SMSFs: ATO to check on investment strategy compliance
Over 17,000 SMSFs that are heavily invested in one asset class will soon receive a “please explain” from the ATO to check whether they can justify their diversification risk. Diversification is just one of five key matters that all SMSF trustees must regularly review as part of their investment strategy. Know the essential requirements and ensure your fund’s strategy is airtight.
Trustees must consider the risk involved in making, holding and selling the fund’s investments, and the likely return they’re expected to generate (having regard to the fund’s objectives and expected cash flow requirements).
Trustees must consider whether inadequate diversification will expose the fund to unnecessary risk. If you’ve heavily invested in a particular asset or asset type, could a market downturn or other investment risk have a significant adverse effect on the value of member benefits and/or income earned by the fund? This matter is important in light of the ATO’s planned SMSF contact.
(c) Liquidity and cash flow requirements
Liquidity means how easy it is to sell an asset and convert it to cash. Trustees must consider their liquidity needs in light of the fund’s cash flow requirements (see more on “liabilities” below.) If your fund has “lumpy” assets like real estate and minimal cash, this could present a cash flow problem.
Trustees must consider their ability to meet both existing and future liabilities. This would include things like the SMSF’s operating expenses, tax liabilities, insurance premiums and costs of managing its assets. Two important liabilities that trustees often need to consider when planning fund investments are annual income stream payments to members and loan repayments on any “limited recourse borrowing arrangement” undertaken by the fund to buy an asset.
It’s possible to hold various types of insurance within superannuation. The trustees must consider whether the SMSF should hold cover for its members, which requires the trustees to consider the particular circumstances of the members.
Does your strategy stack up?
The ATO’s warning about diversification is a timely reminder for SMSF trustees to review their strategies. Contact our office on (03) 8534 5500 if you have any questions about investment strategy requirements or for assistance documenting your fund’s strategy.