«Anne Marie Rice Director, Rice Naughton Joseph Box Partner, Grant Thornton Australia 2 Contents Background to the superannuation industry 3 Type of ...»
and family law
Anne Marie Rice
Director, Rice Naughton
Partner, Grant Thornton Australia
Background to the superannuation industry 3
Type of funds 4
Accumulation funds v defined benefit funds – key concepts 6
Why is superannuation important 7
Compliance/regulatory environment 8 Providing financial assistance to a member 11 In-house asset rule 11 Gearing 12 Non-compliance 13 Taxation of self-managed superannuation funds (Sale of assets) 14 Getting the money out 14 Transition to retirement 17 Superannuation splitting and family law 19 How to value a fund 20 Valuing a SMSF 28 Issues to consider when splitting 32 Other points 34 Conclusion 34 3 Background to the superannuation industry Superannuation has, in the 20 years since the introduction of compulsory superannuation contributions, grown to be a significant part of the Australian financial system.
Assets held by superannuation funds now make up approximately 24% of all assets held by Australian financial institutions with only the banking industry holding more assets.
Total assets in superannuation have grown to almost $2 trillion at 31 December 2015 and are predicted to be close to $3.5 trillion by 2020.
4 Type of funds
There are five main types of superannuation funds:
1 Industry funds – regulated superannuation entities that have historically provided for employees working in the same industry or group of related industries.
2 Retail funds – regulated superannuation entities that offer superannuation products to the public on a commercial basis.
3 Corporate funds – regulated superannuation entities generally only open to people working for a particular employer or corporation.
4 Public sector funds – regulated superannuation entities that provide benefits largely for government employees, employees of statutory authorities, ore are schemes established by a Commonwealth, State or Territory law.
5 Small super funds – predominantly self-managed super funds (SMSFs), which are regulated by the ATO and have less than five members. They work like any other super fund, but the responsibility of managing it rests solely with the trustee, who is often the member.
The distribution of assets and members over the different funds is detailed in the table below.
While the number of member accounts that are in SMSFs is relatively small at approximately 3% of total accounts, they hold a substantial proportion of total assets and have been growing strongly as represented in the table below which approximates the average assets per SMSF member and per SMSF at the end of each financial year.
One question often raised in relation to SMSFs is how much superannuation do you need in order to set up your own fund? A report by ASIC published in September 2013 indicated that SMSF face a number of challenges in being cost competitive against other larger funds.
The ASIC Report included some analysis that suggested:
Accumulation funds v defined benefit funds – key concepts Regardless of the type of superannuation your client has, it will be held in one and very rarely both
of the following types of funds:
Accumulation funds The Australian Prudential Regulation Authority (APRA) defines accumulation funds as “…superannuation entities where all members receive benefits based on defined contributions (accumulated benefits).
The assets of the fund are invested and any earnings (or losses) are credited (or debited) to the member’s account less any charges such as administration fees and insurance premiums…” Defined benefit funds APRA describes defined benefit funds as “…superannuation entities where all members are entitled to receive defined benefits. In defined benefit funds, a member’s benefits are calculated based on a formula specified in the trust deed. Usually the member’s final benefit depends on years of service with an employer (or years of membership of the fund) and level of salary near retirement.”
Once commonplace in the public sector, defined benefit plans are being phased out in favour of accumulation funds, with many now closed to new members. The Commonwealth Superannuation Scheme, a defined benefit and accumulation fund, opened to new members in 1976 and closed in
1990. Likewise, the Public Sector Superannuation Scheme, a defined benefit superannuation fund, opened to new members in 1990 and closed in 2005. The Public Sector Superannuation Plan, an accumulation fund, opened to new members in 2005. The Military Superannuation and Benefits Scheme, opened to new entrants of the Australian Defence Force in 1991 and its predecessor, Defence Force Retirement and Death Benefits Scheme, which closed to new members in 1991, are both defined benefit schemes.
Defined benefit funds are not exclusive to the public sector, however. Some older corporate and industry funds, for example, still have defined benefits members. APRA’s Superannuation Fund-level Profiles and Financial Performance – interim edition 2014 (issued 20 May 2015), provides a listing of superannuation funds and classifies them as defined benefit, accumulation or hybrid.
This projected increase in the age of the population will lead to tremendous economic change:
as more people retire, there will be less people in the workforce, potentially leading to reductions in productivity and economic growth retirees discretionary spending is generally lower than that of workers, reducing economic activity a reduction in both numbers of workers and economic activity will lead to a reduction in the tax that is collected and from which the government pays for age pensions and healthcare a declining tax base and increasing budget requirements will present the government with a funding gap that would need to be met by either increasing taxes, reducing spending or increasing debt The Treasurer, Scott Morrison, stated in a speech on 27 November 2015 that the ordinary Australian worker should no longer expect to receive an age pension from the government when they retire.
Superannuation is one of the measures that will be relied upon the narrow this funding gap.
