Understanding self-managed superannuation funds: Extract
UNDERSTANDING
SELF-MANAGED
SUPERANNUATION FUNDS
EXTRACT
© CPA Australia Ltd 2015 1
Understanding self-managed superannuation funds: Extract
CONTENTS
Course overview 1
Learning objectives 1
Course content 1
Knowledge assessment 2
Symbols 2
1. Introduction to superannuation 4
1.1 Introduction 4
1.2 Funding retirement 4
1.3 Demographics in Australia 4
1.4 Australia’s retirement income system 4
1.5 Incentives to use superannuation 6
1.6 Restrictions with superannuation 6
1.7 Regulatory overview 7
1.8 Types of superannuation funds 9
1.9 The place of SMSFs 10
1.10 Summary 10
2. Why choose an SMSF? 11
2.1 Introduction 11
2.2 What is an SMSF? 11
2.3 SMSF statistics 13
2.4 Why are SMSFs different? 14
2.5 Advantages of an SMSF 16
2.6 Disadvantages of an SMSF 17
2.7 Costs of an SMSF 18
2.8 Issues in making a choice 19
2.9 Summary 20
3. Establishing an SMSF 21
3.1 Introduction 21
3.2 Key questions before starting 21
3.3 Eligibility to be a trustee 21
3.4 Trustee structure 21
3.5 An eight-step process 23
3.5.1 Step 1. Establish a trust deed 24
3.5.2 Step 2. Appoint trustees 24
3.5.3 Step 3. Apply to be regulated 25
3.5.4 Step 4: Open a fund bank account 26
3.5.5 Step 5: Admit members to the fund 27
3.5.6 Step 6: Make initial contributions 27
3.5.7 Step 7: Establish an investment strategy 27
3.5.8 Step 8: Appoint service providers 28
3.6 Definition of an Australian superannuation fund 28
3.7 Life insurance 29
3.8 Service providers 30
3.9 Summary 30
2 © CPA Australia Ltd 2015
Understanding self-managed superannuation funds: Extract
4. Trustee duties and outsourcing 31
4.1 Introduction 31
4.2 Common law requirements for a trustee 31
4.3 SIS covenants 32
4.4 SIS operating standards 32
4.5 Trustee declaration 33
4.6 Outsourcing 34
4.7 Outsourcing process 36
4.7.1 Step 1. Define service needs 36
4.7.2 Step 2. Select service providers 36
4.7.3 Step 3. Make contractual arrangements 37
4.7.4 Step 4. Monitor the arrangement 38
4.8 Special outsourcing arrangements 38
4.9 Summary 39
5. Contributions 40
5.1 Introduction 40
5.2 Statistics 40
5.3 Definition of a contribution 40
5.4 Contribution caps 41
5.5 Sources of contributions 43
5.6 Steps in accepting a contribution 44
5.6.1 Employer contributions 44
5.6.2 ‘Self-employed’ contributions 44
5.6.3 Personal contributions 45
5.6.4 Other contributions 46
5.6.5 Low Income Superannuation Contribution 47
5.6.6 Spouse contribution 47
5.6.7 In specie contributions 47
5.6.8 Business real property 48
5.6.9 Small business CGT concessional contributions 48
5.6.10 Personal injury payments 49
5.6.11 Overseas pension payment 49
5.6.12 First Home Saver’s Account 49
5.6.13 Contributions from a family trust 49
5.6.14 Contributions from reserves 50
5.6.15 Splitting contributions 50
5.6.16 Summary of treatment of contributions 50
5.7 Summary 51
6. Investment basics 52
6.1 Introduction 52
6.2 Trustee powers 52
6.3 Title to fund assets 52
6.4 Investment strategy 52
6.5 Sole purpose test 54
6.6 SIS investment standards 54
6.7 Providing financial assistance to members and relatives 55
6.8 Dealing on an arm’s length basis 55
6.9 Acquisition of assets from related parties 55
6.10 Borrowing 55
6.11 In-house assets 56
© CPA Australia Ltd 2015 3
Understanding self-managed superannuation funds: Extract
6.12 Failure of an investment 57
6.13 A decision making process 57
6.14 Summary 59
7. Investment universe for SMSFs 60
7.1 Introduction 60
