Is bigger better? Expanding the membership of SMSFs

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The 2018 Federal Budget confirmed the maximum number of members in an SMSF is likely to increase from four to six people.

Benefits of a larger membership

An increase in membership could mean greater flexibility, especially for:

  1. Small businesses with multiple owners who may wish to pool their super into one fund.
  2. Families wanting an intergenerational transfer of assets, especially business property.
  3. Limiting the impact of Labor’s proposal on franking credit refunds. With more members there’s likely to be a larger pool of assets in one fund. Excess franking credits could be absorbed in the fund and offset against non-franked income and taxable contributions.

At the moment, more than two-thirds of SMSFs have two members, just over 20% have one member and only about 7% of funds have three or four members. This suggests a limited underlying appetite for larger membership funds, and if passed into law, there’s likely to be little impact on the SMSF sector at least initially. It may change if Labor’s policy becomes law.

Downsides of a larger membership

For SMSFs expanding their membership, one possible issue could be increased administrative complexity.

Investment decisions need to cater for a larger pool of members, and this may lead to a more conventional investment mix than otherwise. Recent research by SuperConcepts and the University of Adelaide shows that as the number of fund members increases, investments tend to become less risky and groupthink leads towards more familiar assets such as cash and domestic equities. Funds expanding their membership will need to take care to properly identify and address these behavioural factors.

More members may also mean a more decentralised fund with less desirable outcomes. Think of the scenario of children outvoting their parents on investments, estate planning and other fund matters. The outcome could be undesirable and inequitable.

Six members could also result in more frequent membership changes as some members pass on, or move to their own SMSF or a publicly offered fund, placing a strain on fund administration and associated costs.

Allowing funds to have up to six members further underlines the importance of appointing a corporate trustee for an SMSF. A fund with a corporate trustee would be penalised only once with a breach. In contrast, individual trustees who breach the rules could each be penalised personally for the breach.

Weighing up the pros and cons

The main benefit of a membership increase relates to the pooling of assets that would otherwise be spread more thinly. However, there are potential downsides relating to administrative efficiencies as well as investment decisions and performance.

When considering the best number of members for an SMSF, there’s no one-size-fits-all answer. It will depend on individual circumstances, and a good first step may be advice from a qualified professional.

 

Graeme Colley is the Executive Manager, SMSF Technical and Private Wealth at SuperConcepts, a sponsor of Cuffelinks. The material in this article is for general information and does not consider any individual’s investment objectives.

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One Response to Is bigger better? Expanding the membership of SMSFs

  1. Gary M May 31, 2018 at 11:54 AM #

    ATO has cauthioned on the intergenerational wealth transfer. Assistant Commissioner Tara McLachlan has warned about the complexity: “The average SMSF has 1.9 members so it’s usually either a single member fund or a Mum and Dad scenario. When SMSFs have multiple members in there they will need to consider the requirements of each member at different stages. Where you have a younger generation that have got purely accumulation phase funds, you might look at a more aggressive investment strategy or look for capital growth where liquidity is not a problem. As opposed to retirement phase when you have to pay pensions and you’ve got liquidity needs. So it adds a level of complexity. I also wanted to mention some of the things I’ve heard around the traps in terms of the idea that when Mum and Dad pass away, they can then just push the benefits in their SMSF to the kids or whoever. That’s not going to be the case because death is a compulsory cashing condition. If you’ve agreed to pay a lump sum to those beneficiaries, then it needs to come out. So that’s another liquidity issue that you need to think about. On the death of a member, you need to be able to liquidate assets and get that money out of the fund.”

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