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Should you include the kids in your SMSF?

Feb 19, 2019, 14:44 PM

By Graeme Colley

Graeme Colley SuperConcepts SMSF expert

It’s on the cards that the maximum number of members in an SMSF will increase from four to six members, as of 1 July 2019. And this raises the question: is it worthwhile having a family SMSF that includes the kids?

The jury’s out

Many media commentators recommend against including the children. However, in some cases I’ve seen it done exceptionally well. Here, the children play an important role in the fund, there’s a high level of respect amongst the family and decisions are made collaboratively to the benefit of everyone.

On the down side, have a look at the ever-increasing number of court cases. Some involve children taking money from the family fund for their own purposes, and others where the children have weaselled their way in and have taken over their parents’ super.

Whether to include children depends on the reasons for doing so, their ages, personal situation and their sense of responsibility.

Each family is different and so is each child within that family. Only the right type of person should be allowed as a member of a family super fund. A child who has difficulty managing their own personal finances will probably have the same issues within an SMSF. They may be better off as members of a retail or industry fund, where professional managers look after the fund investments.

As I see it, children can be split into three categories by age and circumstance – those under 18, single adult children and those children in a relationship, possibly with their own family.

Children under 18

A child under 18 can be a member but not a trustee of an SMSF.

Super can be provided for them usually by a parent or relative as child contributions up to $300,000 over a fixed three-year period. If the child is working, contributions may be made by an employer or the child. Any contributions will help the fund provide a bigger pool of money for investing.

18 and over

A child 18 or older has legal capacity in most cases to be an individual trustee of the fund or director of the corporate trustee. Along with the other trustees or directors they are responsible for the operation of the whole fund, not just themselves. This can be a catalyst to get your child involved in the investment of their super savings and understand the workings of an SMSF.

Whether you would allow any of your children with a spouse but no dependants themselves as a member of an SMSF depends on the situation. In many cases it may be worthwhile to include the child until they have enough to start an SMSF for themselves and their spouse.

Children with their own family

The time may come when your child has their own family. Whether the child should be a part of your SMSF or have their own depends on the situation. The same outcomes can be achieved by the child having their own SMSF, as the child’s fund can make investments jointly with the parents’ fund.

Want to incorporate the children? Here are some considerations

You may wish to consider segregating investments amongst the fund members. Investments supporting the children’s super balances can be segregated from their parents’ investments. This could be done by using separate bank and investment accounts, with record keeping left to an SMSF accountant or administrator who has the skills and systems to handle segregated investments.

Having children in the family SMSF may also enable an inter-generational transfer of family assets – such as a commercial property used in the family business or other real estate. However, a word of warning, if this strategy is used it must be structured and handled correctly otherwise compliance problems can occur. There are several ways in which the investment could be owned by the fund, either jointly, as a company or a unit trust. The strategy can allow ownership of real estate by one SMSF or split across different SMSFs and allows flexibility if one fund wishes to purchase units or the property in future.

Case study

Mal, Irene and their two adult children are members of an SMSF. The fund wishes to purchase a shop from which the family business will operate. The shop currently has a mortgage over it. The members’ balances in the fund are just about high enough to purchase the property outright, thus doing away with the need for a mortgage. Having sought professional advice here are the options available to the fund:

  1. The fund could purchase 100% of the property, but it’ll leave the members with a very lumpy asset and the fund’s cash flow will be tight for some years. If the children decide to rollover their super to another fund the shop may have to be sold.
  2. The fund could purchase part of the property as tenants in common with the current owners, which would make sense from a cash flow perspective. However, as an SMSF can’t directly own property that’s mortgaged (as opposed to a limited recourse borrowing arrangement), part of the purchase price will need to be used to pay out the mortgage.
  3. A fixed unit trust or private company could be established and providing there is no mortgage over the property the fund could purchase units in the trust as well as other family members who would own the units personally.

Whatever strategy is decided on, the purchase is helped by family members combining their resources from the SMSF to purchase the shop. In addition, the tax-deductible rent from the shop is paid to the owners, which would include the SMSF either directly or indirectly. If the children wished to run the business after the parents retire, then having the shop in the SMSF can mean an intergenerational transfer of the asset which is seamless.

A word of caution

I’ve looked at some of the positives of incorporating children, but unfortunately there are some negatives to consider.

Dipping into the fund

Children who become members and trustees of a family SMSF can be in a position to access the fund’s resources. This type of access without proper controls in place can have tragic consequences.

There was a court case some years ago involving an SMSF setup by a husband and wife and which incorporated their adult son. Unfortunately the son was drug addicted and left the fund almost penniless and non-compliant for tax purposes. If better control had been exercised over the operation of the fund, and the trustees understood their responsibilities, the loss may have been stemmed or avoided altogether.

Relationship breakdown

In a relationship breakdown superannuation forms part of the asset pool which is to be divided between the parties. This means that as part of a settlement one party may have access to the other’s super. It could mean having to sell the family’s business assets to free up cash as part of the agreement. And the situation is not isolated to just the parents – children as members of the fund may also be going through a relationship breakdown.

Control on death

When it comes to estate planning and SMSFs, who’s in control is an important factor, determining whether the wishes of the deceased are correctly carried out, or not.

There’ve been court cases where children have been appointed as trustees of an SMSF, as the legal personal representative of their parents, and where things have gone south.

In one case, a father and daughter were members and trustees of an SMSF. The father completed a non-binding nomination for his super balance to be split 50/50 to his daughter and son. At the time of his death, the son was not a member or trustee of the SMSF, so the daughter appointed her husband and proceeded to pay 100% of her father’s benefits to herself. The court found in her favour. As trustee she (and her husband) had discretion, as the original nomination was non-binding. Even if the nomination was binding, the fact that the daughter was in control of the SMSF could have caused a protracted and costly legal battle between the beneficiaries.

To include or not to include, that is the question

There can be many benefits by admitting children and other family as members of an SMSF. But considerable thought should be given to the potential risks that can arise when family and money are combined.

Weigh up the pros and cons before making your decision, as the needs and motivations of family members may be different to your own and could lead to conflict.