SMSFs... what happens after the love has gone?
By Janet Manzanero-Caruana, Senior Technical Manager
There were 49,032 divorces granted in 2017, an increase from 46,604 in 2016, and that’s not counting de facto relationship breakdowns.1 What usually follows separation or divorce is the splitting of the couple’s assets under a family law property settlement.
Superannuation interests can be quite considerable, particularly for members of self-managed super funds (SMSFs). Since 28 December 2002, superannuation has been considered in family law property settlements under the Family Law Act 1975 (FLA). These settlements are called payment splits. Payment splitting rules apply to the property settlements of former married couples from 28 December 2002 onwards. The rules have applied to de facto couples, including same sex couples, in all states except South Australia and Western Australia since 1 March 2009. South Australia adopted payment splitting rules from 1 July 2010, however, the rules do not yet apply in Western Australia.
Retail super funds have established processes for dealing with payment splits, but SMSF members, who are also trustees of their SMSFs, may be ill-prepared for dealing with a payment split. An SMSF trustee’s obligations under the payment splitting rules are the same as the obligations of a retail fund trustee. Obtaining expert professional advice is therefore essential to guide SMSF trustees through a payment split at what can be an emotional time.
SMSF payment splitting
Trustees should first check the SMSF trust deed for any provisions regarding payment splits. These provisions will apply if they don’t conflict with the FLA and superannuation law. If a trust deed is silent or contradictory in relation to payment splits, then the FLA prescribes that the relevant provisions are deemed to be included in the trust deed.
The steps for payment splitting are:
- Obtain information about the member’s super
- Decide the splitting method
- Determine the payment split amount and payment method
- Serve agreement or an order on the trustee
- The trustee notifies the parties and receives payment instructions
- The trustee implements the payment split
Property investment by an SMSF may raise capital gains tax and cash flow issues that can significantly impact SMSF member interests.
Obtaining information about a member’s SMSF
In a family law property settlement, the net asset pool of the separating parties must be clearly defined and known by both parties. Before a court orders superannuation to be split, it must determine the value of each member’s superannuation interest.
Either or both members can submit a superannuation information request form to the SMSF trustee together with a declaration (Form 6 Declaration2) that the information relates to a family law property settlement. If these requirements are met, SMSF trustees must comply with the request. Although SMSF members can obtain the information informally, spouses or partners who are non-members must make formal requests. The FLA specifically prohibits a fund trustee from advising a member that a non-member spouse or partner has made a request for information. However, given that members are also trustees in an SMSF, this can be difficult to achieve. This measure was introduced to protect members or non-member spouses from domestic violence by not revealing their address. To achieve this protection, a non-member spouse who makes a request for information from an SMSF should use email rather than the postal service.
What information must be disclosed in relation to a family law settlement?
SMSF trustees must provide the following information about the member’s super interest:
- Whether the interest is in accumulation or pension phase.
- Whether the interest is unsplittable, which is defined as interests of less than $5,000, or less than $2,000 per year is paid from a non-commutable lifetime or fixed term annuity or pension.
- Tax and preservation components.
- Any existing payment split or flag that the interest may be subject to.
- Any binding nomination in favour of a person other than the party requesting the information.
- A copy of the trust deed.
- The expected costs to the SMSF for implementing the split.
- The date the member joined the fund and their eligible service date.
How is a splittable interest valued?
If both parties are members, and therefore trustees, of the SMSF, it’s easy to assume that information about their superannuation is readily available. However, unlike retail super funds many SMSFs don’t have systems that provide daily values for member accounts. To value the superannuation interests of members an accountant usually needs to be engaged.
An accountant will often value a splittable interest based on the following:
- The current market values of the SMSF assets supporting the interest.
- Which SMSF assets will be sold or transferred in specie to enable the payment split.
- The costs to facilitate a payment split.
- The potential capital gains tax (CGT) liability.
- Any potential CGT rollover if assets are rolled out of the SMSF in specie (see the section on CGT implications later in this article).
- The method used for adjusting the base amount for market movements.
