Revealing the true cost of poor quality SMSF administration services
By Venetta Sacha, Director Hall Consulting Group and David Saul, Director Saul SMSF
SMSF trustees are increasingly facing retirement and estate planning decisions, that ultimately include the payment of death benefits. It’s a complex area, that can puzzle even the best at times.
Many of them don’t realise that these decisions can be significantly affected by the accuracy and completeness of record-keeping, during the life of their fund. A trustee can save money in the short-term by compromising on the quality of the fund administration services, but the true cost will likely be a larger tax liability down the track when it really matters !!
Many trustees are unaware of the importance of the information included in the financial statements prepared by SMSF fund administrators and how errors, omissions or inadequate information may impact their benefits.
The financial statements report the net income and financial position of the fund, but the key reports (relied upon by advisers when preparing pension or estate planning advice) are the Members Statements. These reports include not only the member’s withdrawal balance, but also provide details of the tax components of this balance.
A new law came into effect on 1 July 2007 requiring classification of the superannuation account balances to taxable and tax-free components. Fund administrators were required to reclassify existing members' balances to preserved, restricted non-preserved and unrestricted non-preserved benefits, as well as split the benefit balance into taxable and tax-free components.
These components are extremely important to determine how much tax will be paid if a transition to retirement pension stream commences or a death benefit is paid.
A new SMSF client of Hall Consulting Group recently became painfully aware of the differences between a good quality fund administrator and a cheap administrator:
Case Study: Dodging a Bullet!!
Crisis averted, a $44,200 tax bill in the making… The trustees approached us with a request for assistance in retirement and estate planning strategies. The fund had two members in accumulation phase. The latest financial report prepared by their previous fund administrator contained Members Statements that only provided information of the withdrawal balances. These statements did not mention many key member details and, critically, excluded the tax-free and taxable components. When contacted, the previous accountant advised that all benefits were 100% preserved and 100% taxable.
However, with some critical analysis - the client recalled that they had made non-concessional contributions over the last few years. The reconstruction of contributions history over the last 10 years and review of rollover statements from industry funds revealed that the withdrawal benefit of the older member included 40% tax-free component.
The older member inquired about transition to retirement. His superannuation benefit was approximately $650,000. If a pension strategy was implemented based on the advice that the entire benefit is 100% taxable, at his tax level, this member would have paid $3,536 extra tax on his pension per annum until he turns 60.
If both members were to die together suddenly, a death benefit payment would be made to their 2 adult children and the taxable component of the lump sum taxed at their marginal tax rate less a tax credit of 15% or 17% (including Medicare Levy), whichever is lower. As a result, if the advice of the previous fund administrator had been accepted without question,then beneficiaries of the deceased would be subject to an extra unwarranted tax of at least $44,200! The tax could be as high as $88,400 if marginal tax rates apply.
This is just a simple illustration of the potential cost to members and beneficiaries if the fund's records are not maintained in an accurate and complete manner.
There is more to consider when planning for retirement. In the case discussed above: the fund was established with individual trustees, the trust deed was 10 years old and did not align with current legislation. From a compliance perspective, the trustees had never considered insurance and did not have an up to date investment strategy. There were no death benefit nominations or wills in place. The previous tax agent was also the auditor of the fund.
This is not an isolated case. SMSF trustees need to be educated on the composition of their superannuation benefits and have a basic understanding of how benefits are taxed on death or retirement. Their focus should be on making sure they sign meaningful reports and deal with quality providers to avoid unnecessary rectification costs and excess taxes in the future.
We work together with our SMSF advisers, SMSF auditors and SMSF legal specialists to create awareness and educate our SMSF trustees on a number of topics relevant to their decision making process, such as:
Composition of superannuation benefits, when they can be accessed and how they are taxed on withdrawal or as death payment;
Quality and accuracy of the annual financial report of the fund and all key information;
Importance of having an independent quality SMSF auditor. A truly objective auditor’s eye will more likely spot a problem and request clarification. Quite often the trustees aren't aware of the true independence of their auditor;
Importance of current SMSF trust deeds. Are they well-suited to the needs of fund members and do they comply with the latest superannuation legislation;
The advantages of having a corporate trustee;
The importance of death benefit nominations and when they are valid. Learn about non-lapsing nominations and consider trust deeds incorporating non-lapsing binding death nomination provisions;
The importance of estate planning and how death benefits are taxed. Often non-resident beneficiaries are nominated not knowing that the benefits paid to them are subject to capital gains tax;
Types of pension streams, commutation and the benefits of reversionary pension.
The current focus of many advisers is to provide a proper statement of advice upon set up which outlines strategies to trustees to meet their goals. These benefits can be lost during the life of the fund to administration shortcuts and laziness in record keeping.
Our message to all SMSF trustees is to choose their fund administration provider wisely and ask many questions. They should ensure that they engage an independent auditor and read their recommendations. They should surround themselves with quality trusted advisers and stay informed!
We hope this article has now got you thinking about these important issues as well as how you might benefit from further research and inquiry into this area. If you have any questions about your own fund administration or establishing a new SMSF (a great opportunity to start fresh with all the fundamentals in place!), please don’t hesitate to contact us.