Super law says that all superannuation funds need to meet “the sole purpose test” – all the time. If you have an SMSF, broadly speaking the sole purpose test is:
"Can you honestly say your SMSF is being maintained to solely provide benefits for you in your retirement or to protect your family if you die earlier?”
Why is the sole purpose test important?
It’s one of the foundational requirements for all super funds, including SMSFs.
Sounds simple right?
And in a way it is – why else would we save in super other than to build up a retirement nest egg or protect our families?
Where it gets more complex is that we’re all expected to apply this test to absolutely everything we do when we’re making a decision about our SMSF.
Why does the sole purpose test exist and how does it protect members?
Before we get into the detail, why do we even have the sole purpose test?
It’s because all super funds pay quite low rates of tax. From the Government’s point of view that makes sense if it’s helping you build up savings for your retirement. Having those savings at your disposal in retirement will mean you don’t cost the community as much (via age pension payments). So not surprisingly, the Government is very invested in making sure that’s really exactly what you’re doing with your SMSF – saving for your retirement, ie complying with the sole purpose test.
If it’s that important, why don’t we hear about it all the time?
As well as the sole purpose test, super law includes a whole lot of very specific rules. These cover things like what super funds can invest in, when benefits can be paid, who can make contributions, and more.
Sometimes these rules become the ‘trees’ that are hiding the ‘wood’ of the sole purpose test. Accountants, trustees and advisers tend to focus on the things super funds can and can’t do that are laid out in the specific rules and forget that the sole purpose test sits above them all. It’s the guiding principle; the specific rules are the detail.
Perhaps the easiest way to understand the sole purpose test is to think of it like this. The rest of the super rules will tell you that your SMSF can or can’t do a specific thing. The sole purpose test is all about why you’re doing it.
For example, SMSFs can invest in commercial property. They can even lease the property to a member’s own business at market rates. All of these things are clear from the specific rules. But even if an SMSF followed all these rules to the letter, it would still be important to understand why the fund was leasing the property to the member’s business.
What if the SMSF got a better offer from another potential tenant (well above market rent)? If the SMSF is really all about saving for retirement, it might make more sense to take up that offer (subject to meeting any contractual obligations to an existing tenant).
Or what if the SMSF only bought the property because the member’s business was in a bind? It needed new premises, none were available to rent in the area, and the fund bought the property despite that particular investment not being sensible for the members’ retirement savings?
Both of these would be breaches of the sole purpose test despite appearing to meet all the super rules.
And in both cases, it hinged on “why” rather than “what” the super fund did.
SMSFs get special scrutiny when it comes to the sole purpose test. That’s because it can be really difficult to untangle what members want or need personally from what they would do if they were really only focussed on optimising a pot of money for retirement.
Perhaps the best way to test yourself when it comes to the sole purpose test is to think: if I was managing someone else’s money, and trying to maximise their retirement savings, would I do this?
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