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HNW Strategies for SMSFs - August 2010


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This is a copy of the presentation of the August 2010 Webinar on High Net Worth SMSF strategies conducted on 'thedunnthing' blog,

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HNW Strategies for SMSFs - August 2010

  1. 1. High Net Worth (HNW) Strategies for SMSFs Aaron Dunn B.Bus (Acc), CPA, SSA SMSF Specialist AdviserTM 31 August 2010
  2. 2. Housekeeping • Attendees are muted for the session • You can type questions to the presenters from your screen • PowerPoint presentation and the recording will be made available to participants after the session • Including all Q&A’s from the session
  3. 3. About Aaron Dunn • 15 years within the accounting and financial services industry focusing on the Self Managed Super Fund industry • CPA and SMSF Specialist Adviser TM • Previous role as Head of SMSF Solutions, Snowball Group Limited • Personally invited by Jeremy Cooper to meet and discuss Phase Three of the Super System Review • Part of the ATO Auditor Working Group for Super Simplification • Regular presenter within the industry and to trustees on SMSFs • Recently established new specialist SMSF consulting business focusing on strategic advice, training and education • Specific technical assistance, helpdesk, in-house SMSF training, webinars/seminars , white- label content including presentations, newsletters and trustee fact sheets • more details about this exciting new venture will be available in the coming weeks
  4. 4. Today’s Session • SMSF Statistical Analysis to understand traits of HNW Trustees/Members • High Net Worth Strategies for SMSFs • Including case study examples
  5. 5. HNW SMSF Statistical Analysis • Average Fund Balance = $912,739 (June 2010) • 25.2% of SMSFs have balance greater than $1,000,000* • 15.9% of SMSFs have $1m - $2m (68,080 SMSFs) • 8.0% of SMSFs have $2 - $5m (34,250 SMSFs) • 1.1% of SMSFs have >$5m (4,710 SMSFs) • 0.2% of SMSFs have $10m+ (856 SMSFs) • Estimated Fund Assets held by HNW SMSFs is $266 billion • Represents 68% of total assets within SMSFs ($266bn / $390bn • $260bn calculated as mid-point of asset ranges above multiplied by number of funds $0 - $200k 25.47% $200 - $500k 26.47% $500 - $1m 22.88% $1m + 25.17% SMSFs by Fund Size $0 - $200k 3% $200 - $500k 10% $500 - $1m 19% $1m + 68% SMSFs by Fund Assets
  6. 6. Statistical Breakdown % of total SMSF assets % of SMSFs holding these assets Average HNW >$1m holding these assets Highest % $1m HNW Cash 26.4% 90.4% 23.7% 26.3% ($1-2m) Listed Shares 32.4% 63.3% 33.3% 34.6% ($10m+) Non-residential property (BRP) 9.2% 12.6% 9.3% 10.7% ($2-5m) Residential property 3.3% 6.5% 2.7% 3.4% ($1-2m) Listed Trusts* 7.7% 33.2% 7.0% 8.1% ($1-2m) Unlisted Trusts 8.7% 19.1% 10.1% 11.5% ($2-5m) Other managed investments* 5.8% 13.8% 5.8% 6.4% ($10m+) * Both likely to include managed fund investments as reported in SMSF Annual Return – could be up to 13.5% • Where are these assets invested?
