Single bank account for an SMSF? Proceed with caution

SMSF practitioners and trustees should be aware that while a single bank account sounds appealing, there can be additional risks and fees.

Many SMSF practitioners will have breathed a sigh of relief last year when the ATO announced its view that trustees could hold segregated pension assets whilst still only maintaining a single bank account for the fund. However, whilst a single bank account may appear to be more convenient, it can also mean additional administration, fees and greater risks for trustees segregating assets.

Background

The income earned on assets that are segregated to wholly support current pension liabilities is entirely exempt from tax. In order for assets to be segregated in this way, their value must not exceed the value of the pension accounts that they are supporting. The ATO has previously made clear its view that it is not possible to segregate part of an asset. For example, a proportion of the value of a property held by an SMSF cannot be segregated to support a pension, only the whole property.

The question therefore arose as to whether a bank account was classified as a single asset and whether a separate bank account would be needed to support segregated assets. The ATO confirmed in TD2014/7 that a bank account could be shared between segregated and unsegregated pools of assets, provided appropriate accounting records were kept. This seems like good news for trustees as they do not need more than one account when choosing to segregate assets.

Additional administration

In order to maintain a segregated pension asset strategy it is necessary to be able to track and identify the income earned on these assets as well as other cash flows into and out of the segregated asset pool. If using a single bank account, this must be done by the careful use of notional sub-accounts. Interest earned on the bank account will also need to be appropriately allocated between the different sub-accounts.

The convenience of a fund having a single bank account needs to be weighed against the additional costs of administering this more complex arrangement. It may be that the additional administration of operating a single bank account outweighs the convenience of not having to operate two bank accounts.

Greater risks

Another difficulty with maintaining sub-accounts is the lack of visibility to trustees of the ongoing balances in these different accounts. This has the potential to lead to trustees overdrawing on their segregated asset pools and rendering the intended segregation invalid. Trustees can run into liquidity issues without realising it.

This is best illustrated with an example:

Jack (aged 67) and Jill (aged 62) have an SMSF with a total balance of $1 million, $600,000 supporting Jack’s account based-pension and $400,000 in Jill’s accumulation interest.

As trustees, Jack and Jill have invested their fund’s assets in a rental property worth $580,000 and a share portfolio valued at $370,000 with the remainder in a cash account. They have resolved to segregate the property to Jack’s pension interest so that the rental income is tax-free and that the capital gain is not taxable when they decide to sell the property.

In order to meet the minimum pension standards for his account-based pension Jack must receive a pension payment of 5 per cent of the opening balance, i.e. $29,000.

Whilst a precursory look at the fund’s bank balance shows sufficient cash ($50,000) to meet this payment, Jack would need to be very careful in doing so as his segregated sub-account actually only has a balance of $20,000. In the absence of any rental income adding to his pension account, making a pension payment of $29,000 would cause the balance of his pension interest to fall below the value of the property.

As noted above, the value of a segregated asset cannot exceed the value of the pension account it is supporting. In this case, the rental property would no longer be segregated and it would fall into a single unsegregated pool of assets with the other fund assets. In order to determine the proportion of income earned after this point that is exempt from tax, including any rental income on the previously segregated property, the trustees would need to obtain an actuarial certificate. Had the trustees sold the property, any capital gains would be taxable in the same proportion meaning it may have proved to be a very costly mistake.

The trustees’ visibility of the balances in their sub-accounts will be further complicated by other cash flows into and out of Jack’s sub-account during the year such as rental income, property expenses and his allocation of fund administration costs. It may be that later in the financial year, the rental income has increased the balance in Jack’s notional sub-account to the point where he is able to make the necessary pension payments. Careful administration and a good understanding of the issues are needed to ensure notional sub-accounts are used effectively.

Conclusion

The ATO’s determination that notional sub-accounts can be used to allow trustees with segregated pension assets to operate their funds with a single bank account is a pragmatic and welcome decision. In the right circumstances it could simplify their operation. However, their use should be approached with care as they can increase administrative complexity and also the risk of trustees getting things wrong. For many SMSF trustees and their administrators it may be a more attractive option to maintain two separate bank accounts.

Melanie Dunn, actuarial analyst, SMSF technical services manager, Accurium and Doug McBirnie, consulting actuary, Accurium

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