7.2 Investment issues 60
7.3 Use of structures 60
7.4 Borrowing to invest 62
7.5 The investment universe 62
7.5.1 Cash 62
7.5.2 Fixed interest 62
7.5.3 Shares 63
7.5.4 Property 66
7.5.5 Collectibles 69
7.5.6 Running a business 70
7.6 Summary 70
8. Tax and administration 71
8.1 Introduction 71
8.2 Taxes that can be payable by an SMSF 71
8.3 Fund tax in the accumulation stage 71
8.4 Fund tax in the pension stage 73
8.5 Scope of administration 74
8.6 Ongoing activities 74
8.7 Annual activities 75
8.8 One-off activities 78
8.9 Non-complying funds 80
8.10 Legacy products and strategies 80
8.11 Summary 81
9. Benefits 82
9.1 Introduction 82
9.2 Preservation 82
9.3 Conditions of release 82
9.4 Superannuation tax components 82
9.5 Lump sum benefits on retirement 83
9.6 Pension benefits on retirement 85
9.7 Legacy pensions 87
9.8 Age pension issues 88
9.9 Divorce 89
9.10 Summary 89
10. Insurance, death, disability and estate planning 90
10.1 Introduction 90
10.2 Life insurance 90
10.3 Types of life insurance 90
10.4 Conditions of release 91
10.5 Death 91
10.6 Terminal medical condition (TMC) 93
10.7 Permanent incapacity 93
4 © CPA Australia Ltd 2015
Understanding self-managed superannuation funds: Extract
10.8 Death of a pensioner 94
10.9 Temporary incapacity 94
10.10 Estate planning 95
10.11 Summary 95
11. Winding up an SMSF 96
11.1 Introduction 96
11.2 Motivation for winding up 96
11.3 Types of restructure 98
11.4 Changing to a corporate trustee 98
11.5 Changing to a SAF 99
11.6 Appointing an attorney to act for a trustee 99
11.7 Impediments to winding up 99
11.8 Winding up process 100
11.9 Coordination of the wind up 102
11.10 Summary 102
12. Future SMSF developments 103
12.1 Introduction 103
12.2 Regulatory watch 103
12.3 ATO determinations and interpretations 103
12.4 Licensing of financial advisers 103
12.5 Role of accountants 104
12.6 Breaches and appeals 105
12.7 Service options 105
12.8 Poor investment choices 105
12.9 Fraud 105
12.10 Competition 106
12.11 Demand 106
12.12 Summary 106
Case studies and activities 107
1. Introduction to superannuation 107
2. Why choose an SMSF? 107
3. Establishing an SMSF 109
4. Trustee duties and outsourcing 111
5. Contributions 112
6. Investment basics 115
7. Investment universe for SMSFs 118
8. Tax and administration 118
9. Benefits 119
10. Insurance, death, disability and estate planning 122
11. Winding up an SMSF 124
12. Future SMSF developments 126
Appendices 127
Appendix 1: NAT 71089 Trustee declaration form 127
Appendix 2: NAT 2944 Application for ABN registration for superannuation entities form 131
Appendix 3: NAT 71226 Self-managed superannuation fund annual return form 142
© CPA Australia Ltd 2015 5
Understanding self-managed superannuation funds: Extract
Suggested answers 158
2. Why choose an SMSF? 158
3. Establishing an SMSF 161
4. Trustee duties and outsourcing 162
5. Contributions 163
6. Investment basics 164
8. Tax and administration 166
9. Benefits 167
10. Insurance, death, disability and estate planning 169
11. Winding up an SMSF 170
6 © CPA Australia Ltd 2015
Understanding self-managed superannuation funds: Extract
1. INTRODUCTION TO
SUPERANNUATION
1.1 INTRODUCTION
Australians treat superannuation in many different ways. Some love it and some hate it. Few really
understand it or take the time to learn about it. Governments of all persuasions continue to fiddle
with superannuation to raise more tax, motivate individuals in various ways, or make the system
‘fairer’.