  7. 7. Key HNW SMSF Strategies 1. Maximising Contributions 2. Fund Reserving Strategies 3. Limited Recourse Borrowing Arrangements 4. Multi pensions – tax free proportion income streams 5. Investment Segregation 6. Anti-detriment reserves 7. Non-lapsing death benefit nominations & SMSF ‘Wills’
  8. 8. Strategy 1 – Maximising Contributions • What strategies are available? – In-specie asset transfers • e.g. shares, widely held trusts, commercial property (BRP), in-house assets • BRP – CGT small business concessions, stamp duty exemptions* – Re-contribution strategies • Shifting taxable component to tax-free component – Contributions Reserving (June contributions each FY) – 10% rule for concessional contributions • Remember the impact RESC (salary sacrifice) – Deferral – Debt forgiveness on BYO Banker limited recourse borrowings – Remember the CGT caps and use of the Small Business Concessions – TR2010/1 – superannuation contribution Remember the timing of the ‘bring forward’ rule before age 65
  9. 9. Example - Contributions Deferral • What if a client’s MTR is 46.5%? • Can potentially salary sacrifice or make a personal deductible contribution up to CC cap plus up to NCC cap • Employer / individual receives full deduction on contribution • Excess tax payable, but on receipt of a Notice of Assessment (NoA) • Provided no further NCCs or excess CCs made in subsequent years there is no ‘double’ taxation
  10. 10. Example – Contributions Deferral • Ken (62) is a company director, earning $1,000,000 (incl. super). This includes a $500,000 bonus, payable in September 2010. • He would like to retire in approx. three years time from his job • Ken intends to salary sacrifice up to his CC cap of $50,000 • Expected personal tax payable on Ken’s taxable income of $415,300; • What if, – Ken salary sacrificed $484,800* of his bonus to super in 2010/11? – Excess concessional contributions of $450,000 – Excess concessional contributions tax (31.5%): $141,750 – Excess non-concessional contributions: $0 • Instead of PAYGW on salary, taxed within SMSF – Salary is withheld upfront vs. deferred at least 11 months after end of financial year (May 2012 - due date of SMSF Annual Return) * $500k bonus adjusted for SGC up to maximum super contribution base of $42,220 per quarter
  11. 11. Example – Contributions Deferral Sept 2010 30 June 2011 May 2012 Jan/Feb 2013 Excess Contribution Made Financial Year End 2010/11 SMSF AR lodge & payable NoA for excess CC tax payable 21 months Up to 30 months • Cash is able to work harder within the SMSF • SMSF benefits from $209,750 invested up to 20 months, plus ability for $141,750 to stay in the fund if Ken pays tax personally (which he can elect to do)
  12. 12. Strategy 2 – Fund Reserving Strategies • Types of SMSF Reserves – Anti-detriment Reserves • Allows for additional payment as a lump sum to a SIS dependent of a deceased member. – Contributions Reserves • Allows for short-term ‘parking’ of contributions up to 28 days – Pension Reserves • Provides for solvency of income streams to ensure it can be continued to be paid at an agreed rate. – Self Insurance Reserves • Allows for the trustee to fund TPD payment to members as well as death benefits to dependents and/or legal estate of deceased members – General (Investment) Reserves • Allows for the trustee to allocate earnings of the fund – Expense Reserves • Allows for trustee to use reserves to fund general and specific expenses of the fund.
  13. 13. Example – Contribution Reserving • Tom (53) inherits a commercial property worth $700,000 • Tom is not married and has no children • You were approached by Tom in May 2010 as to the best strategy to transfer the property into a SMSF? • He could have contributed 100% of the asset in June 2010 to the SMSF 1. Non concessional contribution of $600,000 – $150k allocated to as NCC to member before 30 June 2010 / $450k into contributions reserve – $50k allocated as CC to member before 30 June 2010* / $50k into contributions reserve* 2. Post 1 July (within 28 days of contribution made) – Allocate $450k to member as NCC contribution – Allocate $50k to member as CC contribution* * Need to consider any other SGC or salary sacrifice arrangements • This strategy can also be used to identify excessive contributions made in June 2010, whereby they can be ‘housed’ in a contribution reserve and allocation in July 2010.
  14. 14. Things to know about operating Reserves • Typically reserves are built by using fund earnings – May also be formed from insurance proceeds • You must develop a separate investment strategy for the use of reserves (section 52(2)(g) SIS Act) • Need to consider contribution caps for anti-detriment payments when paying out the beneficiaries • Anti-detriment tax deduction can be used to offset CGT when assets sold in accumulation phase – No longer pension phase (per example) Further discussion on the use of anti- detriment reserves shortly
  15. 15. Strategy 3 – Limited Recourse Borrowing Arrangements • Requirements to borrow inside an SMSF – The borrowings must be for the acquisition of a single asset – The asset must be held on trust – The trustee has a right to acquire the legal ownership by making one or more payments – The rights of the lender and any other person against the trustee is limited to the rights of the acquirable asset – When the borrowing is fully repaid, the Fund has the right for the asset to become an asset of the SMSF • Significant attraction for direct property exposure • Lender options - Bank vs. BYO banker arrangements
  16. 16. BYO Banker – Borrowing Arrangement
