Superannuation Legislation has provisions and methods on how trustees can legally withdraw from their self managed super fund before they reach their retirement age, but if these procedures are not followed, it can result in the fund breaching various provisions and be subject to penalties including the fund becoming non-compliant.
In a recently decided case, Deputy Commissioner of Taxation (Superannuation) v Graham Family Superannuation Pty Limited, (click here for case law) two directors of the corporate trustee of an SMSF have been penalised $40,000 and made liable to pay court costs of $10,000.
The facts of the case are as follows:
- On 1st July 2007, an amount of about $490,000 was rolled into the fund;
- The fund then purchased a residential property for $285,408.92, and spent $48,500 furnishing it. The property was leased fully furnished to the son of the trustees. However, rent was not paid by the son with arrears outstanding as at the 30 June 2012 of $60,762;
- The trustees then purchased a caravan for $24,500 plus paid a further $4,570.46 on storage, registration, maintenance and insurance; $56,226.50 on the purchase of a cattle stud and purchase of two motor vehicles. No income was derived by the fund from these expenditures.
- By 30 June 2012, the fund's loan account stood at $260,064, with around 80 contravening loans made to the members over a 4 year period.
The ATO argued to the federal court that the loans caused the fund to contravene the following provisions:
- Section 62 - by failing to ensure that the fund was maintained solely for one or more purposes set out in S.62 of the SIS Act 1993. Instead, the ATO argued that the fund was maintained for the significant purpose of making loans to provide financial accommodation to the members.
- Section 65 - by lending money using the assets of the fund to the members.
- Section 84 - by failing to take all reasonable steps to ensure that the in-house asset rules were complied with, instead making loans to members of the Fund which caused the market value ratio of the Fund's in-house assets to exceed 5%. The fund also failed to prepare a plan setting out steps to ensure the disposal of in-house assets in excess of the 5% limit.
- Section 109 - the trustee and the members failed to deal with each other at arm's length,
or the terms were more favourable to the third party than what would be expected if the parties were dealing at arm's length.
The Commissioner did not declare the fund to be non-complying for the relevant years because the Fund was repaid by the trustees from their assets. The contraventions were very serious and fell into two broad categories:
1. The making of 80 contravening loans to members over a four year period for a wide variety of private purposes, namely the purchase of a caravan, motor vehicles, stud cattle for hobby purposes and other unspecified private purposes.
2. The lease of the fund's principal asset, being residential premises, to the son of the trustees and the failure to collect rent from July 2007 to February 2013.
In defense, the trustees argued that in large part their actions were unintentional or the result of reliance on an unidentified financial adviser and an unidentified quantity surveyor "each of whom provided informal guidance regarding the regulatory restrictions applicable to the acquisition and use of property by a regulated superannuation fund." However since one of the trustee (husband) was an educated man, a school principal, the court did not accept the plea and did not agree that it is possible for the trustees to not be aware of the basic regulatory requirements.
Our readers should note statutory maximum penalty of $220,000 applies to contraventions (2,000 penalty units of $110 each) when there is a corporate trustee and a maximum penalty of $10,200 per trustee, per offence, in case of individual trustees. Although, as the applicant submitted, the offences are serious ones, they fall well short of a worst possible case, where moneys are withdrawn and spent.
In deciding the penalties the Federal court considered that the trustees had shown remorse, they made early admissions and co-operated with the Commissioner, they also remedied their conduct and decided that a penalty should not be imposed which is "crushing". At the same time, the penalty should serve as a deterrent and mark the Court's acceptance of the need to enforce the regulatory scheme.
This case should be taken as guidance by trustees to learn the basic regulations and know the law before embarking to set up an SMSF and before attempting to withdraw any money before they retire.
How to withdraw from an SMSF prior to retirement?
Trustees of the super fund can access money before commencing a pension on various grounds which are listed in Schedule 1 of SIS Regulations (item of the schedule). Basically they are;
- Compassionate Grounds, SISR 6.19A(1) - Item 107
- Severe Financial Hardship - Item 105
- Terminal Medical Condition - Item 102A
- Temporary Incapacity - Item 109
- Permanent incapacity - Item 103
- Super Death Benefits - Item 102
- Super is less than $200 - Item 104
Compassionate Grounds
Medical Issues
A member can request a trustee to withdrawal from super to pay for medical treatment for themselves or their dependant if the member or their dependant has a life threatening illness or injury, acute or chronic pain, or acute or chronic mental illness, and the member or their dependant need assistance to meet the costs of medical treatment which is not readily available through the public health system or covered by insurance and the members do not have the financial capacity to pay for the expenses without accessing their superannuation.
