As part of the 2018/19 Federal Budget announcements, the Government confirmed that they intend to legislate to increase the maximum number of members that can belong to a single SMSF from four to six. This change is to apply from 1 July 2019 but has not yet been legislated.*
This announcement has prompted many to think about whether it can be beneficial to add adult children as members of their parent’s SMSF or is this a strategy to be avoided.
What are the Advantages?
Having your adult children as a member of your SMSF can offer a number of advantages including:
- potential savings in overall cost (depending on the investments, transactions undertaken in the SMSF etc),
- allowing the SMSF to diversify its investments,
- allowing for the intergenerational transfer of fund assets. For example, some parents who now have a mix of both retirement phase pension and accumulation balances are choosing to undertake a modified form of withdrawal and recontribution strategy whereby they withdraw money from their accumulation account, loan the monies to their children and their children then make concessional and non-concessional contributions to the SMSF. Depending on the time available and the quantum of the dollars involved, the need to sell fund assets on your death may be eliminated,
- helping meet any liquidity issues of the SMSF. The cashflow generated from your children’s contributions or rollovers into the SMSF could be used to meet your minimum pension requirements, finance limited recourse borrowing arrangements etc, and
- acting as a way of mitigating some of the impact of the Australian Labor Party’s plans to limit refunds of excess franking credits for some taxpayers. Having the children direct their concessional contributions to the SMSF would enable the franking credits to be used, thereby minimising or eliminating any excess franking credits. Our modelling suggests that concessional contributions have a much larger impact on excess franking credits than assessable investment income generated from accumulation balances.
What are the Disadvantages?
There are potentially a number of perils in adding additional members such as adult children to your SMSF including:
- your children will be privy to information about your SMSF entitlements and any arrangements you have put in place (eg reversionary pensions, binding death benefit nominations),
- you risk being “out-voted” by your children in the running of the fund unless you introduce adequate controls,
- trustee decisions must be made in the best interests of all beneficiaries not just the beneficiaries with the majority balances,
- your adult children are likely to have different risk profiles to you, perhaps requiring different investment strategies. While you can run separate investment portfolios and allocate earnings to the specific account balance(s) supported by a particular portfolio, this brings additional administrative complexities. And, as a result of changes made with effect from 1 July 2017, it may be impossible to reflect these different investment strategies when it comes to calculating tax on the fund’s investment income, and
- there would be a greater need to develop a workable dispute resolution mechanism for the fund.
There is no definitely right or wrong choice here – every family is different and every child within a family is different. However, given the number of cases where the inclusion of one or more adult children as members or trustees of an SMSF has caused untold angst for the remaining members/beneficiaries, it is not a decision to be made lightly.
*This proposed change was not legislated before the Federal Election was called and is therefore not law.