On 1 July 2021, new rules came into effect to allow self-managed superannuation funds (SMSFs) to have up to six members. As a result, SMSF advisers may start to receive increased demand for advice on whether clients should take advantage of these new rules to either establish a new “family” SMSF or admit additional members to an existing SMSF, according to Colonial First State (CFS).
In a recent FirstTech update, CFS head of technical services Craig Day said that while these new rules could benefit some clients, advisers need to be across the potential risks and disadvantages when advising clients in relation to this issue, especially around unknowing tax traps that can impact the fund.
Admitting additional members may increase the size of the fund’s investment pool and allow the fund to acquire assets with a high cost of entry, such as direct property, without the need to borrow. In addition, it could also help address asset diversification issues, such as where a large proportion of the fund’s existing assets are invested in a single asset or asset class.
However, the admission of new members who roll over large amounts of accumulation assets into the fund could adversely impact the investment returns of the original members where they had previously retired and fully converted to the retirement phase.
“It could also result in unexpected CGT outcomes. For example, where the admission of new members results in part of the fund’s income being subject to tax, this would generally be deducted from the fund’s gross investment returns prior to the net return being allocated to the member’s on a pro-rata basis,” Mr Day said.
“In this situation, the existing pension members would be disadvantaged – as part of their investment returns, which would otherwise have been tax-free, will now be subject to tax; and the new accumulation phase members will benefit – as part of their investment return that would normally be subject to tax will now be tax-free.”
In addition, where a fund received franking credits, those credits will generally be applied at a fund level to offset the fund’s tax liabilities. As a result, Mr Day said any franking credit refunds the pension members were used to receiving may be significantly reduced (including to nil) due to the addition of new taxable accumulation assets to the fund.
“In addition, where a fund realised a capital gain on an asset it had previously held for many years, after any new members had been admitted and rolled their benefits into the fund, a proportion of what may have previously been a completely tax-free capital gain would become assessable and potentially subject to CGT in the year of disposal,” he noted.
“In this case, it may be prudent to review the fund’s CGT assets prior to the admission of any new members.
Different tax accounting systems may allocate tax liabilities differently, as it is important to note that not all SMSF administration systems allocate tax in the same way, according to Mr Day. Advisers may need to make further inquiries in relation to how the addition of new accumulation members may impact investment returns of any pension members.
“For example, it is FirstTech’s understanding that while some admin systems allocate tax in a similar way as outlined above, others effectively allocate all tax to the accumulation members,” he explained.
“However, this may also lead to unexpected outcomes where a fund disposes of assets that have been used for many previous years to support pension liabilities, but the system then allocates any resulting CGT liabilities in the year of disposal to the accumulation member.”
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