The main benefit of a Self-Managed Super Fund (SMSF) is greater control over your super investments compared to most retail or industry super funds. However, as lucrative as it may sound, setting up and managing your own super fund requires a lot of work and comes with ample risk. You need sound financial and legal knowledge to comply with the relevant tax, super and investment regulations. Additionally, your SMSF must meet the sole purpose test to be eligible for the tax concessions available to super funds.
What is meant by the sole purpose test?
The sole purpose test applies to all superannuation funds, including SMSFs. It is meant to regulate the purpose of a super fund, which should be limited to providing retirement benefits to the trustees.
To make things simpler, the Australian Taxation Office (ATO) defines the core and ancillary purposes for which a super fund may be operated.
To pass the sole purpose test, any super fund, including an SMSF, must only be operated for:
- One or more of the core purposes.
- One or more of the ancillary purposes in addition to one or more core purposes.
A super fund must be maintained to pay benefits to members in one or more of the following situations:
- On or after the member retires from gainful employment.
- Once the member reaches the preservation age.
- On the death of the member (benefits are provided to dependants).
A super fund may be operated to provide benefits to fund members in certain situations in addition to the core purpose of the fund, such as when:
- A fund member’s employment ends with an employer who had made contributions to the SMSF on the member’s behalf.
- A member cannot work due to sickness or ill-health.
- A member dies after retirement, and the benefits are paid to dependants.
A super fund may also be operated for any other ancillary purpose approved by the ATO for SMSFs or the Australian Prudential Regulation Authority for most other superannuation funds. However, it’s worth remembering that a super fund cannot be established solely for ancillary purposes.
What’s the purpose of the sole purpose test?
The main benefit of an SMSF is having direct control over your retirement savings. However, there are strict rules around investing the members’ money to prevent people from making poor decisions and losing their retirement savings. The sole purpose test is one such measure that lays down a strict standard of compliance for all superannuation funds to ensure they operate for members’ retirement benefits only. The rule also prevents the SMSF from providing benefits to members or to another party at the financial detriment of the SMSF.
An example where an SMSF may breach the sole purpose test is when the trustees or their families directly or indirectly invest the fund money to receive personal income. Or, if the fund invests in collectables such as art or antiques, no member can use these items to adorn their walls. That’s because you can’t use the fund’s investment property for personal benefit. It can only be used for generating retirement benefits for the members.
While these examples are useful, there are many more factors that the ATO considers when assessing the purpose of your super fund. So, if you’re setting up an SMSF, it could be worth seeking help from a legal professional to ensure your fund doesn’t fail the sole purpose test. Contravening the sole purpose test can have severe consequences. It may lead your fund to lose the concessional tax benefits. There may also be legal and financial penalties for the trustees.
Overall, even though an SMSF gives you more control over your retirement savings, it can take a considerable amount of time and effort to ensure compliance. Not surprisingly, not everybody is comfortable with the idea of setting up and managing their own super fund. However, it’s possible to exert at least some control over your retirement nest egg by comparing the performance of different super funds from time to time to find the right one for growing your retirement savings.