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Self Managed Superannuation Funds: What are the Risks Associated with SMSFs?

What are the Risks Associated with SMSFs?

Considerations Background and Explanation
1. Responsibilities and obligations for SMSF trustees associated with running an SMSF SMSF trustees need to comply with a number of obligations under the superannuation and taxation laws, as well as the trust deed. There may be various consequences—for example, loss of taxation concessions—if an SMSF trustee fails to comply with their obligations. Even if one trustee is less actively involved, all trustees are equally liable for the fund’s compliance with the superannuation and tax laws. 

The Australian Taxation Office (ATO) requires new trustees to make a declaration that they understand their responsibilities and obligations as an SMSF trustee, including to:

  • ensure that the SMSF is managed in compliance with the relevant laws and be responsible for and control the SMSF;
  • maintain the fund for the sole purpose of providing retirement benefits to SMSF members, or to their dependents if a member dies before retirement;
  • accept contributions and pay benefits (pension or lump sums) to members and their beneficiaries in accordance with superannuation and taxation laws and the SMSF trust deed;
  • value the fund’s assets at market value for the purposes of preparing financial accounts and statements;
  • have the financial accounts and statements for the SMSF audited each year by an approved SMSF auditor; and
  • meet the reporting and administration obligations imposed by the ATO.

It is important that trustees understand that they remain responsible for managing the fund even if they outsource some or all of their responsibilities to external service providers.

2. Risks associated with an SMSF
a) Lack of insurance for SMSFs Unlike APRA-regulated funds, SMSFs do not come with insurance. The potential loss of insurance benefits as a result of switching from an APRA-regulated fund to an SMSF is an important issue. SMSF trustees should consider whether it is appropriate to take out separate life insurance for members, including income and total and permanent disability cover, as part of the fund’s investment strategy. Although taking out this insurance will be at an additional cost to the SMSF, the risk of not having appropriate insurance is that it may leave members worse off in retirement.
b) Other risks associated with an SMSF structure There may be risks, for example, associated with: 

  • a lack of access to the Superannuation Complaints Tribunal to resolve SMSF complaints;
  • using individual trustees as opposed to a corporate trustee; and
  • a breakdown in the relationship of fund members, especially in circumstances where the membership structure of the SMSF is unusual.
3. The need to develop and implement an appropriate investment strategy for an SMSF Developing and implementing an appropriate investment strategy is a serious responsibility for SMSF trustees. The trustee will ultimately remain responsible for the fund’s investment strategy even if they seek investment advice from an adviser. 

It is important that trustees understand:

  • the benefits associated with asset diversification and investing across a number of asset classes (e.g. shares, real property and fixed interest products) in a long-term investment strategy, such as improving the risk and return profile of an SMSF fund;
  • there are some restrictions on SMSF investments and, as part of their obligations, trustees are prohibited from entering into certain transactions, such as lending the fund’s money, or providing financial assistance to a member of the fund or their relatives; and
  • they should conduct a regular review of the SMSF’s investment strategy to ensure that the investment strategy continues to reflect the purpose and circumstances of the fund and its members.
4. The time commitment and skills needed to run an SMSF effectively Trustees can use external research or advice to develop their financial knowledge over time, but they remain ultimately responsible for ensuring that investment decisions are made and implemented according to the SMSF’s investment strategy.
5. The costs of managing an SMSF The costs associated with managing an SMSF are potentially significant and should be considered to make an informed decision about whether an SMSF structure is a suitable superannuation vehicle for them.The costs of managing an SMSF include: 

  • establishment costs (e.g. preparation of a trust deed and development of an investment strategy); and
  • ongoing costs associated with operating an SMSF (e.g. annual administration and investment costs, the cost of outsourcing the trustee’s compliance obligations and statutory charges).

Please see Appendix H for more details and examples of the costs.

6. The need to consider and develop an exit strategy for an SMSF Trustees and members need to consider and develop an exit strategy for the SMSF in situations, for example, where the compliance requirements become too onerous or costly for the SMSF trustee. 

It is important to be aware of the process for winding up an SMSF and the likely costs associated with that process.

7. The laws and policies that affect SMSFs are subject to change The taxation and superannuation laws and policies that apply to SMSFs may be subject to continual change, including changes to legislation, and regulatory policies and standards.

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