitted transfers of life insurance policies when discovered during ATO audits. According to the ATO, such a transfer was only permitted when the SMSF was the original purchaser of the policy (on behalf of the fund member) and the life insurance company mistakenly placed the policy in the individual’s name.

Mistakenly in name of fund member, rather than in name of SMSF

A couple of years ago, I requested an official ATO response to the question about transferring personal life insurance policies, and set out below is an extract from the ATO’s response:

The ATO said:

… where a fund has purchased a life insurance policy from a life insurance company, but for some reason or other the policy was issued in the name of the member, the fund is required to do all it can to ensure the name of the holder of the policy is changed to that of the fund. This is because self-managed superannuation funds are required under section 52 of the SISA [SIS Act] to keep assets of the fund separate from assets of the trustee (often the member) and also to exercise care and diligence when dealing with the property of the fund. Care and diligence requires that the fund ensure third parties are aware of its interest in all its assets.

Where the tax office encounters a life insurance policy that was purchased by a self-managed superannuation fund, but incorrectly issued in the name of a member, the tax office works with the trustee to get the name on the policy changed to the fund’s name where possible. If this is not possible the tax office works with the trustee to find some other way to reflect the fund’s interest, such as drawing up a declaration of trust over the policy.

The above situation is not a transfer of ownership of the policy. It is a different situation entirely where a member purchases a life insurance policy and then at some later stage wants to transfer that policy to the fund. This is the transfer of ownership of an asset, and … is specifically prohibited by the SISA.

Claiming tax deductions for life insurance premiums

Life insurance premiums are deductible within a superannuation fund. Note that if a SMSF claims a deduction for such premiums, and then you are unlucky enough to die and leave your benefits to a non-dependant, then some or all of your insurance payout may be subject to 31.5% tax. Life insurance payouts to dependants via super funds are tax-free regardless of whether a tax deduction has been claimed for the life insurance premium. I suggest you discuss the tax implications, and the estate planning implications of any life insurance decisions with your adviser.

Related posts:

1. SMSFs and life insurance
2. SMSFs: Can I purchase health insurance within my DIY super fund?
3. SMSF: If I die young, will my wife pay super tax on the life insurance payout?

Another helpful tool that I use is my list containing the 10 commandments of DIY super. Over the past decade, when presenting to investment forums on DIY super, I often used the term ‘ten commandments’ as a tool to help the audience grasp the major rules that apply to self-managed super funds (SMSFs). Here are my 10 commandments of DIY super.

1. You shall . . . always remember you’re in control

If you put in the time to understand the rules, and seek advice when necessary the prospect of complying with the superannuation laws shouldn’t deter you from running a SMSF.

If you do find the compliance side too overwhelming, you can delegate some of the tasks, but not the responsibility, to service providers, or in extreme cases, you can wind up your SMSF.

Note: Outsourcing your obligations doesn’t remove your ultimate responsibility as trustee of your own fund. You may choose to hire a company to look after your administration and compliance; but, in the end, you’re responsible for what happens in your fund. For more information about your C-A-R-T (compliance, administration, reporting and tax) obligations visit the ‘DIY super’ section of our website. As a starting point you can check out the article SMSF providers: What should I look for when setting up my DIY super fund?

2. You shall. . . comply with the sole purpose test

In the SMSF trustee declaration that new trustees must sign, the trustee declares that he understands ‘. . . it is my responsibility to ensure the fund is maintained for the purpose of providing benefits to its members upon their retirement (or attainment of a certain age), or for beneficiaries if a member dies’. You can find out more about the SMSF trustee declaration by clicking on this link.

If you enjoy a direct or indirect benefit before retirement from your SMSF’s investment, that is, more than an incidental or insignificant benefit, your fund is probably breaching the sole purpose test. You can learn more about the sole purpose test by reading the following ATO document: SMSFR 2007/D1.

3. You shall. . . follow your fund’s trust deed

The trust deed is your SMSF’s rule book. As a SMSF trustee, you must act in accordance with your trustee responsibilities as set out in your fund’s trust deed. If that document isn’t enough incentive, the Superannuation Industry (Supervision) Act 1993 (the SIS Act), the main legislation governing super, expressly states that the trustee of the fund must comply with all of the trust deed provisions. Penalties for non-compliance apply if you don’t follow your trust deed.