This chapter will provide a brief overview of retirement planning and the superannuation system in
Australia.
1.2 FUNDING RETIREMENT
Until the 20th century there was no such thing as a period of leisure after a lifetime of work. People
continued working until they were forced to stop by age, disability or death. The concept of retiring
made sense in that it freed up jobs for younger people and was perceived as a ‘reward’ for a long
working life. It was also affordable for Governments and individuals when retirement only lasted a few
years.
Many countries offer a guaranteed pension to citizens on reaching a predetermined age (sometimes
in the past as low as 50). Different countries have different systems but they all rely on being
substantially funded by Government revenue.
The problem for all developed nations in the 21st century is that retirees are living for 25 to 30 years
after the traditional retirement age of 65. Individuals generally have not saved enough to support
themselves for this period of time and Governments cannot afford to support them.
Because of this pressure on funding, Governments around the world have been forced into unpopular
policies such as extending the age at which citizens become eligible for a pension and lowering the
level of benefits.
1.3 DEMOGRAPHICS IN AUSTRALIA
Australia faces the same dilemma. The last intergenerational report (IGR) published in January 2010
contains the following statistics:
• In 1975 there were 7 working people for everyone over age 65. Today there are 5 workers per
retiree and it is projected that by 2050 there will be 2.7 workers supporting every retiree. These
trends are not unique to Australia – Japan, for example, is expected to have 1.4 workers for every
retiree by 2050.
• The number of older people (over age 85) is increasing from 2% in 2010 to an expected 10%
by 2050.
• Ageing and health pressures are projected to result in an increase in total Government spending
from 22.4 per cent of GDP in 2016 to 27.1 per cent of GDP by 2050.
1.4 AUSTRALIA’S RETIREMENT INCOME SYSTEM
The system has three pillars – a taxpayer funded means tested age pension, compulsory employer
contributions and incentives for voluntary contributions.
Taxpayer funded means tested age pension
The age pension is available to virtually all Australians from age 65. The eligibility age will increase
progressively to age 67 for all new applicants from 2017. The maximum pension is guaranteed not to
© CPA Australia Ltd 2015 7
Understanding self-managed superannuation funds: Extract
be less than 27.7% of Male Total Average Weekly Earnings (MTAWE) as determined by the Australian
Bureau of Statistics (ABS).
Unlike many overseas schemes the age pension in Australia is means tested using an income test and
an assets test. When a person has income or assets over a threshold, the pension payable gradually
reduces until it cuts out altogether. The test that pays the lowest pension is the one that is used.
The Institute of Actuaries of Australia has estimated that the age pension for a single person is
equivalent to a lifetime annuity with an initial capital value of $550,000.
The pressure on Government funding for the age pension has led to rumours that it may not be
available in the future. It may not be sustainable at the current level for every retiree who would
currently qualify but it would seem to be politically impossible and socially irresponsible to remove it
completely. It forms a safety net for people with no (or few) resources.
Compulsory employer contributions
The Superannuation Guarantee (SG) scheme requires employers in 2014-15 to pay 9.5% of ordinary
times earnings for most of their employees to superannuation. It is now legislated that the SG rate
will remain at 9.5% until 1 July 2021 when it will be increased to 10%, and this will be progressively
increased by 0.5% each year until it reaches 12% by 2025.
Workers on low incomes whose tax rate is 15% or less get no tax benefit by receiving SG
contributions. From 1 July 2012, a Low Income Superannuation Contribution (LISC) of up to $500 will
rebate the tax paid on SG contributions made on behalf of individuals earning less than $37,000 pa
directly to the individual’s superannuation fund. However, the LISC was repealed by parliament in
2014. The LISC will continue to be payable in respect of concessional contributions made up to and
including the 2016–17 year, but determinations of LISC will cease at 1 July 2019.
The scrapping of LISC will not come into effect until Royal Assent has been received.
