tax

It’s SMSF audit time: What is it, and how does it work?

Everybody (everybody) who runs a self-managed superannuation fund (SMSF) has to have their fund audited every year to ensure the fund isn’t breaking any rules.

As we all know, if your SMSF isn’t compliant with superannuation rules, you can get into a lot of trouble with the Tax Office, so getting your SMSF audited is essential.

So what does an SMSF audit involve, and how does it all work?

What is an SMSF audit?

Your SMSF must undergo a financial and compliance audit to ensure it remains by the Australian Taxation Office (ATO) every financial year. An audit has to be completed before you can lodge your SMSF’s annual tax return.

As we’ve mentioned, there are two parts to an SMSF audit: a financial audit and a compliance audit. The financial audit component looks at the fund’s financial statements by Australian Auditing Standards (ASAs). The compliance audit component checks that your SMSF fund is compliant with all superannuation legislation by the Standards on Assurance Engagements (ASAE) produced by the Auditing and Assurance Standards Board (AUASB).

An SMSF audit must be undertaken by a registered and approved SMSF auditor appointed by the trustee(s). The auditor also has to be audited by the ATO (so much auditing). You can’t audit your SMSF fund or that of an immediate family member.

Now, take a shot at every time I use the word audit in this article.

How much does an SMSF audit cost?

Not many things in life are free, and neither are SMSF audits.

Because many SMSF auditors are private professionals, they can set their rates meaning there isn’t a universal SMSF audit fee.

According to the ATO, these are the average and median SMSF audit fees up to 2017/18 and SMSF audit fee price ranges. As you can see, the median SMSF audit fee is $550, with the lion’s share of SMSF audit fees falling between $500 – $999.

If you’re trying to cut costs and save money by getting a cheap SMSF audit, tread carefully. A few years ago, the ATO investigated ‘lower-cost audits’ (defined as audits that charge below $400) and found several issues with cheap SMSF audits.

ATO Commissioner Chris Jordan said many cheap SMSF audits failed to meet the most basic standards.

“No great surprise, we have found cases of concern where they’ve failed to conduct any sort of adequate audit that complies with any of the standards,” Mr Jordan told the SMSF Association’s national conference in Melbourne.

“They had no written audit plan or representation letters from trustees, all the things you would expect to be done, and we have taken action there.”

Tt’s very much a case of you get what you pay for.

Auditing an SMSF that is winding up

If you’re winding up an SMSF (closing it), the trustee has to appoint an SMSF auditor to do the final audit and check that the SMSF fund is compliant with wind-up requirements.

The auditor has many responsibilities to comply with when doing this, which are listed in great detail on the ATO’s website if you want a bit of light reading.

SMSF audit checklist

So. If you’ve made it this far, congrats. Have another shot. Now, if you’re about to get your SMSF audited, these are the documents you’ll need:

Documents required for an SMSF audit:

  • The auditor requires source documents to verify transactions of the fund for the financial year.  This may include bank statements, contract notes, rental statements etc.
  • Some accounting software can accept electronic data from banks, brokers and managed fund platforms, making the need to provide physical paper statements and documents not applicable. However, don’t assume this – check whether the accountant you work with has the appropriate software, whether there are data feeds in place and if the auditor will accept this.

If the first year an auditor is auditing the fund, they will require signed copies of the documents that established the super fund. For example:

  • Trust Deed
  • ATO Trustee Declarations
  • Investment Strategy
  • Resolutions and acceptance of appointment as trustee of the fund
  • Membership application

Ms Brown said if trustees fail to keep accurate documentation and records, the auditor has to report it to the Tax Office.

Some of the more common issues we have seen that means auditors have to report a breach or caution the client by qualifying the audit and recording the case in a management letter to the trustee include:

  • You are not keeping sufficient documentation to substantiate the activities and transactions of a super fund. You can’t just provide an excel spreadsheet of items to the auditor that you wish to claim. You need to have original bank statements, invoices for expenses etc.
  • I am not holding onto the documents that established the super fund. The signed trust deed, ATO trustee Declarations and establishment minute are just a few critical documents that the trustee must maintain and maintain.
  • Ensuring they have documented a current investment strategy
  • The fund’s assets must be held in the super fund’s name to ensure the separation of assets between the trustees’ help and the super fund.