4. You shall. . . comply with the SIS Act

The superannuation laws are set out in the SIS Act, and the Superannuation Industry (Supervision) Regulations 1994. A SMSF, as with all super funds, must comply with the SIS Act and regulations, including the following rules:

• Contribution rules. You must satisfy the contribution rules, for example, if a member is aged 65 or over they must satisfy a work test before contributing. For more information see the ‘boost your super’ section on the SuperGuide website.
• Investment rules. You must satisfy special investment rules. See the fifth and sixth DIY super commandments.
• Benefit payment rules. You must not breach the payment rules when paying a lump sum or pension, for example, a SMSF member must satisfy a condition of release to access preserved super benefits. For more information see the ‘accessing super’ and ‘retirement planning’ sections on the SuperGuide website.
• Administrative obligations. Your fund must meet its administrative obligations such as preparing minutes of trustee meetings and decisions, and keeping accounting records — including recording all contributions, expenses, tax paid, investment transactions and other transactions throughout the year. For more information see the ‘DIY super’ section on our website.

5. You shall. . . formulate an investment strategy

The super laws demand that trustees formulate and implement an investment strategy. Section 52 of the SIS Act states that when formulating your strategy you need to take into account:

• Likely risk and return of any investment
• The fund’s investment objectives
• Diversification — investing across a broad range of assets, and any risks from investing in a small number of assets, or a single asset
• Liquidity — the ability of the fund to pay taxes, expenses and members’ benefits.

You can read about where SMSF trustees invest the $400 billion or so of super cash by checking out our article, SMSF investment: where does all the super money go?

6. You shall. . . not break any investment rules

Besides the requirement to create an investment strategy for your SMSF, you must also ensure your SMSF doesn’t breach any of super’s special investment rules. The SMSF trustee declaration that new SMSF trustees must sign clearly lists these rules as follows:

• Ensure your SMSF meets the sole purpose test
• Keep personal money separate from SMSF assets
• Protect the ownership of fund assets
• Don’t lend money or provide other forms of financial assistance to fund members or relatives of fund members
• Don’t purchase assets from fund members, unless those assets are listed securities, business real property or managed funds
• Don’t borrow money on behalf of your SMSF, unless it falls within one of the exceptions
• Don’t have more than 5 per cent of the fund’s total assets as in-house assets. An in-house asset is a loan to, or investments in, related parties of the fund, or a lease arrangement with related parties
• Ensure any fund investment is made on an arm’s length basis.

7. You shall. . . arrange for your SMSF to be audited

The SIS Act states that trustees of a SMSF must appoint an ‘approved auditor’ in each income year to audit the fund’s operations of the fund, and that the auditor must provide the trustees with an audit report in the approved form. You can only appoint an approved auditor to conduct these audits. An approved auditor can be a registered company auditor or a member of one of the accounting bodies. You can read the following SuperGuide article for more information: SMSF audit: you must appoint an approved auditor

8. You shall. . . lodge tax and compliance returns

Your SMSF must lodge a return each year with the ATO on or before the due lodgement date. When lodging your fund’s return, you also must pay the annual supervisory levy of $150.

9. You shall. . . keep your fund separate from your personal finances

You wear a very distinctive cap when you take on the role of SMSF trustee — you act on behalf of fund members, including yourself. Legally, your role as a SMSF trustee is different from your role as fund member, which means you must manage your SMSF separately from your personal and business affairs.

10. You shall. . . seek professional advice, when necessary

You shall seek professional advice before you set up your SMSF, and seek advice on an ongoing basis, when necessary:

• Even if you choose to do everything yourself, advice at the outset and regular chats to a chosen adviser are essential.
• Even if you choose to use that adviser as a coach or mentor, instead of getting him or her involved in the nuts and bolts of your fund.

Related posts:

1. SMSF basics: Wrap vs DIY super
2. SMSF basics: Updating SMSF trust deeds
3. SMSF basics: Is there a minimum or maximum age for starting a DIY super fund? (2 questions)

If you run a self-managed super fund don’t be expecting to invest in anything exotic, or to get up close and personal with fund assets, based on the latest preliminary recommendations from the Super System Review (SSR).

The SSR, chaired by Jeremy Cooper, has released another preliminary report, ‘Self-Managed Super Solutions’, which sets out the SSR’s preliminary recommendations on SMSFs.

The report opens with 10 guiding principles that the SSR believes should underpin the regulation of SMSFs, including the principle that leverage (borrowing) should not be a core focus for SMSFs. The SSR states that leverage “should be ancillary to the main strategies employed to build retirement savings over the longer term.” The SSR also recommends that the borrowing rules be reviewed in two years’ time.

Note: This article is merely reporting what the SSR has recommended rather than providing any in-depth analysis of the contents of the report. The final report will be delivered to the Government by 30 June 2010.

