Many trustees of super funds invest in assets which have limited liquidity – classic example being in property.
Where a Limited Recourse Borrowing Arrangement (LRBA) is utilised for a SMSF to borrow to buy a property, the death of a member can place significant strain on the liquidity of the fund.
Where such a fund is a ‘mum and dad’ fund and the beneficiary is a spouse, this can be managed by providing a death income stream rather than a lump sum. However, even that may not resolve the liquidity issue within the fund. Consider if the deceased member was the main ‘breadwinner’ of the family, contributing to the fund to assist with the cash flow required to service the debt on the property. In these circumstances, the need to have insurance on the members of the fund at appropriate levels is critical.
Death cover in this circumstance will alleviate the financial pressures within the fund by either allowing the surviving member to retire debt and, if designed properly, having sufficient liquid investments in order to continue to fund pension payments to the surviving beneficiary, until an appropriate decision can be made in relation to the fund’s assets.
Additional complexities arise with the transfer balance cap limitations around death benefits. Previously, a death benefit had no maximum value. Now there is an implied maximum as a result of these reforms – effectively linked to the recipient’s personal transfer balance cap amount.
Example
Jason and Sarah each have a retirement phase income stream, both commencing with the full transfer balance cap of $1,600,000. At Jason’s death, his balance is $1,900,000, while Sarah’s balance is $1,800,000. Sarah can commute all of her income stream, and effectively her transfer balance cap would become -$200,000. This means that she can receive a death benefit income stream from Jason of up to $1,800,000 – any amounts in excess of this would need to be paid as a death benefit lump sum.The more complex issue comes when the deceased member does not leave behind a beneficiary that satisfies the definition of a “tax dependent” and therefore the death benefit must be paid as a lump sum. Similar complexities are also potentially involved where the Fund has membership by non-family members (i.e. business owners who have a Fund together and use it to purchase the business premises together). The trustees of the fund must therefore pay out the death benefit in the form of a lump sum as soon as is practicable.
Some options for consideration in these circumstances, to help trustees pay a lump-sum include:
- Increasing the fund membership. In the case of a fund with mum and dad, when one passes away, there is the potential that up to 3 children will be able to become members in the fund. If they have superannuation balances of their own that they roll into the fund, then this can potentially assist with the cash flow to pay out either some (or all) of the death benefit.
- It might be worth considering having the death benefit paid out by virtue of the cash created by the insurance proceeds and then immediately re-contribute these back into the Fund as a Non-Concessional contribution for the children. A withdrawal and re-contribution strategy of sorts where the death benefit is capable of being paid in a manner consistent with the legislation (i.e. an interim and final payment)
- The Trustees could simply transfer the property out to the beneficiaries as a lump sum benefit in-specie in satisfaction of the death benefit. Simplest method, but perhaps not the most tax effective long term.
Naturally, the tax and cash flow of the fund and beneficiaries would need to be considered with any of these options and explored fully before final conclusions are made.
An illiquid asset may form part of a properly considered and formulated investment strategy. The ATO’s increased scrutiny and literature on investment strategies, combined with recent case law, indicates that these documents need more than an “obligation” mindset.
Like a business, understanding the entry and exit strategy is important in a fund context. The entry and exit costs on property assets are high (consider stamp duty, solicitor, advertising, estate agent costs). Further, proper consideration to the Fund’s cash flow needs while owning the asset is crucial to avoid forced sale.
Trustees unsure of how to complete an investment strategy should seek the assistance of a licensed adviser.
For more information, call us on 03 9886 0800 or email us at super@tagfinancial.com.au.
Come along to our next TAG Super Seminar to find out about the best super strategies- happening in Melbourne, Sydney, Brisbane and Adelaide. Find out more.
Enjoy our updates? Receive TAG Tips via email!
Disclaimer: The information contained is general in nature. Professional advice should be sought before acting on any aspect on this page.