Adding a member to an SMSF – pros and cons

SMSFs can now have up to 6 members (prior to from 1 July 2021, a limit of 4 applied). We have since received considerable interest regarding many SMSFs wishing to add members. In particular, numerous parents wish to admit their children to their SMSFs.

While SMSFs are considered family friendly, family members still have disputes, get divorced or separate with their spouses and may not get along well with each other. Indeed, adding children to an SMSF may result in the children outvoting their parents unless appropriate prior planning is implemented.

If you (ie, the SMSF trustee) decide to admit a member, there are various considerations and decisions to make. Indeed, before adding a member, have you stopped to consider the possible advantages and disadvantages of doing so?

There are also a number of strategies and documents that can be implemented to minimise risk. Generally, we don’t recommend adding more members to an SMSF unless there is some material advantage in doing so and appropriate prior planning is implemented.This article focuses on the key considerations and strategies to minimise risk.

Company versus individual trustees

For SMSFs with individual trustees, before adding any member, we strongly recommend moving to a sole purpose corporate trustee. There are many compelling reasons why a corporate trustee is far more superior than individual trustees. Moreover, where an existing company acts as an SMSF corporate trustee and also acts in one or more other capacities, it is recommended that a sole purpose corporate trustee be appointed for the SMSF. Otherwise the new member may become involved in the company’s other activities.

For more information on individual versus corporate trustees refer to the following articles:

• Should your SMSF have a corporate trustee or individual trustees?
• Changing SMSF trustees — why advisers should be more alert to the tips and traps

Having got this out of the way, we will now proceed on the basis that a sole purpose corporate trustee will be used before admitting a member.

Advantages of adding members

Some advantages to adding a member may include:

• Having greater family involvement in the family’s investments and keeping the family together.
• Greater flexibility and potential diversification in terms of the amount and range of investments.
• Potential cash flow benefits and cost savings.
• Potentially lining up succession to the SMSF for the future generation.

Disadvantages of adding members

Some disadvantages to adding a member may include:

• Adding a member who subsequently separates/divorces their partner/spouse may result in the SMSF becoming involved in an expensive and protracted family law dispute.
• Other disputes may arise among members, eg, the parents may want conservative investments while the children may want to take more risk, eg, crypto currency. Parents will need to share information on their retirement savings and may not like to be accountable to their children for bade investment decisions.
• In one sad case, the son with a drug addiction had access to the fund’s bank account (as he was an individual trustee) and misappropriated almost all the fund’s assets (including all his parents retirement savings) to feed his drug habit (Triway Superannuation Fund and Commissioner of Taxation [2011] AATA 302). The parents, as loving parents tend to do, then sought to cover up the misappropriation by their son until the auditor found out and notified the ATO. This case shows the risks of adding children as trustees/directors of an SMSF.
• Increased chance of death benefit disputes including challenges to reversionary pensions to a surviving spouse, challenges to binding death benefit nominations (BDBN) and similar disputes. Even with a BDBN in place, disputes may still arise challenging various items such as the effectiveness of the SMSF deed, pension or BDBN documents, any change of trustee or whether an attorney was acting appropriately under an enduring power of attorney (EPoA) or in conflict.

The above advantages and disadvantages are a broad summary and are not an exhaustive list. For more information, please read our article Six member SMSFs –– the pros and cons.

Maintaining control of the fund

Maintaining control of the fund is a key consideration. Planning who has control and management of the fund in advance is important before admitting a member. Some of the key considerations here include:

• Whether the proposed new member should be admitted as ordinary member or a conditional member. A conditional member is admitted subject to specified conditions which can result in them being ejected. The DBA Lawyers’ SMSF deed has special provisions to facilitate a conditional member being rolled over to another fund or paid out (if they have satisfied a relevant condition of release) upon the occurrence of a specific event or upon a specified time, eg, there is a material dispute or a member divorces or separates from their spouse. Note that a conditional member provides their consent to transfer or rolling over their benefits upon specified events on admission. Otherwise, transferring a member out requires the member’s written consent which may prove time consuming, costly and difficult. For more information, please click here.
• Whether the new member should be appointed as a director of the corporate trustee. Indeed, certain people may not have the skills or capability to fulfil the usual duties and obligations imposed on a director. Moreover, directors are subject to a myriad of obligations and potential penalties. Where there are more than 2 directors, the accounts and financial statements must be signed by at least half of the directors each financial year under s 35B of the Superannuation Industry (Supervision) Act 1993 (Cth).