Members can apply to trustees to withdraw from super if they want to modify their home or vehicle for special needs of any member or their dependant because of a severe disability or to pay for funeral or burial expenses.
To be eligible, the medical issue must be for the member or their dependant. Members will need a report of the medical issue from a registered medical practitioner & a registered medical specialist at the time of making an application to withdraw from super. Members must be able to prove that a dependant is a person who is dependant on the member for financial, domestic, personal or medical care and a partner, spouse or a child of the member are automatically included.
There is no limit on how much you can withdraw as long it is an amount which is reasonably required for the medical treatment and at one time a maximum amount of 12 months treatment can be withdrawn. The amount withdrawn is treated as lump sum payment for the member by the super fund.
To apply for this withdrawal, the member of the SMSF has to apply to the trustees with all documents and a letter of approval from the department of human services. The form for this permission from department of human services is available by
clicking here.
Mortgage Assistance
A member of a fund can also request the trustees for a payment from their super balance for repayment of a housing loan to prevent them from losing their home. To be eligible the mortgagee should be threatening to repossess or sell the members home due to arrears on mortgage payments. The property under threat should be the member's usual place of residence.
Members are not eligible to request this payment if they are in arrears on mortgage or are having difficulty making future payments, it is only when the mortgagee is threatening to repossess the members home.
This request for mortgage assistance is granted by human services only if the mortgagee is threatening to repossess or sell their home. If the trustees are renting, they cannot request this payment if their rent is in arrears.
The maximum amount that can be released by the trustees in a 12 months period is 3 months repayments, and 12 months interest on the outstanding balance of the loan.
Severe Financial Hardship
If a member has received Australian Government income support payments continuously for 26 weeks and is unable to meet reasonable and immediate family living expenses, then the member can apply for a payment with the trustees of the super fund. Department of Human Services can provide a letter to prove to the trustees that a member is eligible for this payment.
This payment is a lump sum withdrawal and only one withdrawal is allowed in a period of 12 months. Minimum payment must be $1,000 and a maximum payment of $10,000 can be paid to
each member. This lump sum is included in the member's taxable income and taxed accordingly.
Terminal Medical Condition
If a member has a medical condition that is likely to result in the member's death within the next 12 months, then the member can apply to the trustees of the super fund to release a payment as a lump sum. There is no maximum amount which can be withdrawn.
Two medical practitioners (one specialist) need to certify that the member has a terminal medical condition to support the member's application. On withdrawal no tax is to be paid by the member on lump sum withdrawal regardless of their age.
Temporary Incapacity
A member is eligible to withdraw if the member is temporarily unable to work or needs to work less hours because of a physical or mental medical condition. Application to withdraw must be made with the trustees of the super fund with appropriate medical reports from two registered Medical Practitioners.
This amount is paid as an income stream and the maximum amount which can be paid is an amount equivalent to full time earnings of the member before incapacity. Since this payment is for a temporary disability, it is envisaged that this regular payment should not go beyond a period of 2 years, if it extends beyond this period, then it is possible for the member to apply under permanent incapacity provisions.
Permanent Incapacity
To be eligible a member must be permanently incapacitated, which means that "trustee are satisfied that the member has a physical or mental medical condition, that is likely to stop the member from ever working again in a job the member is qualified to do by education, training or experience".
Member has to apply for a permanent incapacity condition with the trustees with all the medical reports clearly declaring the members physical and metal health. This payment can be paid as an income stream or a lump sum. At least two medical practitioners must certify this medical condition of the member to receive concessional tax treatment.
If paid as an income stream the member must include the payment in their taxable income. Due to insurance claims, some of the payments may include un-taxed component and if the member is under the preservation age, the member can claim a tax offset of 15% on the taxed element of the taxable component of the payment.
Please note that before any such payment can be made by trustees of an SMSF, the trust deed of the self managed super fund must allow these payments. If your SMSF does not allow these payments, then you can update your super fund trust deed. To update your deed for $125, click here.
