They say families who play together stay together, but what about families who save together in a multigenerational self-managed super fund?
Now that the maximum number of members allowed in an SMSF has increased from four to six, the question is even more topical. Although judging by recent membership trends, demand may be limited.
According to the most recent ATO statistics, the vast majority of SMSFs (69.5%) have just two members, usually a wife and husband. A further 23.5% have one member. The remaining 7% have three or four members, typically parents and their adult children. Obviously multi-generational SMSFs are a minority – but are they a good idea?
All for one, or one for all?
Meg Heffron, managing director of Heffron SMSF Solutions, treats most SMSFs as a single generation vehicle. However, she says there are circumstances where combining the generations makes sense. “We see it mostly where there’s commercial property in the fund or a family business,” she says.
SMSF Association CEO John Maroney agrees that two-member funds are likely to remain the norm. However, for some larger families, he says the ability to have up to six members has the potential to make a real difference, giving them additional flexibility and choice.
So, what are the main benefits and pitfalls of mixing family and fortune?
- Cost efficiencies: Maroney says having up to six members in your SMSF will provide for greater cost efficiencies with set-up costs, levies and audits spread across more members. This can be helpful for adult children just starting out, where their relatively low super balance would generally put an SMSF out of reach. What’s more, an increase in an SMSF’s balance will help cut costs as a percentage of assets.
- A bigger pot: By joining forces, parents and their adult kids can invest in large assets such as a business property. This is a common strategy where a family runs a business together. Once a business property is acquired by an SMSF it can be leased back to a related party for business use without the normal 5% limit on in-house assets applying. Heffron says adding members may also make it easier to set up a limited recourse borrowing arrangement (LRBA) because the risks of not being able to cover borrowing costs are lower if there are more members making contributions.
- Cash flow for pensions: Even if parents draw a minimum pension when they are in retirement phase, there comes a time when assets need to be sold to make these payments. “If a client has children who are making contributions to super, one benefit of combining is that their cash flow can finance the client’s pension. In effect, the cash contributions are being used to buy a share of the fund’s existing assets,” says Heffron. This intergenerational transfer of wealth can occur within the fund without the need to buy or sell assets and the tax and other costs that come with that.
- Estate planning: When both parents die, their remaining super balance must be paid as a lump sum death benefit to their beneficiaries or their estate. If they hold property in their fund the family must either sell or transfer the property out of super. However, Heffron says if the children have made contributions over many years and these have been used to buy new assets such as shares, these may be used to pay some or all death benefits. “This may well enable the family to leave part or all of the property in super well beyond one generation,” she says.
- Knowledge transfer: Non-financial benefits should also be taken into account. By managing their super together, parents may be able to provide a hands-on financial education for their adult children. But the knowledge transfer is not necessarily all one way; adult children may bring valuable expertise. Many hands may also make light work as administration tasks can be shared.
- Conflicting interests: Members of different generations may be at very different life (and super) stages with differing priorities. Once in retirement phase, parents will naturally focus on income and capital preservation while children in accumulation phase remain intent on growth. “While it’s possible to run the two generations’ investments separately within the same fund, doing so may start to undermine the very reason they joined forces in the first place,” says Heffron.
- Administration complexity: As members leave or join – perhaps after marriage or divorce – it can be complex and costly to manage the change. As well as the additional reporting involved, assets may need to be sold, triggering capital gains tax and sales tax on the sale or transfer of assets. “In some cases, the outcome can be the forced sale of assets that the other members do not want to sell,” says Maroney.
- Control: The reason people cite for running their own super fund in the first place is often the control it gives them. Yet one ‘difficult’ member can derail decision-making and create tension within the family – and let’s face it, families often fall out over money. Maroney says SMSFs considering additional members need to get advice on voting rights and other terms in their trust deed. “All fund members are trustees; none can be excluded. It means they are all legally responsible for the fund, so it is critical they all understand their rights, roles and responsibilities,” says Maroney. If the trustee is a company operating on a ‘1 director, 1 vote’ basis, Heffron says the death of a parent could result in the surviving parent being outvoted by their children.
- Differing state laws: While all members must be trustees and all trustees must be members, Maroney says state-based trust laws may cause issues where the SMSF has individual trustees. “These limit the maximum number of trusteed and do vary across the states and territories. As an alternative, funds should consider the use of a corporate trustee,” he says.
- Moving overseas: If children move overseas for work or parents retire overseas, there’s a risk that their fund could become non-complying (see note below). To remain compliant, central management and control must remain in Australia. This is only possible if at least half the members remain in Australia. Also, balances of the active (contributing) Australian members must be at least 50% of the total of all active member balances. This is harder to achieve in practice, especially if the Australian members are in retirement phase. At the very least, day-to-day decision-making and administration can be difficult if one or more members move overseas.
- Estate planning issues: When a member dies and their death benefits are paid out as a lump sum, assets may need to be sold triggering tax and other costs. Contribution caps also make it difficult for children to get money back into super, so an SMSF offers no advantage over a public offer fund in that way. Issues may also arise when parents die if not all children are members of the fund, although the increase to six-member funds should make it easier to include the whole family. “Effectively the siblings who do belong have far greater power over how the super is dealt with than those who do not,” says Heffron. Similarly, there may be concerns if one sibling has power of attorney for a parent who loses mental capacity.
There have been cases where the courts have overturned decisions of a person with power of attorney who do not exercise it in the best interests of the person with incapacity. While that won’t stop some people ignoring their obligations if they think no-one is watching, it does demonstrate such a course is fraught with dangers.
Separation of assets
At first glance, keeping your retirement funds all in the family may seem like a good idea. In practice though, both the older and younger generation may value a little privacy and the ability to manage their money without having to justify their decisions.
Heffron also wonders out loud how many people manage their finances in conjunction with their kids, unless they are all involved in a family business. “Personally, I don’t belong to my parents’ SMSF and I’m not going to invite my children into mine – yet. But as I look into the future, I do wonder if there will be a time when my sons are playing such a significant role in my financial affairs that belonging to my SMSF will make sense.”
There are also some myths about multigenerational funds. One myth is that your kids can tell you how to invest your money – they can’t. Member choice for SMSFs means any member can invest their account balance as they see fit.
Many of the pitfalls noted above can be managed or eliminated with careful planning. While multigenerational funds are likely to remain the exception rather than the rule, for some families the benefits can flow down the generations.