They say families who play together stay together, but what about families who save together in a multi-generational self-managed super fund?
According to the most recent ATO statistics for 2015-16, the vast majority of SMSFs (69.8%) have just two members, usually a wife and husband. A further 22.9% have one member. The remaining 7.3% have 3 or 4 members, typically parents and their adult children. Obviously multi-generational SMSFs are a minority – but are they a good idea?
Change called for
Under current rules, SMSFs can have a maximum of 4 members. All members must be trustees (or directors if there’s a corporate trustee) responsible for decisions made about the fund and compliance with the law.
The 2018 Budget proposed increasing the maximum number of SMSF members from 4 to 6, but legislation lapsed ahead of the 2019 federal election. SMSF Association head of education and technical, Peter Hogan says it remains Coalition policy and would be welcomed by the superannuation industry, which has long argued for an increase to 10 members.
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.
So, what are the main benefits and pitfalls of mixing family and fortune?
- 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 a SMSF it can be leased back to a related party for business use without the normal 5% limit on in-house assets applying.
- 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.
- 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. For example, assets may need to be sold, triggering capital gains tax and sales tax on the sale or transfer of assets.
- 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. Additionally, 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.
- Moving overseas: If children move overseas for work or parents retire overseas, there’s a risk that their fund could become non-complying. 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, Hogan says 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. Hogan says contribution caps also make it difficult for children to get money back into super, so a 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. “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.
Hogan says there have been cases recently 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. “It doesn’t mean people won’t ignore their obligations if they think no-one is watching, but (such a course) is fraught with dangers.”
Separation of assets
Hogan says, only half joking, that one downside of having your kids in your fund is that they get to know how much money you’ve got. “They may not appreciate it when you start spending their inheritance,” he says.
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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.
There are also some myths about multi-generation funds Hogan is keen to correct. “One myth is that your kids can tell you how to invest your money – that’s rubbish. Member choice for SMSFs means any member can invest their account balance in a particular way,” he says.
Many of the pitfalls noted above can be managed or eliminated with careful planning. While multi-generational funds are likely to remain the exception rather than the rule, for some families the benefits can flow down the generations.
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