Louise Biti explores how reserves for self-managed super funds are set up, and when they might be useful.
Reserves can be used by self-managed superannuation funds (SMSFs) to provide flexibility for the distribution of benefits across members of the fund. In so doing, reserves may create taxation advantages or provide strategic opportunities such as:
• Inject liquidity through the use of insurance policies to raise the cash to pay out death benefits without needing to sell certain assets;
• Allocate contributions (made in June) across two financial years to avoid an excess contribution assessment;
• Fund insurance needs without an external insurance policy;
• Boost a death benefit payable through anti-detriment provisions;
• Transfer wealth across generations and potentially minimise tax on death benefits to adult children.
Setting up reserves can add complexity and expense to the fund. So before using reserves it is important to decide the purpose, whether other avenues exist to achieve the same advantage, and the costs or disadvantages. Just because a reserve is possible does not necessarily mean it is a good idea.
‘A question has existed over whether allocations can be made to a pension account’
HOW RESERVES ARE SET UP
Reserves are unallocated amounts and form part of the fund’s general assets – that is, the money in reserves does not belong to an individual member.
Section 115 of the Superannuation Industry Supervision (SIS) Act 1983 allows the trustee of a super fund to maintain reserves unless prohibited under the governing rules of the fund. The Trust Deed does not have to specifically allow or mention the establishment of reserves; rather it just should not prohibit their use.
However, it may be prudent to ensure the governing rules of the fund provide directions on:
1. Allowing the creation of reserves.
2. Enabling the trustee to provide a purpose and rules around a reserve.
3. Policies for allocations to and from a reserve.
Benefits cannot be transferred out of a member’s account into a reserve. Reserves need to be built up from insurance proceeds paid to the trustee or from investment earnings. These amounts can be added to a reserve account instead of a member’s account.
Amounts added to a reserve from investment earnings are still part of the fund’s taxable income and are taxed at 15 per cent. The exception is for segregated pension reserves used to meet current liabilities, as these earnings are tax-free. Section 52(2)(g) of SIS requires that if reserves exist, the trustee must formulate and give effect to a reserving strategy to cover the prudential management of the reserves.
The reserving strategy should be docu- mented and reviewed at least annually. It should consider:
• The purpose of reserves and how they will be created.
• The investment strategy for the reserves – this can be a separate strategy for each reserve or a strategy to cover all reserves. It is separate to the investment strategy for the member accounts but should be consistent with that strategy.
• The amount that is considered appropriate to be held within each reserve.
• How allocations will be made from the reserve.
The trustees also need to decide whether the assets of the reserves will be segregated or not and maintain appropriate accounting records.