The after-tax value of property and the costs of disposal to meet a family law property settlement must be carefully considered. Investment properties in an SMSF may raise CGT and cashflow issues that can significantly affect SMSF members’ interests. Once an agreement or order is finalised it will be difficult to change the value of the split. Any costs and tax liabilities must be accounted for otherwise the remaining SMSF members may have to bear these liabilities and costs.
Decide the splitting method
A formal written agreement, consent order or court order is required to initiate a payment split.
A formal written agreement details how the parties in a family law property settlement will split assets, including superannuation. Both parties must sign a declaration that they obtained independent legal advice, which is certified by their lawyers. The requirement for certification may result in agreements being a more expensive option than obtaining consent orders, which are explained below.
Parties can apply for consent orders from the Family Court of Australia (FCA) at any time after separation, but they should generally file within 12 months of divorce or within two years of separation if they have agreed on financial and property matters. They can submit an application for consent orders form available on the FCA website, together with proof of valuation of their superannuation interests. This is likely to be the least expensive option. Alternatively, consent orders may be drafted by lawyers for a fee. To avoid problems in the future, it’s strongly recommended that clients seek independent legal advice.
The SMSF trustee must be notified about the terms of the consent orders at least 28 days before filing the application to allow the trustee to consider whether the terms can be complied with. Unless the SMSF trustee objects within 28 days of being notified, the application for consent orders can be filed.
If the parties are in dispute, then either or both parties can apply for a court order. After a hearing or trial a court order is issued by the court and all parties must comply, if they don’t it can result in contempt of court, which carries penalties.
Determining the payment split amount and payment method
The FLA regulations require certain super funds to use a specific formula to calculate a member’s splittable interest. There is no specific formula for SMSFs to calculate the amount to be split, referred to as the base amount. The base amount is initially agreed to, but it can be adjusted for the SMSF’s investment performance. The calculation for any adjustments should be specified.
If the splittable interest is a defined benefit pension its reserve may be included.
Serving the agreement or order on the trustee
A copy of the payment splitting agreement or court/consent order should be served to the SMSF trustee as soon as possible after separation or divorce to protect the receiving party’s interest. A payment split for an SMSF is effective on the fourth business day after it is served, which is the operative time.
The agreement or court/consent order must be accompanied by the divorce order terminating the marriage or, if a married or de facto couple separate, a separation declaration dated not less than 28 days before the agreement is served on the trustee. The separation declaration must be signed by either or both parties and if the total superannuation interest of the member spouse exceeds the low rate cap, which is $210,000 in 2019-20, it must state that the couple:
- were married or lived in a de facto relationship, and
- have separated and lived separately and apart continuously for at least 12 months and in the opinion of both or either party there is no reasonable likelihood of living together again in the future.
The trustee notifies the parties and receives payment instructions
The trustee must issue payment split notices to each party informing them that their member’s interest is subject to a payment split. This should be done within 28 days of being served the agreement or order.
Either party can give the trustee a written request of the preferred payment method, this should be within 28 days of the payment split notice being issued.
The request must:
- be signed by the party requesting the split
- state the date it is given to the trustee
- include the name, date of birth and postal address of the requesting party, and
- if the paying party makes the request, it must include the receiving party’s written nomination of their superannuation fund account.
If the splittable interest is a non-commutable pension, then a fixed percentage of future pension payments can be paid to the non-member spouse. However, if the pension is non-reversionary then payments will stop when the member passes away.
How does the trustee implement the payment split?
Subject to the SMSF trust deed and the receiving fund’s rules, options to implement a payment split are:
- retain the benefit in the SMSF in the receiving party’s account
- rollover the amount to the receiving party’s nominated super fund
- pay a lump sum to the receiving party if they meet a condition of release or if the member’s interest has met a condition of release, such as unrestricted non-preserved.
The payment must be in proportion to preservation and tax components.
|Example 1: Preservation and tax components|
George’s splittable interest is valued at $700,000 at payment date. Mary will be paid the adjusted base rate amount of $400,000 under the payment split.
|George’s $700,000 consists of these components:|
|Mary’s $400,000 payment split consists of these components:|
Potential issues when the SMSF holds property
Many SMSFs hold property as their main asset. Some SMSFs have limited recourse borrowing arrangements in place, in which case a payment split may force the sale of a property where insufficient assets are available to implement the split. If the property can be retained, then the ability to cover loan repayments with reduced contributions and any pension payments must be considered.