Main SSR recommendations for SMSFs

The recommendations contained in the report include:

• A ban on investing in collectibles and personal-use assets: such as, art, jewellery, exotic cars, yachts, antiques, race horses and wine. Existing collectibles held within SMSFs to be sold by 2020.
• A ban on new in-house assets, and existing in-house assets to be removed from the SMSF by 2020.
• Impose restrictions on how SMSFs transact with related parties
• No requirement to record your investment strategy (!)
• Potentially increase the ATO supervisory levy (to fund dispute resolution for death benefits – see later in article)
• Retain the four-member limit for each SMSF
• No minimum account balance requirement
• No compulsory education for SMSF trustees
• No requirement for third-party custodians to hold SMSF assets
• No compulsion to have a corporate trustee, although the SSR believes a corporate trustee is a better option
• Develop an online SMSF resource centre to assist SMSF trustees in developing skills and improving decision-making
• Introduce more flexibility in the ATO penalty regime
• Impose more onerous identity requirements when establishing a SMSF
• Improve the competence and independence of approved auditors, including the requirement to register as an approved auditor
• Amend legislation to give the ATO power to make binding rulings in relation to SMSFs

Death benefits, insurance and the Superannuation Complaints Tribunal

The SSR also recommends that where an individual, who is not a member of a SMSF, believes he or she is entitled to a death benefit paid or payable from a SMSF, then that individual should be able to deal with this dispute via the Superannuation Complaints Tribunal (SCT).

The SSR also recommends that SMSF disputes relating to insurance from external providers be dealt with via the SCT.

According to the SSR, any additional resources that the SCT needs to take on this role, can be sourced by increasing the ATO supervisory levy.

Separate legislation for SMSFs, within the SIS Act

The SSR recommends that the Superannuation Industry (Supervision) Act 1993 (SIS Act) be restructured so that SMSFs are regulated under a separate section of the SIS Act. Other SIS-related recommendations include:

• changing the SIS Act to ensure SMSF trust deeds remain current when the superannuation laws change.
• considering death and disability insurance should be part of the process when formulating an investment strategy.

The SSR will deliver its final report to the Government by 30 June 2010. You can check out the SSR’s preliminary reports by clicking on the links below:

• Clearer Super Choices: Matching Governance Solutions (14 December 2009)
• SuperStream: Bringing the back office of super into the 21st century (22 March 2010)
• MySuper: Optimising Australian superannuation (20 April 2010)
• Self-Managed Super Solutions (29 April 2010)

Related posts:

1. Cooper Review: Top 10 recommendations from final report
2. Cooper Review: Government flags ‘bye bye’ to SMSF borrowing
3. Cooper Review: Our Government’s four-pronged response

NEWS UPDATE: On 10 March 2010, the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP announced two changes to the instalment warrant rules in relation to superannuation:

• Only licensed advisers can recommend and implement instalment warrant arrangements.
• A superannuation trustee who enters into a limited recourse borrowing arrangement to purchase an asset, as permitted under subsection 67 (4A) of the SIS Act (instalment warrant provisions), will be treated as the owner of the asset for income tax purposes, thereby averting the triggering of the capital gains tax rules when paying the final instalment.

Certain borrowing arrangements by superannuation fund trustees which are permitted by the Superannuation Industry (Supervision) Act 1993 (the SIS Act) will now be financial products under the Corporations Act 2001. What this means is that only licensed financial services providers can offer these arrangements to superannuation funds, which cuts out accountant, mortgage brokers and property spruikers (unless they also hold an Australian Financial Services Licence). The Regulations formalising this change will take effect three months after being made.

According to Minister Bowen, the second change, relating to ownership of the underlying assets for tax purposes, ensures that trustees of superannuation funds who have entered into permitted limited recourse borrowing arrangements will not face capital gains tax obligations at the time the last instalments are paid. The changes to the ownership status will apply for income tax assessments from 2007/2008 year onwards.

Minister Bowen also flagged that due to some areas of uncertainty in relation to the borrowing arrangements permitted by super funds, there may be further announcements in relation to instalment warrants.

The following text is an edited extract from Trish Power’s book DIY Super For Dummies ($39.95, Wiley). Reproduced with permission.

Instalment warrants – the basics

Instalment warrants are becoming increasingly popular with SMSF trustees seeking to gear an investment portfolio without breaking super’s ‘no borrowing’ rules.

