SMSFs are not forever. There are various reasons that an SMSF needs to come to an end, and then there are various ways that the end can be managed.
The ATO have released a short, easy-to-understand video on winding up an SMSF:
Reasons to finish up an SMSF
In an article for the excellent online publication, Cuffelinks, commentator Julie Steed nominated the ‘seven D’s’ that may cause an SMSF to be finished up with. They are:
- Departure; and
In some ways these are self-explanatory, but some deserve a little more comment.
The death of a member typically requires the payment of a death benefit to an eligible death benefit beneficiary. Depending on the balance of the member who died, this might reduce the benefits that remain within the SMSF below the point at which the SMSF remains efficient. Remember, ASIC suggest that it is difficult for an SMSF to be efficient with a balance below $200,000.
Unless an SMSF has a corporate trustee (that is, a company is the trustee for the fund), then it must have at least two members. In cases where there is not a corporate trustee and a member dies, there needs to be at least two surviving trustees to continue managing the fund. A new member may join the fund following the death of the previous member, keeping the number of members above one. Alternatively, the sole surviving member may establish a company and transfer legal ownership of the SMSF’s assets to this new corporate trustee. However, if there is no such person available, then the sole surviving member will need to wind up the SMSF and transfer their benefits to an alternative type of fund.
The ATO have created a simple video explaining what happens when a member of an SMSF dies:
Disability and Dementia
A member of a fund who becomes disabled might trigger the need for the fund to pay a disability benefit to the member. Once again, this might reduce the benefits that remain within the SMSF below the point at which the SMSF remains efficient.
Alternatively, the disability or dementia may mean that the member no longer has the mental capacity to manage their own super.
Trustees of a SMSF own the assets of the fund and must therefore be competent to manage those assets.
The following video discusses some of the duties that trustees must be able to perform.
If trustees lose interest in managing their own super, then they will need to wind up the fund and transfer their benefits to a fund manager who can manage the fund on their behalf.
Sometimes, SMSFs are known by their colloquial name: mum and dad funds. As this name suggests, many SMSFs are operated jointly by a husband and wife, often with one or the other partner taking more managerial interest in the fund.
While there is no requirement that a SMSF must be wound up in the event of a divorce between two of its members, it would be a rare situation where a SMSF could continue to be operated dutifully by a couple who have separated. Trustees of a SMSF owe a fiduciary duty to the members of the fund. This means that they must put the interests of the members before even their own. In the case of a divorce, this is usually a very difficult standard to reach and maintain, and so it is much more usual that a divorcing couple would also wind up the self-managed super fund.
There is nothing to stop each partner then commencing their own SMSF, although they would need to use a company as the trustee unless they could each find at least one other co-trustee. It is also possible for one person to leave an SMSF, rolling their benefits over to another fund, while the other trustees remain. This does entail quite a lot of administration on the part of the SMSF, however, as the departing trustee’s status as the legal owner of all of the fund’s assets would need to be altered.
A separation of trustees can lead to complex tax calculations and is otherwise a difficult area. We encourage you to seek specialist legal assistance if you have client’s in this situation.
A SMSF must be a ‘resident regulated superannuation fund’ at all times if it is to maintain it’s status as a compliant super fund. There is a three-step test for residence.
Step 1: was the fund established in Australia or does the fund have assets in Australia? The fund’s establishment is a historical fact, and so this step is met if the fund was initially established in Australia, even if this was many years ago. If it was not, then there must be at least one asset in Australia each year.
Step 2: was the central management and control of the fund ordinarily in Australia? The concept of ‘ordinarily’ is critical here. The concept is actually subjective and depends on the intent of any person leaving Australia. A person who leaves Australia with no fixed idea about when they will return is unlikely to meet this test. A person who is out of Australia for an extended period, but who continues to regard themselves as a resident and whose intention is for the absence to be temporary, may be able to argue that their fund is ordinarily managed from Australia.
Step 3: does at least 50% of the balance of the active members of the fund relate to active resident members? Active members are those on whose behalf the fund is receiving contributions. If the fund does not have active members, this step does not apply. If it has both active and inactive members, then it is only the balances of the active members that are included in the calculation.
If one or more trustees depart Australia and the effect is that one or more of these tests cannot be met, the fund will be unable to retain its status as a complying fund and will need to be wound up. Losing this status can have substantial tax implications, so retaining status as residential is critical.
A disqualified person must not continue as a trustee of a super fund. One of the main ‘disqualifiers’ for a SMSF trustee is bankruptcy. If a member who is a trustee in their own name becomes bankrupt, they are given six months to arrange things such that they are no longer a trustee. If a member is a trustee via being a director of a trustee company, then they must also discontinue as a bankrupt person cannot be a company director.
Remember, in an SMSF all members must be trustees, so that means that the member’s benefits must be removed from the SMSF in either of the above events. This may require the SMSF be wound up.
Effectively, this means that bankruptcy will typically necessitate the winding up of a SMSF.
Options for winding up the SMSF
There are three options available when a fund is wound up. These are:
- Pay out the benefits; or
- Convert the fund to a small APRA fund; or
- Roll the benefits over to some other form of fund.
In order for the fund to pay out the benefits, the members must all have met a condition of release allowing such payment to be made. The SMSF needs to retain sufficient assets to pay the expenses of winding down.
If one or more members are not in pension mode, then the sale of assets to facilitate paying out the benefits may trigger a tax event. This will depend on whether the asset has realized a capital gain. Such gains are taxed at 15% if realized within 12 months of the asset’s acquisition, or 10% if the asset has been held for longer than 12 months.
Converting the fund to a small APRA fund may allow for this disincentive (that is, a CGT event) to be avoided. The fund effectively continues, but with a change of legal owner. As there is no change in beneficial ownership, this change does not give rise to a tax event. This option can be a useful one if the SMSF cannot be continued, but there is one or more assets that the members would like to retain. A larger managed fund (such as a retail or industry fund) will be unable to accept such an asset as either a rollover or a contribution.
Once again, the ATO have developed a short video explaining the need for an SMSF to plan for things that might cause an SMSF to need to finish up:
ASIC have also provided a short page on their excellent Moneysmart website dealing with getting out of an SMSF. You can view it here.