What happens if I don’t complete an SMSF audit?

self managed super fund

You can’t lodge your tax return for an SMSF until it has been audited, so the penalty enforced by the ATO for SMSF non-compliance would apply here.

“Some of these penalties include monetary fines, a requirement to undertake education, rectification directions, trustee disqualification, winding up of the fund, civil and criminal penalties and the fund being made ‘non-complying,” Ms Brown said.

“A non-compliance notice is for grave breaches of the SMSF legislation. The fund loses its concessional tax rate of 15%. Instead, a rate of 45% applies to the fund’s income and the value of the fund’s assets.

“Franking credits can’t be claimed, and the exempt current pension income deduction isn’t available. Any tax or capital losses can’t be carried forward either.”

Ms Brown added these sanctions would exist until the SMSF fund is wound up or the breaches are rectified, and the Tax Office advises the fund is again compliant.

Is a self-managed super fund suitable for you?

A self-managed super fund (SMSF) can be great for those who have the time and know-how to manage one because they offer the kind of flexibility and control that retail and industry super funds don’t. On paper, an SMSF sounds like a no-brainer – after all, who doesn’t want total control over how their hard-earned retirement savings are invested?

But an SMSF is a pretty significant investment decision that takes a fair amount of legal knowledge and time, and money to set up. You’ll also need a pretty decent super balance (yes, sometimes bigger is better) and an excellent understanding of the risks involved in managing your super. After all, you can face some pretty severe legal consequences if you breach regulations.

If you’ve been thinking about taking a DIY approach to your super, don’t do it just cos your parents are. Here’s what you need to know about what it takes to manage an SMSF (hint: a lot).

What is a self-managed super fund?

As the name implies, a self-managed super fund is managed by you. So unlike your typical retail or industry superannuation fund, where you effectively outsource how your retirement nest egg is invested to a superannuation provider, you’re in charge of where that money is invested.

Sounds good, right? So what does that look like? Well, most retail and industry superannuation funds let you choose from a range of basic investment options, which usually include growth, balanced, ethical, conservative, cash, etc. But you usually can’t directly pick which shares to invest in or see what shares your investment option is supported in, other than an overview of how much of your super is allocated into different asset classes (e.g. 22% Australian shares, 32% international shares, 4% cash, 15% property, etc.).

But an SMSF allows you to choose your investments and offer a more comprehensive range of investment options that many industries and retail super funds don’t provide. Artwork and other collectables, physical gold and investments in some unlisted entities are all permitted within an SMSF”.

An SMSF can have up to four members who are friends or family, all of whom must be trustees and, as a result, are equally responsible for decisions made about the fund and the compliance of the fund with super and tax laws.

What sort of Australian has an SMSF?

As we’ve already mentioned, over one million Aussies have an SMSF – but they’re not all old white men. According to the Australian Tax Office (ATO), the gender split between SMSF fund members is pretty even, with 47.3% of women and the remaining 52.7%.

The age ranges of people with an SMSF fund are also pretty evenly spread across both genders, with the lion’s share of SMSF fund members between 35 and 84.

Not many Australians under the age of 34 have an SMSF.

However, according to the ATO, young people are increasingly beginning to establish their SMSFs.

In the March 2020 quarter, 13.7% of new SMSF fund members were between 25-34, and 1.4% under the age of 25.

Age and sex of members of SMSFs established during March 2020 quarter

Not everyone who has an SMSF is necessarily on a six-figure income. While it’s true that in the financial year 2017/18, all SMSF members’ average taxable income was $117,000, the median taxable income was $64,000.

As you can see from the table below, many fund members who established an SMSF fund in the March 2020 quarter were on a taxable income of between $0 to $100,000. These members represented more than half (50.9%) of all new SMSF members.