REGULATORY
WATCH
Incentives for voluntary contributions
There are a range of incentives for individuals to make extra contributions to superannuation. These
include:
• the ability of employees to salary sacrifice;
• tax deductibility of personal contributions to superannuation by the self-employed (and those
earning less than 10% of their income through employment);
• the co-contribution scheme where individuals who make a personal after tax contribution are
rewarded by an additional contribution from the Government;
• a tax offset for an individual who makes an after tax superannuation contribution for a low income
spouse; and
• a capital gains tax (CGT) exemption for certain contributions from the sale of small business
assets.
These three pillars provide all Australians with the opportunity to create a retirement income to suit
their needs. The age pension is a safety net for those who have been unable or unwilling to save for
retirement. Compulsory contributions are a means of ‘forced savings’ to ensure all workers have at
least some superannuation. Voluntary contributions allow individuals (whether working or not) to build
a more comfortable retirement income.
8 © CPA Australia Ltd 2015
Understanding self-managed superannuation funds: Extract
1.5 INCENTIVES TO USE SUPERANNUATION
Superannuation is a concessional taxed structure that aims to encourage people to save for
retirement.
Tax concessions on employer and deductible contributions
Under Australia’s progressive tax system income is taxed up to 47% (including the 2% Medicare levy).
Note that for the 2014–15 year, the rate will increase to 49% due to the Temporary Budget Repair
Levy Employer contributions (and those where a tax deduction is granted) are taxed at a flat rate of
15% in superannuation. Salary sacrifice contributions, where an employer pays extra superannuation
contributions instead of taxable salary, have become increasingly popular.
From the 2012–13 financial year, to more fairly spread the tax concessions of superannuation, higher
income earners are taxed at a higher rate on their superannuation contributions. Concessional
contributions (CCs) paid by (or for) those earning over $300,000 are taxed at an additional 15%.
Tax concessions on fund earnings in the accumulations stage
Income from investments held personally is taxed up to 47%. Investments in superannuation are taxed
at a flat rate of 15%.
Capital gains on assets held personally are taxed up to 47% but will qualify for a 50% discount if held
for at least 12 months. Capital gains on assets in superannuation are taxed at 15% but will qualify for
a one-third discount (10% tax) if held for at least 12 months.
Fund expenses and most life insurance premiums are deductible. Imputation credits from dividend
paying shares can be used to reduce tax.
Tax concessions on fund earnings in the pension stage
The income (and capital gains) from assets backing a pension are exempt from tax.
Fund expenses are not deductible because there is no taxable income. Imputation credits from
dividend paying shares will be wholly refundable.
Tax concessions on benefits and pensions
Superannuation is for retirement and once an individual reaches their preservation age (currently
55) tax concessions apply for the payment of lump sums and pensions. From age 60 lump sums and
pensions are tax free.
Chapter 8 will cover the application of these rules for SMSFs.
1.6 RESTRICTIONS WITH SUPERANNUATION
No Government can provide unlimited incentives and to prevent abuse there are restrictions on the
scale of these tax concessions and the way superannuation is accessed.
Contribution limits
Since 2007 tax penalties have applied for contributions made by or for an individual per year that
exceeded defined thresholds (called ‘caps’). There are two types of contribution caps:
• Concessional contributions (CCs) – these are contributions which are taxed at 15% rather than
the individual’s marginal tax rate. The major types of CCs are employer and salary sacrifice
contributions and personal contributions for which a tax deduction has been claimed.
• Non-concessional contributions (NCCs) – these are predominantly contributions made from after
tax income.
Chapter 5 will cover the application of these rules for SMSFs.
Preservation
Superannuation is for retirement and generally cannot be accessed until that event occurs. The
Superannuation Industry Supervision Act 1993 (SIS Act), commonly referred to as ‘SIS’, states the
© CPA Australia Ltd 2015 9
Understanding self-managed superannuation funds: Extract
‘conditions of release’ which define what retirement means. Preservation age is the minimum age at
which a member can claim a retirement benefit.