An instalment warrant is similar to a hire purchase plan — a third party purchases, say, a shareholding in a company. You pay an instalment now on the purchased shareholding, and then pay interest every year; and, after a period of time, you have the option to repay the rest and receive full ownership of the asset. For example, say you own shares in the Bigger And Better Building Company (BBB) and you receive dividends from those shares. A BBB company share costs $10 and is currently paying a dividend of 50 cents a share, whereas a BBB instalment warrant costs $5. If you have $1,000 to invest in BBB, you can buy 100 shares or 200 instalment warrants; plus, you receive an extra $50 a year in dividends by buying the warrants.

A SMSF can invest in an instalment warrant issued over any asset that a SMSF can invest in directly. For example, a product provider may offer an instalment warrant over property, Australian shares, overseas shares, managed funds, private equity investment or even collectibles.

Not everyone in the superannuation industry supports the use of gearing within super funds. Some experts believe that gearing places super savings at too much risk, while others argue that if SMSF trustees can invest in geared managed funds and highly geared listed companies, then using instalment warrants is also legitimate.

The risk of investing in derivatives, such as instalment warrants, is that because you only pay a portion of the full value of the asset, you can buy more instalment warrants compared with what you buy of the underlying asset, with the same amount of money, and it can expose the fund to greater losses if the share price drops substantially. A derivative is a financial asset or liability whose value is linked to an underlying asset such as shares.

The government and the ATO have expressed concerns about the appropriateness of some types of instalment warrants for SMSFs. An instalment warrant with a limited recourse arrangement that gives the product provider recourse only to the asset attached to the instalment warrant (rather than other fund assets) has been given the ATO tick of approval. Limited recourse means the maximum that you can lose is your original capital investment.

Taking the risk of a limited loss, on trust

Before legislation was passed in late 2007, SMSFs only invested in instalment warrants issued over shares. Since the introduction of new rules in September 2007, a SMSF trustee can ‘borrow’ money under an instalment warrant arrangement over most types of assets when the geared product holds the following features:

• Held on trust. The borrowing is used to buy an asset that is held on trust, and the SMSF trustee receives the beneficial interest and a right to purchase the underlying asset.
• Limited recourse. Limited recourse means that the maximum your fund can lose is the original capital investment: Your fund can’t lose more than the original amount invested (including amount borrowed). The lender (product provider) only has recourse to the asset in question if your fund defaults on the loan, rather than recourse to other fund assets. If you don’t make a payment, the asset held in trust is sold on-market and the proceeds of the sale are offset against the final instalment payable. And, if the final payment outstanding is greater than the sale proceeds, then your fund isn’t required to pay the difference because the product included loan insurance.
• Allowable investment. The underlying asset is the type of asset that a SMSF trustee can invest in directly. For example, a SMSF trustee can’t purchase a residential investment property owned by a fund member under such an instalment arrangement because such an asset can’t be purchased directly by a SMSF. If the residential property is bought from an unrelated party, however, then such an arrangement is possible. Unlike residential property, business-related property such as an office or warehouse can be bought from related parties.

Note: SMSF trustees must still comply with other superannuation rules. You must have drafted, and follow, a derivative risk statement if your fund invests in instalment warrants or any other derivative product such as options. Your derivative risk statement must explain your policies when using derivatives, including the risk analysis of using such an approach and the controls you have in place to manage these investments. Your fund’s auditor must sign off on this document each year.

What matters is the quality of the underlying investment

Purchasing property (or any type of asset permitted by the super rules) by using instalment arrangements is a legitimate option for SMSF investors but such an investment approach involves borrowing, commonly known as gearing. When property values are rising, geared products enable to you to accumulate wealth at a much faster rate because you have access to the returns on more assets. In falling markets, however, your losses are also greater when you borrow to invest.

What matters when investing, whether you use borrowed money or not, is the quality of the underlying property investment. You also need to be mindful of the costs of such an arrangement. As a SMSF trustee, you need to ask yourself whether the expected returns on the investment justify the costs of the instalment arrangement. The property warrant products aren’t necessarily cheap, and you may discover you’re being charged several levels of fees.

Note: You need to fully understand that this ‘borrowing’ caper isn’t a regular arrangement, and can be relatively expensive to set up and to maintain over time. Your instalment arrangement must also meet special conditions (refer earlier).

Source: Edited extract from Trish Power’s book DIY Super For Dummies ($39.95, Wiley). Reproduced with permission.

Related posts:

1. SMSF borrowing: What’s the difference between a non-recourse and limited recourse loan?
2. Using unit trusts for purchasing property through your SMSF
3. SMSF investment: Can my DIY super fund invest in direct property?