I’m trying to make here that SMSFs aren’t just for old rich white guys. People of all ages, genders and income levels run and manage their SMSFs, and you probably can too.

Risks and responsibilities of running an SMSF

With that said, managing your superannuation is a significant decision that comes with a boatload of risk and responsibility that not everyone is equipped to handle.

Mr Chapman says people need to make sure they understand what they’re getting themselves into.

“Therefore, as a trustee, you should make sure you have a reasonable understanding of investment options and markets as poor investment decisions will have a direct impact on the assets of your fund and also the retirement savings of other members. Some people simply do not have this expertise.”

Mr Chapman said trustees are also responsible for making sure their fund is compliant with the legislation and rules – a responsibility not to be taken lightly.

“Trustees should become familiar with the tax laws governing superannuation,” he said.

“If the ATO considers there has been a breach of these obligations and responsibilities, it can impose high penalties on trustees who will be personally liable. Serious breaches can result in an imposition of a tax rate of up to 47%.”

Yep, that’s a 47% tax rate on the balance of the fund, which means you could quickly lose nearly half the balance of your hard-earned retirement savings. Severe breaches of compliance may also lead to civil or criminal prosecution, and jail time can even be enforced for the most severe offences.

But it’s essential to keep in mind that for most people who are just trying to do the right thing and accidentally make a minor mistake, the ATO will encourage SMSF trustees to comply with super laws by undertaking further education and only escalate action when it’s required.

SMSF funds also demand a lot of time on trustees to make sure investments are being appropriately managed. Mr Chapman says the time involved in running an SMSF depends on how involved in the process you want to be.

“If you engage professionals to undertake much of the administration and management, you won’t need to spend much of your own time on these tasks. Alternatively, if you choose to do much of the hard work yourself, your time commitment will be greater,” he said.

“It’s a trade-off between time and fees, which each needs to consider according to their circumstance.

“Fortunately, there are SMSF administration managers, such as Klear Pictures, who can assist you in maintaining the accounting records of your fund and making sure your fund remains compliant.”

Costs of running an SMSF

Setting up and running an SMSF ain’t cheap.

According to a factsheet published by the Australian Securities and Investments Commission (ASIC) in October 2019, it costs an average of $13,900 per year to run an SMSF. However, ASIC notes this information is expired but has not yet issued an updated factsheet.

On the other hand, the most recent data from the ATO released in June 2020 states that the median annual expense for operating an SMSF was $3,923 in the 2017/18 financial year – quite a substantial difference!

According to Mr Chapman, typical SMSF start-up costs are around $750 (if you have an individual as trustee) or $1,590 (with a corporate trustee, including the ASIC set-up fee).

“You will also need to pay the annual supervisory levy to the ATO and arrange for an accountant to prepare the financial statements and tax return and conduct an independent audit,” he said.

“Total annual accountants costs are around $2,350. You may also choose to pay for financial advice and insurance for members, and you may need to pay for valuations of fund assets.”

Here’s a detailed breakdown of how much it costs to run an SMSF.

Pros and cons of SMSF’s

Pros:

Wide range of investment choice

One of the most significant benefits of an SMSF is the wide range of investment options on offer compared to other superannuation funds.

Mr Chapman says an SMSF opens the door to investing in just about anything.

“With some limited exceptions, an SMSF can invest in virtually anything providing that this also meets the sole purpose test and adheres to the regulations. This includes investing in direct property,” he said.

“An SMSF can also borrow to purchase an asset. However, this is becoming increasingly difficult as many banks have removed their SMSF lending products from the market.”

Mr Chapman says SMSFs can be especially attractive to small business owners or the self-employed as commercial property can be purchased by their SMSF.

“This property can then be rented to their business, providing this is at the prevailing market rates.”

Flexibility and control

smsf

Another significant benefit of an SMSF is the flexibility and control they provide that isn’t possible withretail or industry funds.

“As the fund members are also the trustees, there is the flexibility to tailor the SMSF rules to suit their specific needs and circumstances. This is not available with other superannuation funds,” Mr Chapman said.

