by Alicia Thomson
Recently, one of our readers contacted us with an interesting scenario, which is likely to become increasingly common. With many SMSF’s having been set up predominantly to purchase a single residential property, the dynamics of the fund change considerably once the members move into the pension phase.
As the SMSF will be required to pay out minimum pensions, having only the sole income deriving from a property (i.e. rent) can create liquidity issues. It is possible that at some point in the future the rental income may not be sufficient to cover the pension payments. The situation can be further exacerbated if there is a loan attached to the property, putting a severe strain on the SMSF liquidity.
A short-term solution may be to liquidate all other assets, but eventually a decision will need to be made by the trustees.
So what options does the SMSF have?
- The simplest option is to sell the property to an arm’s-length third party. While the fund is 100% in pension mode, the capital gains from any sale will be disregarded and the cash received could then be invested in more liquid assets to generate a higher yield
- The property can be sold to a related party. However, it is critical to ensure it is done at market value to avoid compliance issues. We recommend a formal valuation be obtained for that purpose
- The pensioner(s) could take the property as an in-specie lump sum which would remove the need to make ongoing minimum pension payments. In most states stamp duty relief should be available as there is no change of beneficial owner. Again, obtaining an independent market valuation prior to the lump sum will be important and legal advice around the stamp duty (don’t rely on this email)
- Admit new members into the SMSF who can rollover cash or make ongoing contributions which can be used to supplement the minimum pension requirements. The property can then be incrementally acquired by the other members over time. However, this strategy may run into complications in the event of the death of a member where the death benefit has to be paid in cash;
- A more complicated option would be to sell part of the property – either to a related party or third party. However, issues can arise with different entities on the title. We strongly recommend an agreement would need to be in place that documents the arrangement, including the ability of each entity to sell their share, or force a full sale etc.
Please note that pension payments cannot be made in-specie, so a partial transfer of ownership of the property to meet minimum pension requirements is not possible.
If you have clients that could potentially end up in this situation, it may be worthwhile having a proactive meeting with them to discuss their options so they have plenty of time to implement any changes.