Other conditions of release include death, total and permanent disablement, terminal illness, financial
hardship, and on compassionate grounds.
The rules also allow for a super fund to pay an income stream to an individual whilst they are
temporarily disabled or as a transition to retirement pension after preservation age.
Chapters 9 and 10 will cover the application of these rules for SMSFs.
Investment restrictions
One underlying principle of superannuation is the sole purpose test – superannuation must have the
primary purpose of providing for an individual’s retirement or for their dependants if the individual
dies before retirement. The test also allows a superannuation fund to provide benefits on some
ancillary purposes.
Over time a set of superannuation rules have been developed that restrict the assets that a
superannuation fund can acquire or own. These restrictions are aimed at ensuring that the benefits
are available at retirement and individuals do not benefit from their superannuation before
retirement. These rules are particularly important for SMSFs.
Chapter 6 will cover the application of these rules for SMSFs.
1.7 REGULATORY OVERVIEW
When the SG scheme was introduced and superannuation became compulsory the Government felt
it needed to take steps to ensure the money was ‘safe’ and invested appropriately. The decision was
taken to leave it to the private sector to develop and administer superannuation. It was believed that
competition between funds would improve services and reduce costs for fund members.
Superannuation operates as a trust structure. The Government could not closely supervise every
single superannuation fund so responsibility was given to the trustees to manage the funds effectively
and prudently.
Role of APRA
The Australian Prudential Regulation Authority (APRA) oversees all superannuation funds (except
SMSFs) as well as banks, and general and life insurers. It licenses the superannuation trustees of
APRA regulated funds and issues standards, guidelines and circulars based on the SIS Act. The goal
of APRA is to ensure trustees act prudently in the investment and management of member’s money.
Trustees must lodge an annual return with APRA and may be subject to audit and investigation by
APRA.
<http://www.apra.gov.au/Super/Pages/default.aspx>.
REFERENCE
Role of ATO
Superannuation funds have been tax-paying entities since 1988 and the tax rules are contained in the
Income Tax Assessment Act 1997 (ITAA97). All superannuation funds must lodge an annual tax return
to the Australian Tax Office (ATO).
The ATO is also responsible for the regulation of SMSFs. The ATO is only responsible for regulatory
compliance, not whether SMSF trustees are acting prudently. SMSFs must provide a combined annual
and tax return to the ATO and may be subject to audit and investigation by the ATO.
10 © CPA Australia Ltd 2015
Understanding self-managed superannuation funds: Extract
<http://www.ato.gov.au/Super/Self-managed-super-funds/>.
REFERENCE
Role of ASIC
ASIC administers the Corporations Act 2001 which provides (amongst other things) consumer
protection in the financial services sector and the provision of financial product advice under the
AFS licensing regime. ASIC issues AFS licences to provide financial product advice to individuals,
partnerships, companies and other entities such as APRA regulated public offer superannuation
funds. An AFS licensee must supervise their authorised representatives and ensure their continuing
competence and behaviour. The Corporations Act also prescribes the contents and timing of reports
that financial product providers, (including superannuation funds), must provide to investors.
<http://www.asic.gov.au/asic/ASIC.NSF/byHeadline/Financial%20Services%20
home%20page under financial services>.
REFERENCE
Superannuation Complaints Tribunal (SCT)
All APRA regulated superannuation funds must have an internal dispute resolution system to handle
complaints by members against the trustees. Where a complaint cannot be resolved it can be referred
by the member to the SCT which will mediate. The SCT can impose its own decision on trustees.
The SCT is not available to members of SMSFs because the members are trustees and would only be
complaining to themselves.
<www.sct.gov.au>.
REFERENCE
An aggrieved member/trustee or beneficiary can take legal action against a trustee. However, apart
from the expense, the chances of success are low where the decision making powers given to the
trustees are exercised appropriately.
A member who had a complaint about a financial adviser would use the internal dispute resolution
system of the AFS licensee. Where a complaint cannot be resolved it can be referred to the Financial
Ombudsman Service (FOS).
© CPA Australia Ltd 2015 11