Advantages of superannuation:
earnings are taxed at a maximum of 15% contributions are taxed at 15% (taxed at 30% for high income earners ($300,000 income for FY16) which is generally less than personal marginal tax rates earnings and capital gains are tax free on the portion supporting the pension when they are paying pensions to members (pension phase) personal contributions to superannuation can be tax deductible benefits can also be paid to dependants tax free in the event of death and can be an effective estate planning investment bankruptcy protection Disadvantages of superannuation savings will be locked until the conditions of release are met (e.g. retirement) given the length of an investment in superannuation it is likely to be subject to changing regulatory and taxation environments Compliance/regulatory environment The Australian superannuation system is highly regulated, with several government agencies
the Department of Human Services (DHS) – which is responsible for the administration of applications for early release on compassionate grounds As noted above the SMSF sector of the industry is significant. Given the nature of how SMSFs work there is greater risks to member’s benefits in a family law context. This arises with members being the Trustees of the funds and ultimately responsible for how the member’s benefits are used and applied.
The ATO, responsible for regulating SMSFs, describe their activities as:
verifying that a fund’s primary purpose is to pay retirement benefits to its members providing information and forms to help set up and manage your fund checking that the fund is managed in accordance with the super laws implementing and maintaining systems to ensure legal compliance taking enforcement action to correct matters when there is a breach of the law checking that SMSF auditors perform their duties to the required standard
The ATO have published a list of concerns about SMSF audits and the actions of Trustees:
lack of independence – specifically with the actions of SMSF auditors who audit their own or relatives’ funds as well as auditors who audit funds for which they prepare the accounts and provide advice poor documentation – proper documentation allows the ATO and ASIC to understand the process undertaken and the level of detail of the audit – where auditors can’t provide this evidence, or the evidence is incomplete, it raises concerns about the effectiveness, and sometimes, the genuineness of the audit auditor knowledge – ineffective audits are often the result of Auditors that are not as knowledgeable as expected trustees and professionals who fail to understand their obligations trustees who fail to comply with their obligations, including lodging their annual return approved SMSF auditors who don’t audit funds properly or don’t report contraventions SMSFs being deliberately misused: Set up for illegal early release or the money in the fund being accessed early, before a condition of release is met, or the SMSF being used for tax avoidance The ATO reports that the proportion of SMSFs reported to them by approved auditors is relatively stable at about 2% of Funds.
Example - use of work of art by members: more than an incidental benefit A trustee of an SMSF acquires a significant work of art. The investment strategy of the SMSF requires it to hold a certain percentage of its investment as listed securities. The SMSF trustee liquidates all of the listed securities that the SMSF holds to fund the acquisition of the work of art.
The trustee is unable to demonstrate how the acquisition of the work of art is a better investment than the listed securities it previously held. Soon after the work of art is acquired, it is displayed in the home of a member, who pays the SMSF a reasonable rental fee for this privilege.
If an asset, such as a work of art, owned by the SMSF is provided for the use and enjoyment of the member, this may indicate that a purpose of the investment is to provide a benefit otherwise than in accordance with subsection 62(1). Here, the liquidation of a class of assets forming an integral part of the SMSF's investment strategy reinforces the conclusion that the provision of the benefit outside of those stipulated in subsection 62(1) was purposeful and not in accordance with the sole purpose test, even though a reasonable amount is paid to the SMSF for the use of the work of art.
Example - use of work of art by a related party at no cost: more than an incidental benefit Helen and Reginald are trustees of an SMSF. They are also partners in an accountancy firm.
As SMSF trustees, Helen and Reginald purchase a painting as an investment in accordance with the investment strategy of the SMSF. While it is a sound investment due to expectations of strong capital growth, the painting is not a major piece that is likely to attract strong interest from major galleries.
Helen and Reginald wish to avoid the high cost of professional storage of the painting in climatically controlled conditions, and so are willing to lease the painting on the basis that it would be insured and preserved by the lessee. However, they are unable to find an unrelated third party that is willing to lease the painting on this basis.
While continuing to seek third party lessees, Helen and Reginald arrange to hang the painting in their accountancy office. The accountancy firm regularly leases paintings from unrelated third parties to hang in the office on arm's length terms and conditions. However, the firm does not pay any amount to the SMSF for the use of the painting and the painting is not insured by the firm.
This arrangement for the free use and enjoyment of the SMSF's asset by the related firm demonstrates a purposeful benefit that is more than an incidental benefit. The asset is treated in a different way to the other works of art leased by the firm from unrelated third parties. Therefore, on balance, an assessment of these facts indicates that a contravention of the sole purpose test has occurred.
Providing financial assistance to a member Section 65(1)(a) of the Superannuation Industry (Supervision) Act 1993 prohibits the lending of fund money to a member, or a relative of a member, of the fund. Section 65(1)(b) prohibits using fund resources to provide any other financial assistance to a member, or a relative of a member, of the fund.
The ATO regards any of the following as a breach of Section 65(1)(b):