Can your SMSF be wound-up?
Can your SMSF go broke and be wound-up? The short answer is yes. I attended the recent Worrells Solvency & Forensic Accountants Queensland State Conference on the Gold Coast and there was a definite air of concern, with the huge growth in Mum and Dad Self-Managed Superannuation Funds. Experts at the conference agreed that a majority of them are poorly funded, have low capital reserves, and have invested in properties that are over-valued and are poorly performing.
Given the huge growth in SMSF in the last three years, there are at least one million members of these funds. The majority of the growth has come from people purchasing an investment property in their SMSF using debt.
An attendee at the Conference was a SMSF Specialist Auditor who was extremely concerned that many of these super funds in the next 2-3 years will run into solvency difficulties and will in fact have to be wound up. He outlined his reasons why:
- These Mum and Dad SMSFs have purchased investment apartments and houses at overinflated values, typically through slick marketing campaigns run by property spruikers and developers.
- There is minimal “backup” money in the superannuation fund to serve as an adequate buffer for unexpected expenses of the property. Typically such super funds would have less than $30,000 spare cash, hardly enough in reserve especially if one member looses their job and employer contributions dry-up.
- A lack of understanding of ongoing costs. Most people who have set-up a SMSF have received little or no information on the ongoing costs of maintaining a superannuation fund and what the minimal amount should be in their fund to make it viable. On-going administration costs make members uncomfortable when they have very little in their fund in the first place. Most SMSF professionals prefer a minimum of $200,000 in cash or equity in an existing super fund before they consider it cost-effective to roll it into an SMSF.
- Poor rental returns. Most properties acquired by the SMSF are in fact not contributing to the growth of the super fund but rather are draining the super fund life savings of its members because of debt and on-going body corporate fees. This was a particular concern highlighted by the SMSF Audit Specialist at this conference.
- Limited or No Medium-Term Capital Growth. This was also highlighted by the SMSF Audit Specialist who said that most of the funds that he had audited had poor performing properties in them with very little chance of any capital gain in the next 3-5 years. The reason for this was that the bulk of the SMSFs had purchased units and apartments that are currently over-supplied with more construction on the way in the next 3-5 years. This left very little chance of capital growth for those people who had bought a unit or an apartment in an inner-city location.
I also spoke to Jason Bettles, a Partner at Worrells, who has wound up a number of SMSFs on behalf of banks and financial institutions because the debt could not be serviced from rental income and contributions.
Borrowing to invest in an SMSF is no different to borrowing and investing using any other structure. If the investment cannot produce the required cash flow and rate of return to the owner, so as they can meet their monthly loan obligations, then the loan will be in default and at some point the bank or financial institution who you borrowed your money from, will take action.
Jason agreed that typically the owner of the SMSF would need to sell the property at a capital loss just to pay back the loan and then any other retirement savings that remain in the superannuation fund will also be lost to make up the short fall between the property value and the loan obligation.
There was also a voice of concern by other insolvency practitioners at the conference that banks and financial institutions once again seem to be adding fuel to the fire by loosening their lending requirements. This means we are seeing a greater percentage of loans being structured into SMSF where less and less of a deposit is required. Typically the loan structure in a SMSF would be 60% debt and 40% cash used from existing super fund monies that have been rolled into the fund. However, the same SMSF Audit Specialist said he had been seeing this debt ratio increase to as much as only requiring a 20% cash deposit to purchase a property through a super fund. This was an extreme area of concern given the increased gearing of the super fund and the excessive pressure put on people’s life savings to make up the short fall either through salary sacrifice or by making further under-deducted contributions into the fund.