SMSF / SMSF Compliance

The need for a good trust deed indeed…

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The Super System Review (Cooper Review) has posed an interesting question within the Phase Three Issues Paper regarding whether a standard trust deed could be adopted for SMSFs created by the Regulator (Australian Taxation Office) at no cost.  Trustees could elect to opt-out of the standard trust deed and use their own if they wished.

This is an interesting question because the quality of a fund’s governing rules ultimately dictate and outline the availability of strategies that members can undertake within their SMSF. For most SMSFs, the purchase of the trust deed is left in the hands of the professional adviser recommending the establishment of the fund.

I think you would find in the majority of cases, many accountants and financial planners haven’t even undertaken due diligence on trust deed providers to ensure that have the most appropriate deed for their clients (the fund members).  More often than not, it is simply a “numbers game” to buy the cheapest and obtain the greatest profit margin to on-sell to their client.

The cost of an SMSF trust deed can range anywhere from $100 to $1,000 depending on the legal firm or solicitor preparing these documents.  It is simply not a case of the more expensive, the better the deed either!!

An important element in assessing an appropriate trust deed is to consider the level of expertise and business activity that the solicitor (or their organisation) has with SMSFs.  Specialist lawyers within this area can add significant value to the strategies available for fund members, simply because they know their way around the legislation and can apply the law favourably within their deed’s governing rules.

As part of the pre-establishment process of an SMSF, it is important to understand the options available within trust deed offerings, along with consideration as to whether any further prescriptive detail of the deed is required.  To simply grab an “off-the-shelf solution” may have a detrimental effect for the fund members because of a specific event and having to apply a benefit or undertake a certain action in such a way because the rules of the fund require the trustees to do so.  An example of this may be the direction of insurance proceeds from a total & permanent disablement payment.

So what needs to be considered within a trust deed?  I have outlined below a range of issues that need consideration in the establishment phase of an SMSF:

  • Product Disclosure Statement (PDS) – does the trust deed provide a PDS to provide members where there is a financial product consideration (e.g. commencing a pension)?
  • Voting power – do all members have equal voting rights? or should the members have voting power based on $ of account balance?
  • Type of Death Benefit Nominations
    • does the deed allow for both binding and non-binding nominations?
    • if binding is allowed, is there a time frame for the nomination where it must be reviewed and renewed (otherwise it becomes invalid)? SMSFs can have non-lapsing binding death benefit nominations, which is a unique feature of SMSFs over all other types of super funds.
  • Income Streams – does the deed allow for a member to receive an account based pension (to be paid since 1 July 2007), including a transition to retirement income stream (TRIS)?
  • Fund Reserves – does the deed allow for the creation of reserves including an anti-detriment reserve, contribution reserve, investment reserve, etc.
  • Investments – does the deed impose any limits of the type of fund investments?
  • Benefit Payments
    • Can benefits be paid to a member by cash and in-specie asset transfer?
    • Is there an age imposed by the deed where benefits must be paid to a member as either a pension or lump sum?
    • Does the deed allow for benefits to be paid to members under terminal illness?
  • Contributions
    • Does the deed allow for contributions to be accepted from government agencies (i.e. is it allowed to accept co-contribution payments).
    • Can the fund accept contributions in-specie (as well as cash?)
    • To what age does the trust deed allow for a member to contribute to the fund?
  • SMSF Instalment Warrants – Can the fund borrow in accordance with section 67(4A)?
  • Death
    • Does the deed allow for the deceased member’s Legal Personal Representative (LPR) to be appointed as a replacement trustee to ensure that the deceased’s wishes are appropriately carried out (not left to the discretion of other trustees)
    • Can the death benefit payment be paid as a pension, lump sum or combination thereof?
    • Can benefits be transferred from the fund in the event of death in-specie?
  • Allocation of Net Income
    • How is income to be allocated amongst the members?
    • Can net income be allocated to a reserve?

This list is by no means exhaustive, so I encourage readers to comment further regarding additional trust deed considerations.

How often should I update my trust deed?

A common question that is posed to me regularly regards how often a SMSF trust deed should be updated?  The expectation isn’t typically set with clients by advisers that the SMSF trust deed used to establish a fund will in 5 years time (more than likely) be required to be updated because of superannuation and income tax law changes.  Just like a car needs to be serviced regularly to achieve optimum performance, an SMSF needs to be serviced to ensure that it runs at optimum capacity to be able to run strategies in accordance with changing legislation.

