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A COVID-19 SMSF checklist
The current coronavirus-driven economic conditions should prompt a review of SMSF structures and procedures. Bryan Ashenden identifies some critical aspects requiring re-examination.
There can be no doubt COVID-19 has had an impact on everyone. Whether it be catching the virus itself, changes in employment, the impact on savings or simply spending more time at home, the ongoing impact of the coronavirus has been widespread.
It is no different for the trustees of SMSFs when it comes to the operation of their fund. Rather than focusing on the negatives, however, this is, in fact, an opportune time for advisers to work with their SMSF trustee clients to ensure problems – both real and potential – are addressed to help protect the fund and member balances from significant impacts from the current environment.
Is the SMSF still viable?
The starting point should always be a consideration of whether the SMSF remains viable to continue to operate. There are many factors to take into account in assessing this question, but the focus is oft en on the account balance of the SMSF and that of its members, and the running costs of the fund.
In assessing this, it is important to consider what is in the best interests of each member of the SMSF. While the combined balances of all members may give the SMSF a significant asset base that makes the overall fund a viable proposition, the merits of being a member of an SMSF must always be considered on a member-by-member basis.
These considerations should focus not only on the asset balance of a member, but also their ability to meet and discharge their obligations as a trustee. It is here many SMSFs, particularly those with older members, should be reconsidered. This doesn’t mean they should be wound up, rather it is an ideal time to confirm the members still have the capacity and desire to act as trustees.
While we know there are cases of SMSFs where one person largely takes on the trustee responsibilities, we can’t ignore the fact all trustees have equal obligations, and all trustees are responsible and liable for actions taken in the name of the SMSF. Standard 5 of the Financial Adviser Standards and Ethics Authority Code of Ethics requiring advisers to be comfortable their clients understand the benefits, risks and costs of the advice they receive, now necessitates a greater focus on this. If your clients had set up a two-member SMSF, and the member that had taken the lead in the operation of the fund was no longer able to perform their duties as a trustee, how ready is the second member to step up and run the fund appropriately?
Safeguarding the operation of the fund
One option that should always be considered to help the SMSF to continue to operate is having replacement trustees lined up through the use of power-of-attorney arrangements. While this doesn’t solve the problem that arises when one trustee of a two-member SMSF passes away, it can help where one member becomes incapacitated.
This issue is one that is worth advisers revisiting with their SMSF clients during the COVID-19 pandemic. While naturally we would never want it to occur, if a trustee of an SMSF did contract the coronavirus to the extent that they required hospitalisation, the question needs to be asked whether the SMSF can continue to run. While many businesses have been wound back and, in some cases, closed during this pandemic, this is not something that happens to an SMSF as they are not businesses; they don’t rely on customers or other end users. As an investment vehicle they will continue to operate and important decisions will still need to be made and it’s possible some of these decisions will be among the most crucial SMSF trustees have ever had to make as they look to protect the value of future and current retirement balances.
Having a stand-by trustee, appointed under a duly executed power of attorney, will assist in these times of need to ensure the SMSF can still operate. Choosing the individual to act under a power of attorney is important as the existing members will want to ensure the right decisions will continue to be made for their benefit. While the appointed power of attorney does have an obligation to act in the best interest of the person they have been appointed to act for, there is still a risk competing interests may come into play. Superannuation law provides for some level of protection of the members’ interests and can restrict how the SMSF’s funds are invested, but an ill-appointed attorney can be problematic for all concerned.
For this reason, the choice of a family member to act under a power of attorney should always be carefully considered. If it is a child of an existing trustee, do they have confidence the child will not make decisions that benefit the child (whether now or in the future) rather than the trustee/ member? While we all would like to think that would never happen, unfortunately there have been instances in the past where children have taken undue advantage of their parents’ situation.
The bottom is not the right time to sell
Advisers know the bottom of the market is not the right time to sell investments. We also know that you never know when the bottom has been reached until aft er the fact. An element of panic among investors during this time of COVID-19 should not be unexpected and our response needs to be more than simply telling them not to sell as clients should naturally ask: “Why not?”
Beyond the clear rationale where a client has sought investment advice from an adviser, their investments have been chosen based on comprehensive research as to the long-term strength of the investment and, to an extent, their propensity to recover from any losses suffered during adverse economic conditions. In the current economic climate, the first question needing to be considered is whether there has been any change to the risk tolerance of the trustees and members.
It is natural for many investors to become more cautious at a time like this, but a sense of hesitancy doesn’t mean a change in risk tolerance. It may just mean trustees are taking longer to arrive at a decision than they would have in the past. And if there has ultimately been no lowering in risk tolerance, then the reasons to sell are not as strong.
What is more important though is for a review of the SMSF’s investment strategy to be undertaken. While the ATO notes the investment strategy should be reviewed at least annually, it also acknowledges certain other events should trigger a review of the investment strategy, such as a market correction. More important than the question of underlying investments, trustees should be using this time to review the liquidity of their investments.
Unfortunately, not all expenses stop during times like this, particularly the need to continue to pay pensions to members who have commenced retirement income streams from an SMSF. While recent federal government announcements, such as the halving of minimum pension payments for 2019/20 and 2020/21, may assist, this will only be the case where the members only need the reduced minimum payments.
For SMSFs with outstanding limited recourse borrowing arrangements in place, many financial institutions are also offering SMSFs the ability to defer repayments for a period of time, in the same way those offers have been made to individuals and businesses. And if there is a concern for an SMSF in receiving rent from a tenant of a property owned by the SMSF, these loan deferral arrangements may be of considerable benefit.
Are there in-house assets? The other investment-related aspect for SMSFs that may need to be reviewed at this time is the investment in any in house assets. Comprising investment in related parties, loans to related parties, or assets leased to related parties, other than business real property, the value of these investments is at all times limited to a maximum of 5 per cent of the fund’s total assets. With assets such as shares, and possibly property, falling in price, it’s possible the value of any in-house assets of an SMSF may exceed the allowance limit. In such cases, the SMSF trustees need to formulate a plan to bring the SMSF back into compliance with the 5 per cent limit. Waiting and hoping the market value of other assets increase to adjust the ratio is not enough.
Communication will be the key
The real key to how successful SMSFs and their trustees are throughout the duration of the COVID-19 pandemic will be communication on a range of different levels.
Initially, trustees should review their administration arrangements to ensure they are adequate and continue to operate throughout periods where many administrators may themselves be operating differently. It needs to be determined if the administration of the fund is still being conducted on a regular basis so there is no delay in reporting requirements. Are administration systems online, enabling paperwork to still be processed even though the administrators themselves may be working from home? Are the trustees easily able to get a picture of the health of their fund in terms of real-time asset values, as far as possible, so decisions can be made, and action taken, at the appropriate time?
Where the SMSF’s administration is currently conducted through manual, paper-based processes, it may be more difficult for the records of the fund to be kept up to date as ideally sought. Having online access to investment accounts, as an example, will make it easier for assets to be purchased and sold quickly and at the most appropriate time, particularly if investment opportunities start to open once the pandemic starts to subside.
Finally, it is incumbent on advisers to maintain contact with their SMSF clients throughout this period. SMSF members, like most superannuation members more broadly, are likely to be concerned about the impact on their retirement savings caused by the economic environment that surrounds us currently due to COVID-19. The ability to distil the plethora of information and opinions that exist into manageable chunks for clients will be the key to their success and for cementing the value of advice during these difficult times.
