Self-managed superannuation fund (SMSF) members need to think long and hard before winding up their fund. Although there are often compelling reasons for doing so, there are many factors to consider before making a final decision, and failure to do so can prove costly.
The solid growth in SMSFs tends to grab the headlines. What is overlooked is that many SMSF members, for various reasons, decide to wind up their funds. For the year to June 30, 2018, ATO statistics show 25,440 funds being established. But in that same period, 15,573 were wound up. Quite simply, the reasons for setting up a fund may have lost their validity as members' needs and circumstances change, often quite dramatically.
There are myriad events that can warrant closing a fund. Insufficient assets heads the list, usually because members have paid a pension over many years resulting in a low account balance. Or because they have rolled over to an alternative super arrangement, taken out a lump sum, or died and a death benefit lump sum payment has been made.
Members losing capacity can trigger a fund closure. Remember, this is often a gradual process so it's important to recognise the signs early and take the necessary steps for when a member's physical or mental impairment gets to the stage they can no longer act as a trustee. Where a loss of capacity occurs and there is no one to assume the role of trustee, the only alternative is to wind up the fund.
Many couples have SMSFs, and it's quite common for one of them to take primary responsibility for the fund. On the death of that person, the surviving spouse may prefer to close the fund and move to a simpler super arrangement where they have no trustee responsibilities.
Lack of time often prompts members to close the fund because they underestimated the time and effort required to be a trustee. Or their employment or other circumstances change, leaving little time to devote to the fund.
Moving overseas indefinitely can cause an SMSF to fail the residency test requirements in the superannuation legislation. Although there is a two-year window for trustees to be absent overseas without failing the central management and control test, that test requires that the absence be temporary. Remember, too, the consequences of failing the residency test are severe as the fund will be made non-complying in the year the trustees leave Australia.
Pros and cons
But while there often good reasons for closing a fund, a full assessment of the pros and cons must be made. Foremost among these is a member realising a capital gain or loss for the SMSF where tax is payable if the fund is in accumulation phase. So the question must be: is it worth triggering an early capital gains tax liability on an asset they would otherwise have been able to retain in the fund for many years.
This can be particularly important where members are approaching retirement and can use superannuation to start a pension. Once in pension phase, no CGT will be paid when assets supporting pension payments are sold by the SMSF.
Realised capital losses that cannot be utilised before winding up the fund can also be a concern as they are trapped in the SMSF and will be lost on any wind up – a significant impediment.
The same issue applies where a fund is in a net loss position for the year of wind up or has significant unused carry-forward revenue losses. Revenue losses, like capital losses, are trapped in the trust structure of the SMSF and cannot be transferred or distributed out of the fund. Again, any unused revenue losses will be lost on wind up.
Superannuation accounts are typically protected from creditors of the members under bankruptcy law. An SMSF offers the opportunity to own and protect business assets such as business real property used in the members' business.
The alternative of adding new members to an SMSF should not be overlooked when considering a fund wind up. These new members (who could be children, other relatives or business associates) can take advantage of the flexibility of the fund, including any ongoing tax benefits. In family businesses, the continuity of ownership and use of business real property can be an important consideration.
Clearly there is much to consider. So if you are considering winding up an SMSF, get specialist advice to ensure that it is in your best interests to do so, and plan well in advance for a potential wind up in case of reduced capacity or other reasons.
John Maroney is CEO of the SMSF Association.