Alternatively, a member can be represented at the trustee-director level by an existing director. For example, a child being admitted as a member could appoint one or both of their parents as their attorneys under an EPoA to allow their parents to represent them as their director.  Thus, an SMSF could have, for example, mum and dad and their 4 children as members with mum and dad as the only directors provided each child has appointed their parents as their attorneys under their EPoAs.

• The SMSF succession planning to the fund should also be considered. In particular who is in line to take control of the fund in the event of one or more of the directors of the corporate trustee losing legal capacity or passing away. The DBA Lawyers’ constitution has special provisions to allow a director to nominate a successor director to fill their role as director immediately upon loss of capacity of death. For example, both parents can nominate that on the last of them to lose capacity or die, their children are immediately appointed as directors. For more information, please click here.
• The parents’ wills and succession planning should also be addressed including who is to receive the shares in the SMSF corporate trustee. Generally a majority of shareholders hold the power to hire and fire the directors of a company. However, the SMSF deed will determine who has the ultimate control, ie, the appointor power in relation to who hires and fires the trustee company. The member or members that represent the majority account balances in the fund hold the power to hire and fire the trustee under the DBA Lawyers’ SMSF deed.

Example of SMSF set up to minimise the above risks

Harry and Emma have 3 children who they wish to admit to their SMSF. The trustee is Harem Super Pty Ltd. Having regard to the above points, Harry and Emma in consultation with their children and their accountants and lawyers decide to:

• Admit their 3 children as conditional members. Each child can be rolled over to another super fund upon certain events such as if one of their children separate or divorce their spouse.
• The 3 children decide not to become directors as they prefer not to have the extra responsibility and potential liabilities that relate to being a director. The children are happy for their parents to act as the directors of the SMSF trustee and each child appoints their parents as their attorneys under each child’s EPoA.
• The parents nominate their 3 children as their successor directors who will become the directors of the SMSF trustee at the time the last surviving parent loses capacity or dies.
• The parents also leave gifts of shares in the corporate trustee in their wills to their children equally and the parents also leave binding death benefit nominations that result in the superannuation death benefit of the last parent to die to be paid to their deceased estate (ie, legal personal representative).

SMSF documents

Naturally, the SMSF deed must be up to date and provide flexibility to add a new member. If the deed has not been updated in the past 2-3 years, it should be reviewed and, if necessary, updated.

The ATO also makes it clear there are a number of circumstances that may warrant a review of a fund’s investment strategy, including a market correction, when a new member joins the fund or departs a fund, or when a member commences receiving a pension.

Other considerations — SuperStream changes

From 1 October 2021, member benefit rollovers of superannuation moneys to or from an SMSF or a large industry or retail superannuation fund must generally be via the SuperStream system. This will require, among other things, for a fund to be able to have its financial statements brought up to date fairly quickly to determine the member’s account balance including any accrued net earnings after tax up to the time of payment. Please click here to read more.

If a member requests a rollover from an SMSF, for instance, the trustee must generally comply with the request within 3 business days. The trustee must request any missing further information within 5 business days of receiving the request and must then complete the rollover asap or within 3 business days of receiving that information. In short, most SMSFs will find complying with the new rollover rules that apply from 1 October 2021 difficult unless the departing member is co-operating with the trustee and is willing to wait for the accounts and financial statements to be brought up to date to allow an orderly exit. For more information, please click here to read more.

Conclusions and checklist for adding a member

Careful consideration should be given prior to admitting a member to an SMSF. In particular, the chances for disputes and losing control of the fund increase when more members are added. Ensuring that control and management of the fund is appropriately and strategically maintained by those best suited to this role is a key priority.

Even with appropriate planning and documentation in place, the increased risks of disputes occurring, may outweigh any potential benefits from admitting a member. Accordingly, expert advice should be sought to ensure the SMSF trustees and members are well informed and aware of the above risks before admitting a member.

If you would like to proceed with adding members to the fund, we would be pleased to assist and offer advice and documentation that best suits your needs. Please see below a checklist of considerations and services that we offer.

Related articles:

Related articles and links below:

• Why admit a conditional member in an SMSF?
• Six member SMSFs –– the pros and cons
• Admit a conditional member
• An adviser’s guide to SMSF deeds
• Why should you order trusts from DBA Lawyers?

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

By Daniel Butler, Director ([email protected]), DBA Lawyers

23 August 2021