While there are solid reasons for forming family SMSFs, there are important considerations to ensure that significant family events – like divorce, remarriage, stepchildren and death – don’t affect the fund’s ability to achieve its superannuation goals.
Family SMSFs comprise the majority of all SMSFs. It is common for two member SMSFs to be a husband and wife, with the option of adding their children as members at a later stage. While family SMSFs are advantageous for reasons such as succession planning, holding family assets in a tax preferred environment, and managing super with family members, there are some issues which need to be considered.
Keeping it in the family
SMSFs are limited to four members, so this could create a problem for families consisting of more than four people. Deciding who is or isn’t included may trigger family politics. A solution could be to start a second family SMSF, with the parents belonging to both, or having the children commence their own fund, leaving the parents in the original SMSF.
Generational differences between parents and children may cause disagreements over investments, including risk tolerances and investment time frames. This is especially relevant when allocating a large portion of the balance in the fund to a single, less liquid investment, such as property. Difficulties may be created where older members reaching retirement require benefit payments, when their investment horizon and risk appetite are different to younger members.
The extended family
Life events will also affect a family SMSF. When children marry and start their own families, there may be no ability for the spouse to join the SMSF. If they wish to start their own SMSF with their new family, the member’s super balance would be transferred to the new SMSF. Assets may need to be liquidated, incurring capital gains tax (CGT).
Marriage breakdowns present more complex consequences. If the spouses are the only members of their SMSF, and one wishes to leave, the SMSF may need to be restructured. This is because a single member fund with individual trustees must have two trustees. Where there is a corporate trustee, the remaining member must be either the sole director of the company, or one of only two directors.
Both the Family Law Act 1975 and the Superannuation Industry (Supervision) Act 1993 (SIS Act) provide for a super interest or a super payment to be divided or split by agreement or court order in the event of a relationship breakdown. In these cases, the split assets may attract CGT rollover relief for their total super balance transferred from the SMSF as a result of relationship breakdowns. The gains or losses of the transferring SMSF are disregarded and the receiving SMSF obtains the cost base of the transferring SMSF at the date of transfer.
Section 66(2B) and (2C) in the SIS Act provides for an exception to the prohibition against acquiring assets from a related party in the event of a relationship breakdown. Where spouses have separated and there is no reasonable likelihood of cohabitation being resumed, either or both parties may establish their own new SMSF and rollover assets from the old SMSF, as long as the rollover of assets is related to the relationship breakdown. These laws also apply to de-facto couples.
I do, I do, I do
Blended families and remarriages may also pose challenges. Should a member pass away, their super death benefit will attract tax unless it’s paid to a tax dependant. Where members of a super fund include the new spouse, the death benefit may be paid to the new spouse who is a tax dependant, rather than individual adult children in order to avoid tax erosion of the benefit. Further, on the death of the member whose super fund was in pension phase, their superannuation interest ceases, meaning it would no longer be eligible for tax-free status on its income and capital gains. This will occur unless a reversionary pension is paid to a dependant, typically a spouse. So while it may be tax-effective to pay death benefits to the current spouse, it may cause conflict between the member’s children from a previous marriage.
One solution may be a conditional auto-reversionary pension. These allow a reversionary pension to be paid to the current spouse without them accessing the assets or the capital behind the pension. The assets can then be divided in any way desired by the member once all fund members have passed away, including to the children by way of a death benefit. It ensures that the assets remain in the super fund continuing to benefit from tax-free status, while preserving the assets in the fund for adult children, thus reducing estate disputes.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.