My ‘rule of thumb’ is a trust deed would typically need to be updated somewhere between every 3-5 years.  This is ultimately subject to any significant changes being implemented by government.  Take for example, the introduction of the Simpler Super reforms on 1 July 2007, I made all my clients update their trust deed as the changes were so significant and far reaching that it was simply appropriate at that time for an update to take place.

The requirement for a deed update, other than through forced legislative change, is typically “event driven” by fund members.  That is, a fund member may be retiring, wanting to undertake borrowing inside their SMSF to acquire property, etc.

Note: I do not buy into the the benefits of an annual update service.  In my opinion it is simply a revenue grab by the legal profession.

In any client meeting where I may be taking over the administration of an SMSF, the first request I have is always for a copy of the trust deed.  It sometimes horrifies me to see clients who don’t know where it is, or when having provided the deed, it is significantly out of date and the fund is actually non-complying because it is operating outside its own governing rules.  Common examples include the payment of pensions or accepting contributions outside the requirements of the deed.

Last year, I came across an SMSF that had not had a trust deed update since establishment in 1982!!  Let alone the fact that the introduction of the SIS Act in 1993 required a compulsory deed update, in working through the document with the client, it required them at age 60 to purchase a policy with a life company to pay an annuity for their lifetime (amongst many other issues!).  They became mortified once explaining the importance of the trust deed that this was not regularly communicated to them.

Refer to blog, “How compliant is your SMSF” to assess the current health of your SMSF.

Therefore, it is important to understand that an update to your fund’s trust deed is a small investment that potentially allows the fund members to enjoy thousands of dollars of benefits long term.

So, there really is a need for a good trust deed indeed!!


Comments

comments

4 thoughts on “The need for a good trust deed indeed…

  1. Hi Aaron.

    All good points indeed (sorry) !

    Another variation on the Cooper Review’s standard deed may be a pro-forma deed that provides a schedule for variations. This could provide a low-cost solution for the majority of people, with the ability to still tailor to special needs (eg specific estate planning requirements) for a specialised minority.

    Greater standardisation of deeds may also lead to more trustees being familiar with the clauses within the deeds and how to make the most of the potential offered by SMSF’s.

    Whatever the outcomes of the reviews, they will certainly impact upon SMSF’s and the advisers like us that specialise in this area.

    Kind regards,
    Neil

    • Hi Neil,

      I think that greater standardisation could have a positive effect on trustee education, however I believe that many people who end up with this result (upon receiving advice from an accountant or other adviser) will be the worse for it.

      Cheers,
      Aaron

  2. Hi Aaron,

    Nice check list in regards to what to look for in a quality SMSF trust deed.

    You mentioned a couple of times about reserves and the allocation of net income. In your opinion in a SMSF do you need to use an investment reserve to allocate income in a disproportionate manner?

    Provided the SMSF deed allows flexibility in determining the profit allocation to members, will it be a breach of the minimum benefit standards if the trustees don’t allocate the invest return proportionately?

    Maybe the use of reserves and the strategies around the allocation of net income would be a good article topic.

    David

    • Hi David,

      Thanks for the great question. The fund’s governing rules ultimately set out the way in which income must be allocated. Therefore, if there is flexibility or discretion for the trustees to determine the allocation in anyway they deem appropriate, then I don’t see it to be an issue, however most deeds probably stipulate some form of methodology around this area. This strategy would actually be attractive when a member is running multiple super interests within the fund (i.e. 100% tax-free pension), in particular for a single member fund, because there would be no argument from the regulator about a member being disadvantaged over another. The key here is the terminology used within the deed, for example whether the terms “must” or “may” (… be credited or debited to the members account) has been written.

      I have also seen deeds where an equalisation account can be created in essence to do exactly what you have asked, although I’m not sure how widely they are used?

      It certainly won’t be a breach of the minimum benefits standards unless the allocations were previously allocated and vested with the member. If amounts have not been allocated, then the member’s minimum benefit does not include these amounts.

      I’ve taken on board your request for a reserves article. The “intergenerational SMSFs” blog (http://wp.me/pEABL-36) covers the use of reserves for an anti-detriment payment, but I’ll spend a bit of time covering off some of the big attractions in using reserves.

      Cheers,
      Aaron

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