Special SMSF investment rules: A starting guide

Any investments you make as trustee of your SMSF must be within the super rules, in particular, the special restrictions on certain investments. The restrictions are designed to ensure that your super savings are invested for your eventual retirement, and that your personal assets are kept separate from your fund’s assets. The more important SMSF investment rules include the following:

1. Follow SMSF trustee declaration
2. Meet the sole purpose test
3. Keep fund assets separate from personal assets
4. Ensure assets are in super fund’s name
5. Don’t lend SMSF money to SMSF members
6. Follow restrictive rules when purchasing assets from members or relatives
7. Don’t borrow money directly
8. Understand limits on investments in assets owned by related parties
9. Keep investments at arm’s length

1. Follow SMSF trustee declaration

The easiest way to stay on top of super’s special investment rules is to re-read the SMSF declaration that you must sign when you’re appointed a trustee (see SuperGuide article SMSF trustee declaration: a quick guide).

In the SMSF declaration you declare that you understand that it is your responsibility to ensure the fund is maintained for the purpose of providing benefits to members (sole purpose test).

You also declare that you understand by law you must prepare, implement and regularly review an investment strategy, and ensure that your money and other assets are kept separate from your SMSF’s assets, and take appropriate action to protect the ownership of fund assets.

Note: You declare, when you sign the SMSF trustee declaration, that you understand that you are prohibited from:

• lending money, or providing other forms of financial assistance, to fund members or relatives of fund members
• purchasing assets from fund members or related parties, unless those assets are listed securities, or are classed as ‘business real property’ or are managed funds (see later in the article for an explanation)
• Borrowing money on behalf of the SMSF, except in limited circumstances
• Having more than 5% of the fund’s total assets as loans to, or investments in, related parties of the SMSF, or having more than 5% of assets subject to a lease arrangement between the trustee and a member or related party (the in-house asset rule).
• Entering into investments on behalf of your SMSF that are not on a commercial basis (that is, must be on an arm’s length basis).

2. Meet the sole purpose test

As trustee of your SMSF, you must ensure that your fund meets the sole purpose test (SPT) when investing — any investments your fund makes must be for the primary purpose of funding your retirement instead of providing current-day benefits. Plain-vanilla assets, such as shares, investment properties and term deposits that aren’t connected to any of your fund’s members or relatives or business partners, meet the SPT requirements.

Assets that are connected in some way to fund members or relatives or business partners, or are considered to be unusual or ‘exotic’ assets — such as motor vehicles, racing yachts and antiques  — may still meet the SPT, but they’re usually subject to greater scrutiny. And if you enjoy a direct or indirect benefit before retirement from one or more of your SMSF’s investments, then you need to ensure that your fund still meets the SPT.

Special rules apply to collectibles. For example, if you hold artwork, antiques or other collectibles within your SMSF, then you must store these investments according to strict guidelines. The assets must also be properly insured and independently valued (see SuperGuide article SMSF compliance: Strict rules for artwork and other collectibles).

3. Keep fund assets separate from personal assets

You wear a special 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.

You must keep your fund’s assets, including bank accounts and supporting financial records, separate from your personal and business assets.

4. Ensure assets are in the fund’s name

Investing as trustee of your SMSF is similar to investing in your own name except that you must ensure any assets you buy on behalf of your fund (and fund members) are held in your name ‘as trustee’ of the fund. If you have a corporate trustee, the investment must be purchased and held in the name of the trustee company ‘as trustee’.

You must protect the ownership of fund assets, which means that you need to ensure the fund’s trustees are registered as owners of all assets. Such evidence can protect the fund’s assets from personal creditors mistaking fund assets as personal assets. For example, a shareholding simply in the name of, say, John and Betty Grayson, is not

Note: If investing in property, depending on the state in which you live, the local property rules may not permit you to use the name of the fund on title documents. In such circumstances, you need to clearly identify fund ownership by using a declaration of trust, a caveat or other type of legal instrument.

5. Don’t lend money to SMSF members

As SMSF trustee, you can’t lend your super fund’s money, or provide any other form of financial assistance, to a member or member’s relative. A relative is defined to mean a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant, or adopted child of the member, or of the member’s spouse (including same-sex spouse). A relative also includes a spouse (including same-sex spouse) of the member, or the spouse (including same-sex spouse) of any of the member’s relatives as set out in the previous sentence.