SMSF Strategy in the above withdrawals
Assuming that there is no critical medical situation, applying for a medical condition is fairly simple and department of human services are very helpful to those who are in genuine need.
Below are two strategies, if put into place properly, it is possible for members of a fund to legally access their super before they retire:
1) Withdrawal before Preservation Age
After 1st July 2015, those who are born between 1st July 1960 and 30th June 1964 will have incrementing preservation age and those born after 1st July 1964 will have 60 as their preservation age. Preservation age is important as you can commence an income stream from your fund only after you reach your preservation age.
In a few years, if your client is say 57 years old with a preservation age of say 60 years and has lost his job and has enough money to retire in super but cannot access super because of delayed pension commencement restrictions.
It is possible to withdraw a maximum of $10,000 per member under severe financial hardship grounds and if there are four members in the fund, then $40,000 can be withdrawn to supplement any unemployment benefit.
The member can consider claiming under permanent incapacity grounds as the stress alone of not being able to commence a pension could cause some sort of a mental illness "so that the member is likely to stop the member from ever working again in a job the member is qualified to do by education, training or experience".
Please note once the fund commences a disability income stream, the fund moves to pension phase and can claim exempt pension income deduction and due to partial commutation provisions, it is possible that the member pays no tax on lump sums received from the fund.
2) Let the Super fund pay your bank mortgage
If you are a member of a fund with a home loan on a reasonable income and want to reduce tax payable on your income, then it is possible to salary sacrifice your income to super and instead of worrying about paying mortgage payment, it is possible to have your super fund pay for it.
For our example let us assume that a mum & dad have a self managed super fund and a home loan of $400,000 with 5% interest rate (annual interest $20,000) with $66,000 wages each, including 10% super.
From the $60,000 salary after super, both members could salary sacrifice a further $24,000, so that their salary income reduces to only $36,000 (marginal tax rate after $37,000 taxable income is 32.5% plus 2 % medicare levy) each with tax payable of about $3,500 each including medicare levy depending on the number of kids in the family. This translates to about $32,500 cash after tax or total $65,000 cash per year for the family.
The whole of the employer contribution and the salary sacrifice amount of $30,000 each will be subject to tax at only 15% in the self manage super fund (lower if there is super gearing) and for our purpose let us assume that there is no cash savings from the $65,000 from the after tax salary to make any mortgage payment and the lender is threatening to repossess their home as no interest or repayment have been made in the past 12 months.
The idea is to stop paying mortgage payments or interest payments to the bank from after tax salary and instead apply to human services for consent and then apply to the trustee of the SMSF to allow them to withdraw from super to make a payment of 12 months interest.
The strategy begins from converting the interest plus principal loan to interest only loan and ensure that no payment is made at all to the bank for the next 12 months and evoke provisions of SIS regulation 6.19A (6) (b) to get permission from the department of human services to release interest payment from super, once the bank starts to demand payment and threatens to sell your home.
We are aware that this strategy is on the fringe and may not work for many years, but there are huge tax benefits even if is allowed to be implemented for a few years. For starters, if the bank is paid interest from after tax salary, tax @ 34.5% including medicare levy would have to be paid first instead of only 15% tax in super. If the strategy works for a 5 - 6 years, it is possible to build up a sizeable superannuation balance with the help of salary sacrifice strategy.
In our example, if the salary sacrificed amount of $24,000 each or $48,000 is earned as a salary an amount of only $31,440 will be received from the employer after tax @ 34.5%. This amount can reduce the mortgage by $11,440 after interest payment of $20,000. But if the same amount of $48,000 is salary sacrificed, $20,800 can grow in super and earn income after interest payment of $20,000 and 15% tax in super.
Depending on how interest rates move and how often the bank is paid, this extra cumulative growth in assets of $9,360, plus cumulative income within super can help to pay off the mortgage when the members reach retirement age. And most importantly, since the loan amount will stay at $400,000, which is today dollars liability for a non taxable capital growth of the members own home; this will further generate wealth for the member.
Warning: Please note that some advisers would recommend a strategy of paying off the non-deductible home loan outside super albeit at a slower rate; which the writer cannot comprehend. Lastly these strategies may seem to be pushing the boundaries a bit, it is therefore advised to use caution and take legal advice before considering implementing them.