“Managing your super investments directly allows you to make quick adjustments regarding your portfolio following market changes or to take up sudden investment opportunities.”

Protection from creditors

In most cases, creditors (people to whom money is owed) cannot generally access a person’s superannuation if that person goes bankrupt, regardless of whether they are with an SMSF, industry or retail super fund.

But Mr Chapman warns there may be some instances where creditors can access a person’s superannuation.

“That is unless clawback laws apply where someone has deliberately transferred their assets into an SMSF to escape paying their creditors,” he said.

Pooling your super with others

Unlike a retail or industry super fund, SMSFs allow you to pool your superannuation with up to three other people.

“This opens up the opportunity to invest in things an individual may not be able to own their own such as direct property,” he said.

Cons:

Unable to live overseas

If you’ve got an SMSF and decide you want to move overseas, you may find yourself in trouble with the Tax Office.

“The majority of an SMSF’s members must permanently reside within Australia. If you intend to move overseas permanently or make contributions to your fund while living overseas, this could make your fund non-compliant with the law,” Mr Chapman said.

The costs of running an SMSF can be expensive.

As we’ve mentioned, SMSF’s can be kind of expensive to run and manage. Mr Chapman says they can become even more costly to run if your super balance is too low.

“The cost of running an SMSF can be disadvantageous when the assets held within the SMSF are low in value. Many SMSF management costs are fixed and can therefore erode low-value SMSFs,” he said.

“Costs to operate an SMSF do reduce proportionately when the value of the fund’s assets is high. You must do the maths and see whether an SMSF is worthwhile for you based on your particular circumstances.”

He says the general consensus is that you should have at least $250,000 of assets in your fund to make the costs of running an SMSF worthwhile.

Time-consuming

Again, SMSF’s can be very time-consuming to manage, which means they won’t be suitable for those who aren’t prepared to spend lots of time researching investments and keeping tabs on those investments’ performance.

Of course, as Mr Chapman has mentioned, it is possible to outsource some of this work to professionals.

Legal risks

One of the most significant negatives of running an SMSF is that you’re responsible for making sure your fund is compliant with all the rules and regulations, and if it’s not, be willing to accept full responsibility for that which could see you hit with a massive fine or end up facing court or even jail time – depending on how naughty you’ve been.

Suitability of an SMSF

An SMSF might be right for you if:

  • You’ve got a legal background or good legal knowledge
  • You are very financially literate
  • You’ve got a big super balance (the Productivity Commission says SMSFs with balances below $500,000 produce lower returns on average, but the consensus among experts like Mr Chapman is that a $250,000 balance is enough)
  • You are willing to invest significant amounts of time researching investment options and managing your fund.
  • You understand the costs associated with running an SMSF and can cover these costs.
  • You want complete control of your superannuation.
  • You have your income and disability protection insurance (whatever level of cover you have within your current retail or industry super fund will be lost when you move to SMSF)

An SMSF may not be suitable for you if:

  • You have a deficient superannuation balance
  • You’re not financially literate
  • You aren’t willing to put in the time or money to run an SMSF
  • You’re not prepared to take on the legal risks of running an SMSF

Mr Chapman says most people who decide to start an SMSF do so because they want to choose and manage their super investments.

“They are often dissatisfied by the performance of their super to date and believe they can do a better job, generating higher returns.

“Often, an SMSF is created as part of a ‘whole of wealth’ plan by families that run their own business, since the SMSF itself can play a key role in the business, for instance, owning the business premises from which the business is run.”

Alright, an SMSF is for me. Where do I sign up?

For those who decide running an SMSF is for them, Mr Chapman says the next step is to seek advice from the pros.

“Navigating the path to setting up and managing your own SMSF can be challenging, and it helps to have knowledgeable advisors by your side to avoid making mistakes and running into trouble with the ATO,” Mr Chapman said.

Professionals, like Klear Pictures, can help you decide whether setting up an SMSF is the right move for you and, if it is, can also assist with setting up and managing the fund.

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