The tax consequences of poor documentation

These decisions can be significantly affected by the accuracy of record keeping during the life of the fund.

It is therefore vital that SMSF practitioners play a vital role in ensuring that trustees fulfil this requirement, so that they’re able to achieve their desired retirement and estate planning goals.

Recontributing strategies are commonly recommended by financial advisers to provide a higher after-tax income by increasing the amount of tax-free income that can be drawn from a retirement stream or be passed to beneficiaries upon death of the member.

The value of these strategies equally depends on the accuracy of the funds' financial records maintained over many years. When advisers are ultimately dealing with pension payments or death benefit payouts, these can be dramatically affected by inadequate information provided by fund administrators.

The law requiring reclassification of superannuation account balances to taxable and tax-free components came into effect on 1 July 2007. Fund administrators were required to reclassify existing members' balances to preserved, restricted non-preserved and unrestricted non-preserved benefits as well as split the benefit balance into taxable and tax-free components.

Many superannuation accounting software providers updated their software packages to comply with the new classification requirements and provide meaningful and accurate reports. A key report in implementing pension and estate planning strategies is the member’s statement report. As an SMSF adviser and accountant, I have seen significant spectrum in the quality of various services providing by administrators, ranging from high-quality services down to the extremely negligent.

As an example, a new SMSF client approached our firm recently with a request for assistance with retirement and estate planning strategies. The two-member fund was in accumulation phase. The trustees were following their own investment strategy and had not engaged a financial planner. The latest financial report included a member’s statement that only provided the withdrawal balance. The report did not mention many key details and critically excluded the tax-free and taxable components. When asked for additional information the previous accountant advised that all benefits were 100 per cent preserved and 100 per cent taxable. The client, however, recalled that they had made non-concessional contributions over the last few years. Upon further investigation and reconstruction of contributions history over the last nine years and review of rollover statements from industry funds it was established that the withdrawal benefit of the older member included 40 per cent tax-free components and the withdrawal benefit of the younger member was 27 per cent tax-free.

The older member inquired about transition to retirement. His superannuation benefit was approximately $650,000. If TRIS was commenced based on the advice that the entire benefit is 100 per cent taxable, at his tax level he would have been subject to $3,536 extra tax on his pension per annum until he turns 60.

If the husband and wife were to die together suddenly, and had no dependants, the lump sum death benefit would be paid to non-tax dependants. Assuming the taxable component doesn't include untaxed elements, the lump sum death benefit will be taxed at 15 per cent plus Medicare levy. As a result the beneficiary of the deceased husband will be subject to an extra tax of $44,200 if the advice by the previous fund administrator was accepted without questioning.

This is just a simple illustration of the potential cost to members and beneficiaries if the fund's records are not accurate.

There is more to consider when planning for retirement. In the case discussed above, the fund was established with individual trustees; the trust deed was nine years old and did not align with current legislation. From a compliance perspective the trustees never considered insurance and did not have an up to date investment strategy. The tax agent was also the auditor of the fund. Further, there were no death benefit nominations or wills in place.

This is not an isolated case. SMSF trustees need to be educated on the importance of accurate fund reporting and the composition of their superannuation benefits and have a basic understanding of taxing of benefits on death or retirement. The focus should not be on cheap administration services but on quality services and meaningful reporting so that future unnecessary costs are avoided. The money saved on cheap administration services can be easily outweighed by rectification costs or additional end taxes. In many cases trustees will unknowingly pay double tax.

It is important for SMSF professionals to inform their SMSF clients of the following:

1. Composition of superannuation benefits, when they can be accessed and how they are taxed on withdrawal or as death payment.
2. Quality and accuracy of the annual financial report of the fund and all key information. 
3. Are the financial reports of the SMSF audited by an independent auditor? A truly objective auditor will more likely spot a problem and request clarification. The fund audit is often left in the hands of the fund administrator/accountant to arrange. Quite often the trustees aren't aware of the true independence of their auditor.
4. Importance of the SMSF trust deeds. Are they suitable for the needs of the members of the fund and do they comply with the latest superannuation legislation.
5. The advantages of having a corporate trustee. 
6. The importance of death benefit nominations and when they are valid. Learn about non-lapsing nominations and consider trust deeds incorporating non-lapsing binding death nomination provisions.
7. The importance of estate planning and how death benefits are taxed. Often non-resident beneficiaries are nominated and benefits paid to them are subject to capital gains tax. Have members considered this tax when preparing their wills?
8. Types of pension streams, commutation and the benefits of reversionary pension.

The current focus of many advisers is to provide a proper statement of advice upon set-up, which outlines strategies to trustees to meet their goals and achieve desired benefits. These benefits can be lost during the life of the fund in administration shortcuts and laziness in record keeping.

SMSF practitioners and trustees should consider their administration provider carefully and ask plenty of questions. It is also important they engage an independent auditor and read their recommendations.

By David Saul, managing director, Saul SMSF and Venetta Sacha, director, Hall Consulting Group