Note: According to the ATO, using SMSF assets to give financial assistance means providing any assistance that improves the financial position of a person directly or indirectly, including any loans. Remember, you also can’t lend money to any relatives of members. If you lend money to a member or relative of a member you can be subject to a hefty financial penalty (see SuperGuide article SMSF compliance: Administrative penalties hit hard for misbehaving trustees).

6. Follow restrictive rules when purchasing assets from fund members or relatives

Under the super laws, SMSFs can’t purchase assets (or transfer assets as a super contribution) from fund members or related parties, except when the asset falls within certain categories, including:

• Listed security: A listed security can be shares, units, bonds, interests in managed investment schemes and other securities listed for quotation on an approved stock exchange or licensed market. You can find the complete list of approved exchanges on the ATO website.
• Managed funds: The managed fund must be a widely held unit trust, typically a retail or wholesale managed fund where 75 per cent of income and capital entitlements are controlled by more than 20 unrelated unit holders.
• Business real property: This relates to land and buildings used wholly and exclusively in a business, and can include offices, shops, factories and even farms. An SMSF can purchase business real property from a member as an investment, and can then even lease the property back to the same fund member. This generous exemption doesn’t apply to residential property.
• In-house assets valued at less than 5% of fund assets: These are investments in, or loans to, or leasing arrangements with, related parties (see later in the article).

Note: Any assets owned by fund members that don’t fall within the exceptions listed in Section 66 of the SIS Act, can’t be bought by your SMSF, or transferred to the fund as a contribution.

7. Don’t borrow money directly

Your SMSF can’t directly borrow money, except in two instances:

• If you need cash to pay a member’s benefit, you can borrow money. Any loan term must be no longer than 90 days and the loan amount must be less than 10 per cent of your fund’s assets.
• You can borrow money for up to seven days to settle a share transaction.

Important: Your SMSF can use a limited recourse borrowing arrangement to borrow money (see SuperGuide article SMSF basics: Can my DIY super fund borrow money?).

Note: If you do some research, you can discover plenty of strategies that enable you to use gearing (borrowing) in relation to an SMSF without your fund directly borrowing money. For example, you can invest in managed funds that borrow money (geared managed funds).

8. Understand limits on investments in asset owned by related parties

Tread carefully if your SMSF is considering investing in assets that are linked with fund members or relatives of fund members. In general terms, your SMSF can’t invest in, or lend money to, or lease a fund asset to, a fund member or a relative of a fund member, or your business partner or her spouse or children.

More precisely, your SMSF can invest in such an asset, but the investment must be less than 5% of the value of your fund’s total assets. For example, if a fund owns a residential property and leases it to a fund member, the total value of the property would count as the investment.

These types of investments, or loans or leases, are known as in-house assets. Investments in unit trusts and companies that are related to your fund members are also caught by the in-house asset rule.

Warning! Even when your investment meets the 5% rule, such an arrangement is highly likely to breach the sole purpose test (refer earlier). Chat to the ATO before taking any action.

Note: A fund member leasing an office or shop or factory from your SMSF for use in the fund member’s personal business is excluded from having to meet the in-house asset rule (and the sole purpose test). For more information, see SuperGuide article Property and super: What’s the deal? (15 popular Q & As)).

9. Keep your investments at ‘arm’s length’

Any investment or any other transaction you make as trustee of your SMSF must be on an arm’s-length basis. In other words, the sale or purchase of any asset must be on commercial terms, For example, if your business is leasing an office from your super fund, you must pay a market rate of rent and have a formal lease arrangement.

For more information…

For more information on SMSF investment and special investment rules, see the following SuperGuide articles:

• Property and super: What’s the deal? (15 popular Q & As)
• SMSF investment: What assets do DIY super trustees prefer?
• Drafting your SMSF investment strategy: A Super Guide
• Oops! Top 10 SMSF boo-boos
• SMSF basics: Can my DIY super fund borrow money?
• Superannuation investment strategies
• Asset Class Performance Reckoner: Discover investment returns for 13 asset classes