Investment Rules Within SMSF

There are many ways in which an individual's superannuation can be managed. Self Managed Super Fund's (SMSF) have become increasingly popular in recent times as people seek to take greater control over their retirement savings.

There are many investment rules that are unique to the SMSF environment. Ignorance to these rules can often catch trustees out.

People aren't familiar with the fact that assets held within an SMSF cannot be dealt with and used in the same way the same asset can be used if it is held in a family trust, or an investment company or held personally, as well as the use and dealing of assets.

Investment Rules

Some of the common yet often misunderstood (or not known at all!) rules include:

• Assets cannot be purchased by an SMSF from its members (or a related party), even if done so at market value. This includes residential properties.  The exception to this rule is listed shares, managed funds and commercial property

• There is to be NO personal use of SMSF assets by its members or anyone related to them. So, you can't purchase a residential property in your SMSF and rent it to your children, parents etc. Even if they pay market rent.  The only exception is Business Real Property, which can be leased by a member or a related party. This must be conducted on commercial terms

• SMSF's are strictly prohibited from lending, unless under one of the prescribed exceptions, such as Limited Recourse Borrowing Arrangements. The concept of 'lending' gs further than just the traditional notion of what 'lending is'. For example, contributing monies to assist with the purchase of a property when the fund is first established, and then reimbursing yourself when the rollovers are banked is considered lending

• Keep the assets of the fund clearly separate to that of personal assets. This includes ensuring all assets are held in the correct name, 'trustees name(s) as trustee for the name of the SMSF'

• The sole purpose test should be considered and met with every investment decision

• Do not breach the 'in house asset test' – that is, ensure that no more than 5% of the value of the fund is represented by loans to, or investments in related parties of the fund

• All transactions should be conducted on an 'arm's length' basis

Investment Strategy

The trustees of a Fund must formulate and implement an investment strategy for the SMSF. Regulations stipulate the investment strategy must include:

• The likely risk and return of any investment

• The fund's investment objectives

• Diversification; investing across a broad range of assets,

• Liquidity; ensuring the fund has the ability to pay taxes, expenses and members' benefits

It is important that the investment strategy is reviewed and updated regularly. Auditor of the Fund will be looking to ensure that any investments decisions made by the SMSF adhere to the strategy.

Investment Options

SMSFs offer a wider range of investment options compared to other superannuation funds. With some limited exceptions, a SMSF can invest in virtually anything provided it is allowed by the investment strategy prepared by the trustees, adheres to the regulations and that it meets the sole purpose test and adheres to the regulations. That means that assets must be held ONLY to provide for members in their retirement. It therefore follows there is no personal use allowed of super fund assets and depending on the type of asset, additional requirements may exist (such as insurance and how the asset is stored). Assets must be carried at market value and therefore appropriate independent valuations will need to be sought in some instances.

A separate bank account needs to be set up for the super fund and all assets held by the super fund must be clearly identified as those belonging to the superfund and be kept separately to that of personal assets.

An SMSF can also borrow to purchase an asset, however, this is becoming increasingly difficult as many banks have removed their SMSF lending products from the market.

One of the reasons why SMSF's have become so popular is because they are the only retirement vehicle that can hold real property. SMSFs are therefore attractive to small business owners or the self-employed as a commercial property can be purchased by their SMSF. This property can then be rented to their business providing this is at the prevailing market rates, on an arm's length basis. However, a residential property owned by a super fund cannot be occupied by any of its members or their relatives – even if it is at market rental. Furthermore, an individual cannot move an existing residential investment property they own in an SMSF.

Artwork and other collectables, physical gold and investments in some unlisted entities are all permitted within an SMSF. There are, however, stringent criteria that have to be met for these investments to ensure the SMSF remains compliant with the law.

Responsibilities of trustees

The members of a SMSF must also be its trustee (or directors of the corporate trustee). Therefore when you 'self-manage' your retirement savings you take on the responsibility for the control of investments in the fund and all decisions relating to those investments. This is very different to Industry or Retail Super Funds where the trustee is separate from the members and the members have little to no influence or control over investment decisions. Therefore, as a trustee, you should make sure you have a reasonable understanding of investment options and markets as poor investment decisions will have a direct impact on the assets of your fund and also the retirement savings of other members. When acting as trustee, the members of an SMSF can exercise total control over the investments of the fund. Some people simply do not have this expertise.

All SMSFs have a trust deed that prescribes the rules that govern it; this includes provisions dictating what powers the trustee has and what entitlements the members have, including investment decisions and the types of investments the fund can hold. All members of a SMSF are responsible for any breaches of these rules even if it was not caused by their direct actions.  

Serious breaches of the law can result in the fund being deemed as 'non-complying' by the ATO. Any personal use or benefit received from super fund assets by a member or their related parties will constitute a breach. Following the receipt of a notice of non-compliance, the SMSF will lose its concessional tax status and the highest marginal rate of tax would be applied against the income earned and also the market value of the assets held.

Contact H&R Block SMSF Solutions should you require any assistance in the compliance of your fund.