Would you like children with your SMSF?

The ability now for an SMSF to have six members in it has reignited the notion of including children in, what would be considered, a family fund. Graeme Colley puts forward the arguments both for and against this course of action.

Now SMSFs can have six members in them, it begs the question: Is it worthwhile to set up a family fund and have mum, dad and the children as members or expand mum and dad’s SMSF to include the kids? Ultimately the decision to be made is whether the kids should join the existing fund, set up their own SMSF or go elsewhere to an industry or retail fund.

On the positive side, SMSFs provide an excellent way of building retirement savings and when done properly can boost the financial literacy of all members regardless of age. So why not have one exclusively for the whole family?

Would you recommend a family SMSF?

Recommending a family SMSF really depends on the circumstances of those involved and how committed they will be to their personal superannuation fund. There are those who wouldn’t recommend children as members or trustees of a family SMSF, but others have experienced the benefits and acknowledge children played an important part in the operation of the fund. It can engender a high level of respect among family members and especially if decisions can be made collaboratively to the overall benefit of fund members.

On the downside, however, there is an everincreasing number of court cases that are littered with sad stories. Most involve the lack of adequate documentation, which leads to disputes over what was intended. However, some cases involve outright fraud involving children stealing money from the family fund and others where children weaselled their way into the fund as trustees only to subsequently take over their parents’ super.

Reasons to include family members

All members of a family are different and therefore only the right type of person should be allowed to become a member of a family super fund. A child who has difficulty managing their own personal finances will probably have similar issues if they become a member or trustee of an SMSF. That child may be better off as a member of a retail or industry fund where professional managers will look after their superannuation.

As I see it, children can be split into three categories by age and circumstance – those under 18, single adult children and those children in a relationship and possibly with their own family.

Children under 18

Super can be provided for children under 18 by a parent or relative making child contributions up to $330,000 over a fixed three-year period, with those contributions not tax deductible. If the child happens to be working, contributions may be made by an employer or the child may qualify for a personal tax deduction. Any contributions made for the child help provide a bigger pool of money for investing.

A child under 18 can be a member of the SMSF, but can’t be a trustee or director of a trustee company. The child’s parents, guardian or legal personal representative will act as trustee in their place until the child turns 18.

Age 18 and over

A child 18 or older who has legal capacity can become an individual trustee of an SMSF or director of the corporate trustee. In conjunction with the remaining trustees or directors of the SMSF they are responsible for the operation of the whole fund, as well as all the fund members, not just themselves. This can be a catalyst to get a child involved in the investment of their super savings and understanding the workings of an SMSF.

Whether you would allow an adult child who has a spouse but no family themselves to be a member of an SMSF depends on the situation. It may be worthwhile to include the child in the SMSF until they accumulate enough to start an SMSF for themselves and their partner.

Children with their own family

The time may come when a child and their spouse have their own family. Whether they should become members of the family SMSF or have their own will again depend on the situation. The same outcomes could be achieved by the child having their own SMSF as it is possible for the fund to make investments jointly with the parent’s fund.

Introducing family members to the ‘family’ SMSF

One way of introducing children to a family SMSF is to split the responsibility for investments among the members. Investments supporting the children’s super balances can be segregated from their parents’ investments within the fund. This could be done by using separate bank and investment accounts and the records left to an SMSF accountant or administrator who has the skills and systems to handle segregated investments without incurring additional administration costs.

Having children in the family SMSF may also enable an intergenerational transfer or family assets, such as a commercial property used in the family business or other real estate. However, a word of warning, if this strategy is used, it must be structured and handled correctly otherwise compliance problems can occur. There are a number of ways in which the investment could be owned by the fund either jointly with family members, as a company or unit trust. The strategy can allow ownership of real estate by one SMSF or it can be split across different SMSFs and allows flexibility if one fund wishes to purchase units or the property in future.

Case study

Mal, Irene (both 62) and their two children, who are in their 30s, are members of a family SMSF that owns the shop from which the family business operates. The shop is currently mortgaged to the bank. The members’ balances in the fund are just about high enough to purchase the property on commercial terms after the mortgage has been paid out. However, to ensure the purchase can go ahead successfully it will require the members to make additional contributions to the family SMSF.

The four go to see their tax accountant who is an SMSF specialist and she tells them there are probably a few ways in which the shop could be purchased. The options to be considered are:

• The fund could purchase 100 per cent of the property, but it will require cash from the members’ contributions. This may have some issues as the fund will own a very lumpy asset and the fund’s cash flow will be tight for some years. If the children decide to roll over their super to another fund, the shop may have to be sold.

• The fund could purchase part of the property as tenants in common with the current owners, which would be possible from a cash-flow perspective. However, the property cannot be mortgaged and the fund may be able to pay out the mortgage as part of the fund.

• A fixed unit trust or private company could be established, providing there is no mortgage over the property. The fund could purchase units in the trust, as well as other family members who would own the units personally.

Whatever strategy is chosen, the purchase is helped by family members combining their resources from the SMSF to purchase the shop. In addition, the tax-deductible rent from the shop is paid to the owners, which would include the SMSF either directly or indirectly. If the children wished to run the business after the parents retire, the shop can remain in the SMSF so it is transferred through each generation without any taxation issues.

Reasons for not having a family

SMSF So far we have looked at some of the positive aspects of the family SMSF, but unfortunately there is probably a longer list of situations where things could go dreadfully wrong.

Dipping into the fund

When children become members and trustees of the family SMSF they may find themselves in a position where they can access the fund’s resources. Access to the fund without proper controls over the fund’s bank accounts and investments can have tragic consequences.

There was a court case some years ago where membership of the SMSF consisted of a husband and wife and a drug-addicted son. The son was an authority on the SMSF’s bank account and resulted in the fund being left almost penniless and subsequently taxed as non-complying. If better control had been put in place over the operation of the fund and the trustees understood their responsibilities, maybe the loss could have been avoided.

Relationship breakdown

In there is a relationship breakdown, superannuation forms part of a partner’s assets for purposes of the marriage settlement. This means an ex-spouse may have access to their former partner’s superannuation when the court hands down the conditions of the divorce. It could mean selling the family business assets to free up cash as part of the dissolution of the marriage. The situation is not isolated to just the break-up of the parents as the children may also be going through a relationship breakdown that splits their superannuation benefits.

Control on death

When it comes to estate planning and SMSFs, control and decision-making over the superannuation benefits is going to be the most important factor to ensure the wishes of the deceased member are carried out correctly. There are many court cases where children have been appointed as trustees of an SMSF as the legal personal representative of their parents.

In one case, a father and daughter were members and trustees of an SMSF. The father completed a non-binding death benefit nomination requesting the trustee split his super balance equally between his daughter and son. The son was not a member or trustee of the SMSF at the time of the father’s death, so the daughter appointed her husband and proceeded to pay 100 per cent of her father’s benefits to herself. The court found in her favour, concluding as trustees, the daughter and her husband had discretion as the nomination made by the father was not binding.

Even if the nomination was binding, the fact the daughter was in control of the SMSF could have caused a protracted and costly legal battle between the beneficiaries. Therefore, consideration needs to be given to the loss of control over the SMSF in the event of a trustee or member dying or losing capacity.

To include or not to include, that is the question

There can be many benefits from including children and other family members as part of an SMSF. But considerable thought must be given to the potential risks that can arise when family and money are combined.

Anyone contemplating establishment of a family SMSF should weigh up the pros and cons before making the decision as the different needs and motivations of parents may conflict with those of the children.