Oops - Illegal Early Access of super – what happens next?

2 Jul 2020

Alex Denham

Senior SMSF Specialist

A big drawcard for SMSFs is the control and flexibility that comes with them. On the flipside, giving members and trustees full access to their super fund assets and bank account comes with some potential dangers.  

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One of those dangers is the ability to access cash from the fund anytime. This can lead to trustees making withdrawals that should not be made. Another danger is that SMSF trustees are more prone to making errors than commercial superannuation funds when it comes to paying pensions and/or releasing excess amounts.
 
When a withdrawal is made from a member’s superannuation account and that account was all preserved (or less commonly restricted non-preserved) we can have what’s known as “illegal early access” – and that comes with consequences.
 

What are some ways that illegal early access can occur?

A trustee/member might accidentally cause an illegal early access transaction, or it could be intentional.

Accidental early access:

  • Payments over 10% from a Transition to Retirement Income Stream (TRIS) that is not in retirement phase.
  • Conversely, underpayment of minimums from a TRIS that is not in retirement phase or a market linked pension resulting in the pension “failing” for tax purposes that year – all payments that were made are lump sums which are generally not permitted (note this is not a problem for account-based pensions as those monies are unrestricted meaning lump sums are allowed).
  • Withdrawing excess concessional or non-concessional contributions or a Division 293 tax liability before the ATO has issued a “release authority”.

 
Intentional early access:

  • Applying for and obtaining release of benefits under the “release of benefits on compassionate ground - coronavirus” condition of release when the eligibility conditions have not been met (follow our Flowchart here to determine eligibility)
  • Trustee willfully withdraws an amount from the SMSF bank account (even if they plan to repay it soon after) when a condition of release has not been met.
  • Early release super “schemes” where promoters encourage individuals to transfer their super to an SMSF and then withdraw the money rolled over for non-retirement purposes.

 

Oops a withdrawal was made and it wasn’t allowed – what do I do now?

Firstly, have a look at how and why the withdrawal took place.

Was it a genuine administrative error such as paying bills or transferring money from the wrong account when internet banking? 

If so, then it’s actually not an illegal early release amount. The trustee should return the dollars to the fund as soon as they become aware of the mistake.

Note, if a trustee consciously withdrew money from the fund, then later realized that it was illegal, this is not an administrative error.

Returning the money to the fund in any situation where the withdrawal was NOT a genuine administrative error could result in:

  • illegal early access, AND
  • a contribution.

The next step is to look for a legitimate way the money could have been withdrawn.

Could a member have met a condition of release at the time of the withdrawal? If so, determine if it is possible to put the documentation in place for the withdrawal to be a legal lump sum benefit, or perhaps a pension payment from a TRIS.
 

Could the withdrawal be treated as a loan to a member?

Trustees of all super funds are prohibited from lending the fund’s money, or giving any financial assistance using the resources of the fund, to a member or a relative of the member. Not only are loans to members prohibited, they are also in-house assets.

Treating a withdrawal as a loan may solve the illegal early release problem, but it creates another one in the form of a SIS breach. 

In any event the fund auditor and the ATO are unlikely to agree the amount is a loan if there is no evidence to support that position (eg a loan agreement and repayments).


There’s no other way around it, it was an illegal early release…. what are the consequences?

At best

Although it’s an illegal withdrawal, it is still a superannuation lump sum. However the entire amount forms assessable income to the member and is taxed at their marginal rate, regardless of if it includes any tax-free component. For the purpose of the member’s personal return, it should be reported as “other income”.

If it hasn’t already, the fund needs to register for PAYG withholding and issue a PAYG Summary to the member reporting the normal components even though they won’t be taxed that way.

From a fund administration point of view, the taxable/tax free proportion should still be calculated and the tax-free component reduced to reflect the amount of tax free component paid out.


At worst

Trustee penalties will vary, and regard will be had for the circumstances under which the withdrawal was made. In the extreme, trustees who knowingly allow illegal access to a member’s super can incur penalties of up to $532,800, jail terms of up to five years or fines of up to $2.664 million for corporate trustees.

The fund can lose its complying status, and trustees can be disqualified and never be allowed to operate an SMSF again.

The ATO have often flagged their concerns around illegal early release and take deliberate actions by trustees very seriously. In recent years there has been a rising prevalence of unscrupulous scheme promoters targeting vulnerable people, promising them the use of cash and charging high commissions in return and/or resulting in identity theft.

More recently, the ATO have voiced concerns around members of super funds self-assessing their eligibility for the coronavirus early release and have already identified cases of fraudulent withdrawals. Anyone seeking to withdraw under this condition of release should ensure that they meet all of the criteria, including the requirement that they are seeking the release due to suffering adverse financial affects as a result of the coronavirus situation.


Conclusion

SMSF trustees must be very careful not to misuse assets and cash of the fund, and not be tempted to flout the rules by withdrawing illegally. At best, accidental illegal withdrawals will cost the member, and at worst willful withdrawal will cost everyone involved dearly.