When it's time to say goodbye to your DIY super fund

Most people who set up a self-managed superannuation fund hope to keep it running for their whole lives; probably a little longer, as in however long it takes their beneficiaries to get the money out after they die and wind up the fund.

But just because an SMSF was a great idea when it was set up doesn’t mean it will stay that way forever. So, what might prompt winding one up?

The flippant answer to when an SMSF should be wound up is “when the members don’t want to do it any more” but in fact, that’s not a bad place to start. An SMSF takes time, effort and attention. The moment that effort outweighs the benefits is a perfectly reasonably time to wind up.

Diminishing capacity

Another trigger is diminishing capacity. Often two members of a couple belong to an SMSF, so it’s not such a problem when the first member starts to decline. The second member can simply take over the running of the fund as long as there is an important document known as an “enduring power of attorney” in place. But it can be a problem at some point if neither can look after the fund.

Of course, some SMSFs continue regardless of the original members’ capacity. If there are significant downsides to closing the fund – often related to tax or the sale of assets – another family member might take over as trustee. Again, they would rely on an enduring power of attorney to be the trustee in place of the original members. This is not seen much in practice. Generally, when neither member is able to be a trustee, the fund is wound up. At that point, the money is often taken out of the superannuation system entirely.

Death of a member

Sometimes the death of a member is a driver to wind up and there are probably two reasons for this.

One is that when couples have an SMSF together, there is almost always one person more engaged than the other. If the “interested in SMSFs” person dies, it’s common for the survivor to wind up the fund. That often depends on age. Someone who loses the “active” spouse in their 50s probably won’t wind up the SMSF – they will just learn how to manage it and perhaps surprise themselves with their own capability. But someone aged in their 90s might make a different decision.

The second reason death can be a trigger to wind up is that it is frequently a moment when large amounts have to be paid out of superannuation, so the fund inevitably gets smaller. A smaller fund might be less cost-effective, again prompting the decision to wind up the fund.

It is worth bearing in mind that a fund could fall in size for many reasons other than death; poor investments, a need for additional payments by the members (for example, to move into aged care) or even just regular pension payments that slowly reduce the fund's assets.

Costs don't make sense

It is worth regularly reviewing whether the costs still stack up. Remember that many SMSF costs are a fixed dollar amount while public funds often work out at least some of their costs as a percentage of the member’s account balance. SMSF costs that felt very cheap when the fund had $1 million might feel much more expensive when it’s only $300,000. Once the costs outweigh the benefits, it’s definitely time to think about winding up.

Remember that often it is fine to have a small balance when the fund is growing – for example, the members are saving hard and adding more contributions as often as they can. That is because it is clear there is a point at which the costs will become relatively cheaper and getting in a little too early (rather than switching to an SMSF once the members have much more super) can mean tax savings over the long term.

But when the fund is on the way back down again, it can often make sense to get out of the SMSF at a much higher threshold than when the members got in.

Helping the kids

Some people wind up their SMSF (and withdraw all their money from the superannuation system entirely) during their lifetime to save tax for the next generation.

Let’s say there is only one member of the fund and he or she has no one who is classified as a “dependant” for tax purposes. (For most people, dependants in this context are only their spouse and minor children.) Instead, all their super will go to their adult financially independent children.

Superannuation inherited in this way is taxed. The tax rate is at least 15 per cent, and it is applied to any part of the death benefit classified as a “taxable component” (and that’s often most of the benefit). In other words, an adult child inheriting their parent’s $1 million death benefit (which is entirely a “taxable component”) would have a tax bill of at least $150,000 (15 per cent of $1 million). Given the right circumstances, the parent might choose to take all of their super out (and wind up their SMSF) before dying once they get to an advanced age.

Of course, there are several other triggers to wind up that might apply in other cases: relationship breakdown (sometimes an SMSF makes sense when there are two people but not if there’s only one); the sale of an asset that was the primary driver for the SMSF in the first place; or even serious breaches of the law that mean the fund and its trustees have attracted the ire of the ATO.

But there’s one clear truth – all SMSFs will end one day, quite possibly before the members die. When the time comes, it is best to treat it as a process that happens over a few financial years. That is not because it actually takes that long but because it is often the way to get the best tax outcomes.

This article was first published in the Australian Financial Review on 20 December 2022.