When you should close your SMSF

First published in the Financial Review on 05 March 2020.

The five 'trigger' situations include insufficient funds, declining mental or physical capacity, death, lack of time to oversee a fund and moving overseas indefinitely

The growth in the number of new self-managed superannuation funds (SMSFs) often attracts attention. But there is much less focus on the flip side – the number of funds that get wound up. As Australian Taxation Office figures to June 30, 2019 show, in that financial year, 8240 funds were closed – a significant number.
Such a decision should never be taken lightly, nor without advice. But there are valid reasons for doing so, and trustees and their advisers need to be aware of them. In essence, there are five circumstances for dictating the winding up of a fund: insufficient funds; declining mental or physical capacity; death; lack of time to oversee a fund; and moving overseas indefinitely.

A common reason for winding up an SMSF is insufficient assets in the fund because:

  • Other members have left the fund by rolling over to another super fund or withdrawing lump sums;
  • The last remaining member has reduced the fund’s capital by drawing pension or lump sum payments; or
  • Other members have died, and significant death benefit lump sum payments have been made.

Whatever the reason, a time can come when the cost efficiencies of an SMSF can’t be justified and the correct decision is to close the fund.

Nearly half of the nearly 600,000 SMSFs pay pensions. But as trustees age, the risk of physical or mental impairment increases and this can result in the loss of capacity to act as an SMSF trustee.

It’s also important to check whether the appointee’s own circumstances may have changed since the enduring power of attorney was granted, such that they may no longer wish to be the trustee, or be capable of doing so.

Where a loss of capacity occurs and no one holds an enduring power of attorney or is prepared to act in that capacity, the only alternative is for the incapacitated member to leave the fund. If the incapacitated person is the only member or key decision maker, the fund must be wound up.

One spouse driving fund

Most SMSFs comprise married couples, and in many cases one of them is more involved in running it. If that person dies, the surviving spouse may prefer to close the fund and move their money to a simpler super arrangement where they have no trustee responsibilities.

It’s also important to consider the broader implications when one of the members of a two-member fund dies. The executor of the deceased member usually acts as trustee on their behalf until a death benefit has been paid or has started to be paid. Once this occurs, the executor must resign as trustee. The SMSF then has six months to make any adjustments needed to its trustee structure in order to satisfy the legal definition of an SMSF.

SMSF trustees can underestimate the time required to execute their trustee duties when setting up a fund. Alternatively, their employment or other circumstances may change, leaving little time to devote to their fund.

However, trustees must be able to demonstrate participation in the running of their SMSF, and this requires evidence such as minutes of trustee meetings. Where there is insufficient time, a fund wind-up should be considered.

Moving overseas indefinitely can cause an SMSF to fail the residency test requirements in the legislation. In short, a majority of fund trustees (50 per cent plus) must reside permanently in Australia.

Residency rules

Although there is a two-year window for trustees to be absent overseas without failing the central management and control test, the law requires that the absence be for a specified time or to undertake a specific purpose.

The consequences of failing the residency test are severe as the fund will be made non-complying in the year the trustees leave Australia. The net assets (less member-financed contributions) of the previous financial year are included in assessable income and, along with all other income of the fund, are taxed at the top marginal rate.

If the majority of trustees are planning to move overseas indefinitely, then the issue of residency must be addressed and finalised before leaving Australia. This is because once the trustees are overseas, the fund has immediately failed the test and will be made non-complying from the year of leaving.

An option is to wind up the fund and rollover to an alternative arrangement where they are not trustees, making where they live irrelevant. If this is the best course of action, it is critical that the SMSF is wound up before they depart.

Winding up a fund is rarely an easy decision, often coinciding with a tragic event in a trustee’s life. That’s why it’s a course of action trustees and their advisers need to consider well in advance of it happening.

Opinion piece written by
John Maroney, 
SMSF Association