  17. 17. Important recent changes Section 67A & 67B (New Law) Section 67(4A) – (Old Law) Explicitly defines the interpretation of acquirable asset in the singular While the Act refers to ‘asset’ in the singular, it is possible to interpret asset in the plural Ensures that the recourse of the lender or any other person against the super fund trustee for default on the borrowing is limited to rights relating to the acquirable asset. The SIS Act limits the rights over the original asset in terms of the direct lender and associated borrowings. Limits borrowing arrangements to a single asset or a collection of identical assets treated together as a single asset. Allows borrowing arrangements over multiple assets which may permit the lender to choose which assets are sold in the event of a default on the loan. Clearly defines circumstances under which assets can be replaced Allows arrangements where the asset subject to the borrowing can be replaced at the discretion of the trustee or the lender
  18. 18. HNW SMSFs considering borrowing strategies Five key areas that suit strategies using limited recourse borrowing arrangements: 1. Business owners renting or wanting to upgrade 2. Business premises held outside of super 3. Assertive/Aggressive Investor – HNW? 4. Residential and Commercial Property Investors 5. Pre-retirees who are planning a sea-change
  19. 19. The Family Home • Family home = $700,000 • Debt = $300,000 (not deductible) • potentially used as business security The Family business • Run a successful widget business. • Business premises held in family trust • asset protection • Factory Valued at $600,000 • Debt of $200,000 (deductible) • Rental agreement (business & trust) John & Jane Existing Superannuation John = $150,000 Jane = $100,000 Case Study The power of the SMSF & Borrowing Rules Widget Co. Pty Ltd (business) Family Trust Rent Security Security
  20. 20. John & Jane John & Jane SMSF John = $150,000 Jane = $100,000 Borrow = $350,000 (LVR 70%) Case Study The power of the SMSF & Borrowing Rules Widget Co. Pty Ltd (business) Family Trust Rent Security Custodian (Bare) Trust Asset held on trust via Custodian Arrangement Outcomes for John & Jane • SMSF borrows money and holds asset via Bare Trust • Transfer of BRP into SMSF • No CGT (SBC) • ‘going concern’ (no GST) • Dutiable (purchaser) • Family Trust receives $600k • payout FT debt ($200k) • John & Jane payout $300k home loan • Further $100k to invest (can contribute back into super) • 100% deductible debt for SMSF, being made from deductible super and rental payments in business • Future growth of property – no CGT (if sold post retirement) Personal Guarantee
  21. 21. Strategy 4 – Multi-pension strategies • Introduction of “proportion rule” for pensions has provided a greater focus on pension strategies for clients • Why? – Provides tax efficiency under 60 years of age; and • Non-assessable (NANE) pension income – Provides estate planning benefits 60 and over • Locking in tax-free components • No (or reduced) intergenerational tax on wealth transfer • Provides an ability to direct payment on different income streams to different beneficiaries
  22. 22. Example – Multi pension strategies • John (60) starts a pension with $1 million – 50% TFC / 50% TC – Wants $60,000 p.a. indexed at 3% (CPI), net return 8% • After 10 years, now $1,180k = $590k TFC • After 20 years, now $1,235k = $617k TFC • Alternatively, if John undertakes a recontribution strategy and commences two (2) pensions – Withdraws $450,000 and recontributes as NCC and starts pension (ABP #1) (100% TFC); and – $550,000 remaining balance of benefit (ABP #2) (50% TFC) – Still takes $60,000 p.a. indexed at 3%, but can choose which income stream to take from (net return 8%)
  23. 23. Example – Multi pension strategies • Benefit of multi pension strategy: – After 10 years, now $1,180k • ABP#1 = $634,695 (100% TFC) • ABP#2 = 546,219 ($273k TFC) – After 20 years, now $1,235k • ABP#1 = $812,367 (100% TFC) • ABP#2 = $422,775 ($211k TFC) The tax-free component has improved by $317k after 10 years and $406k after 20 years, saving more than $60k in estate death taxes
  24. 24. Strategy 5 – Investment Segregation • Ability to segregate specific assets within an SMSF to a member or ‘pool’ of members – Could be in pension or accumulation phase • Why segregate? – Tax exemption – Members have different risk tolerances – Accelerate the tax-free proportion of an income stream – Improve the tax effectiveness of a TRIS (under 60)
  25. 25. Example - Segregation • Ella (55) has $420,000 and wishes to start a TRIS on 1 July 2009 – Includes $20k NCC • She has the ability to make in-specie share transfer of $330,000 as NCC contribution • Combine or setup two pensions (multi-pensions)? • If setup two pensions (strategy 4): – Can elect to segregate to each pension account – Can assign ‘aggressive’ assets (i.e. shares) to TF pension ($330k) – Share market rebounds 30%; overall fund portfolio increases 15% – TRIS #1 = $420,000 x 1.032* (growth) - $42,000 (pension) = $391,500 – TRIS #2 = $330,000 x 1.30 (growth) - $33,000 (pension) = $396,000 – Increased balance and tax efficiency of TRIS #2 as 100% tax-free • Not assessable even through <60
  26. 26. Strategy 6 – SMSF anti-detriment payments • Additional payment available upon death of the member when a lump sum is paid to a dependant – SIS dependant (which includes adult children) • Fund is entitled to ‘grossed up’ tax deduction on the bonus amount – e.g. $50,000 / 0.15 = $333,333 tax deduction • Only benefits members with taxable component • Effective strategy to use with non-dependant beneficiaries – Tax deduction can help reduce CGT on disposal of assets from SMSF
  27. 27. Example – Anti-detriment reserve • Paul (53), has account balance of $1,050,000 – Includes $135,000 tax-free component • Paul died on 25/5/2010 • No tax dependents (divorced wife & adult children) – Death benefits to be paid to Legal Personal Representative (LPR) • Fund Assets have cost base of $450,000 • What’s required for an anti-detriment reserve? • What’s the benefit of operating such a reserve?