Problems can arise when property is leased to one party’s business and the property must be sold or transferred to the other party to implement the payment split. This could mean one of the party’s being a landlord to the other, which could prove difficult.
Payment splits and capital gains tax implications
A payment split is often paid as a rollover to the receiving party’s nominated super fund. The rollover may be in cash or as an in-specie transfer of assets subject to the SMSF’s and receiving fund’s rules. The sale or in specie transfer of an SMSF asset is generally a CGT event for the SMSF, which means a CGT liability may arise.
Section 126-140 of the Income Tax Assessment Act 1997 allows the trustee of a small super fund, such as an SMSF or a small APRA fund, to apply the CGT rollover to an in-specie transfer of a CGT asset which reflects a member’s interest (either party but not both) to another super fund if the transfer directly results from a payment split agreement or order. To be eligible for a CGT rollover, certain other requirements must also be met. The capital gain or loss at the time of the transfer is disregarded and the CGT event is deferred until the receiving super fund disposes of the asset. The receiving super fund’s cost base is the originating SMSF’s cost base at the time of transfer plus any transaction costs.
The CGT rollover only applies to rollovers made to the receiving party’s super fund. When both parties are SMSF members the rollover can be applied to only one party leaving the SMSF. If the parties decide to close the SMSF and both parties need to transfer assets in specie to their respective super funds then only one of them will be eligible for the concession.
Tip: A CGT rollover to a retail superfund is usually not possible as these super funds have systems that automatically record market values at the time of transfer and not by using historical cost bases. Another issue is that retail super funds don’t hold property.
|Example 2: CGT rollover|
Clare and Mark have interests in an SMSF, which are not subject to a payment split. They reach an agreement after separation which provides that the SMSF trustee transfer shares and a property reflecting Mark's interest to another SMSF. The shares are transferred, and a CGT rollover applied. Subsequently, no CGT rollover can apply for any transfers made by the originating SMSF for Clare’s benefit if Clare subsequently leaves the SMSF. When the originating SMSF transfers the property to Mark’s SMSF, a CGT rollover can apply to that transfer.
Interaction with transfer balance reporting
The amount commuted from a retirement phase income stream to satisfy a family law payment split is a debit in the paying spouse’s transfer balance account. If the receiving spouse uses the amount to commence a new income stream, this will be a credit in that spouse’s transfer balance account. SMSF trustees must report these events promptly to the Australian Taxation Office using the transfer balance account report.
Any percentage splits from pension payments must be reported using the transfer balance event notification form.
Advisers should discuss the consequences of a relationship breakdown with clients who have an SMSF
The financial implications of a relationship breakdown should be discussed with clients as they can be just as important as permanent disability or serious illness. Relationship breakdown is common and unlike illness or death it’s not an insurable event.
SMSF trustees are responsible for meeting their obligations under the law when implementing payment splits. Financial advisers can help clients meet superannuation rules and manage the sale and reinvestment of any remaining assets. Clients will then likely require their financial situation to be reviewed and a new financial plan created.
Accountants also have a role to play. While their expertise is generally not on superannuation law, they can value superannuation interests, calculate base and adjusted base amounts, and advise on any expected tax outcomes resulting from the payment split.
Several types of professionals are required when a relationship breaks down and an SMSF is involved.
SMSF clients who experience relationship breakdown will need assistance from various professionals, including financial advisers, on how to manage the separation and division of their super assets. Advisers are well placed to assist clients by helping them understand their responsibilities as SMSF trustees and in managing their SMSFs. Investment reviews and regular updates of the SMSF trust deed are excellent opportunities to raise these issues.
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
Issued by IOOF Investment Management Limited (IIML), ABN 53 006 695 021, AFSL 230524. IIML is a company within the IOOF Group of companies, consisting of IOOF Holdings Limited ABN 49 100 103 722 and its related bodies corporate.
This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from a financial adviser.