Head of Education & Content
There are some situations where an SMSF is no longer suitable or appropriate for its members. However, it is not always possible to immediately wind up the fund.
To wind up an SMSF, all benefits must be paid out to the members or transferred to other superannuation funds. Importantly, payment of benefits to members will not be possible unless the member has satisfied a condition of release (eg reaching age 65, retiring, permanent incapacity).
In order to pay out or rollover the member’s benefits, all fund assets need to be disposed of and any liabilities repaid. This may not be a simple or quick process where the fund has:
- lumpy assets such as property
- outstanding borrowings under a limited recourse borrowing arrangement
- related party assets (eg units in a related unit trust), particularly if the underlying assets are geared
- investments in managed funds which have been “frozen”
- shares in companies which have been suspended from trading but not yet declared worthless
In the case of members who have not yet retired and are therefore rolling over to another fund, it will sometimes be possible to resolve this by selling the fund assets to members or other family entities. (The fund then has cash instead of problematic assets and it can transfer this cash to another superannuation fund). But this will depend on the amounts involved and the capacity of the member or other family entities to pay.
Pre 1 January 2015 Grandfathered Pensions
Many account based pensions commenced prior to 1 January 2015 are “grandfathered” and subject to different social security treatment than account based pensions commenced after that date. For example:
- Amounts drawn from a grandfathered pension are reduced by a “deductible amount” (based on the pensioner’s life expectancy when the pension started) and only the net amount is counted against the Age Pension income test. However, account based pensions started on or after 1 January 2015 are considered financial investments and included in the income test by way of deeming.
- Amounts drawn from a grandfathered pension are generally not counted towards the Commonwealth Seniors Health Card income test. However, a deemed amount of income is counted towards the income test for account based pensions started on or after 1 January 2015.
Winding up an SMSF will generally involve an account based pensioner stopping their pension and rolling over the proceeds to another fund. This change in pension providers will cause the pension to lose its grandfathering status. In the current low income low deeming environment, this may not be detrimental but should be reviewed as part of the process of winding up the fund.
“Legacy pension” is the term often used to describe a type of pension which can generally no longer be commenced in an SMSF, including complying lifetime, complying life expectancy and market linked pensions. There are a number of SMSFs still paying such pensions as a result of historical arrangements. Where a trustee of an SMSF paying a legacy pension wishes to wind up the fund, there are often significant impediments to doing so.
Most legacy pensions cannot be converted to a lump sum and paid out of the superannuation system. Doing so would be a breach of the superannuation, tax and social security laws for which there could be significant penalties. To wind up the fund, the pension would need to be commuted and rolled over to a public offer fund. However, the proceeds must then be used to immediately commence another similar type of pension in the new fund and there are very few commercial providers still in the market place.
Even if the pensioner was able to find a commercial provider willing to pay the required type of pension, there can still be adverse tax and social security outcomes.
Reserves in SMSFs are not common. However, for those SMSFs that have them, they often complicate (and in some cases prohibit) the wind up process. This is because monies in a reserve belong to the trustees of the fund; not the members. To wind up the SMSF, the monies in the reserve will first need to be allocated to the members. Doing so can cause adverse contribution cap and tax outcomes.
Where an SMSF cannot be immediately wound up, it may be appropriate to consider other alternatives. For example, replacing an incapacitated trustee with their attorney under an Enduring Power of Attorney, admitting new members (although this can bring new complexities and pitfalls) or converting to a small APRA fund (a small fund with a professional trustee).
The Super Companion is an online resource that's regularly updated and will always reflect the latest rules, changes to legislation, case law or regulator views. You can be confident that the information is up to date and accurate. Learn more and subscribe here.