  28. 28. Strategy - Anti-detriment Reserve • $89,349 paid in addition to lump sum death benefit • SMSF can claim tax deduction of $595,665
  29. 29. Alternative ATO Method Data Entry Client name: Paul Eligible service date: 01-March-1956 Date of death benefit payment: 25-May-2010 Total death benefit (including insurance): $1,050,000.00 Tax free component: $135,000.00 Death benefit insurance included in total death benefit: $0.00 Formula parameters Days in eligible service that occur after 30 June 1988 P = 7,999 Days in eligible service that occur after 30 June 1983 R = 9,826 Taxable component of death benefit excluding insurance C = $915,000.00 Results ATO ID formula * Anti-det = 0.15P / (R-0.15P) * C Anti-detriment amount: $127,271.47 Total Benefit: $1,177,271.47 * refer notes below • $127,271 paid in addition to lump sum death benefit • SMSF can claim tax deduction of $1,177,271
  30. 30. Example – Anti-detriment reserve Pension Phase – 0% tax rate Accumulation Phase – 15% tax rate Paul dies (no dependants) Benefits paid to estate - CGT Event 1/3rd discount applies where assets held >12mths Proceeds $1,050,000 Less: cost base ($450,000) Capital Gain $600,000 Less: 1/3 disc. ($200,000) Net Capital Gain $400,000 If, Anti detriment tax deduction ($1,177,271) Tax Loss $777,271 Ensures no CGT and can use tax loss to offset against other income or as a future benefit for members. SAVES $60,000 in CGT and future benefit of $770k of future tax- free income within the fund
  31. 31. Strategy 7 – SMSF Wills / non-lapsing DBNs • Ability to prepare definitive instructions with a non- lapsing binding death benefit nomination – Create a SMSF “Will” for each member • SMSFD 2008/D1 (finalised) – Section 59(1A) SISA, 6.17A SISR • Subject to SMSF trust deed – Must meet conditions imposed by the trust deed – Katz vs. Grossman, Donovan vs. Donovan • SMSF trust deeds now may incorporate either: – Binding agreements (non-lapsing); or – Death Benefit Rules (an SMSF Will)
  32. 32. Strategy 7 – SMSF Wills & Non-lapsing DBNs • Ability to prepare definitive instructions that can be binding on trustees – Death benefit rule is non-binding but allows for control by replacement trustee of the deceased member • Ability to prescriptive with instructions for DBN – Can transfer assets to specific beneficiaries (i.e. BRP in family business) – Can create multiple income streams (incl. non-commutable) for different beneficiaries • Stream interests to spouses, children, disabled children, etc This needs to be appropriately worked through with the client as part of their overall estate plan (considering issues when they are alive and no longer here)
  33. 33. Use SMSF strategies to target HNW individuals 1. Maximising Contributions 2. Use of Fund Reserves 3. Limited Recourse Borrowing Arrangements 4. Multi- pension strategies 5. Asset Segregation 6. Anti-detriment payments 7. Non-lapsing BDN and SMSF Wills
  34. 34. Webinar Timetable Date Topic Late September 2010 Property investment strategies using a SMSF Late October 2010 Limited Recourse Borrowing Arrangements Late November 2010 SMSF Death Benefit Nominations * Recommence in early February 2011, with sessions running every 6 weeks Email me at regarding topics of interest
  35. 35. Thank you • A link to access this Webinar and PowerPoint presentation will be emailed to you shortly once it is uploaded • My contact details: Aaron Dunn 0488 055 836 Providing SMSF Advice & Education to Trustees and Professionals • Specialist SMSF advice & assistance • Technical Consulting SMSF Advice & Consulting • In-house Training • Seminars/Webinars • White-label solutions SMSF Training & Education