Maintain some SMSF Reserves — Understanding how reserves can benefit your Self Managed Superannuation Fund

Maintaining reserves in an SMSF is a strategic tool that can help the trustee to administer the fund and in turn, to provide better benefits to members and their dependants. Here is an overview for SMSF trustees who are sensibly concerned to be prudent in selecting the appropriate types of reserve accounts for their fund.

 

Reserves — some basics

Under superannuation law, an SMSF trustee may maintain fund reserves as long as the SMSF's governing rules do not prohibit maintaining reserves.1 Before creating any reserve, the trustee must review the SMSF's governing rules to check that they don't prohibit maintaining reserves. Cleardocs deeds allow reserves.

How are reserves calculated?

Amounts held in reserve constitute the net market value of the SMSF's assets less the total of members' account balances.

Do amounts held in reserve form part of a member's benefit?

Until the amounts from a reserve are credited to a particular member's account in the SMSF, they do not constitute part of a member's benefit.

How do you fund reserves?

Any money to be placed in reserve is sourced from different areas of an SMSF — for example, from undistributed investment earnings, unallocated employer contributions and forgone or forfeited benefits.

Contribution Caps — How are allocations from reserves treated?

In general, an allocation from a reserve will be treated as a concessional contribution for a particular member, unless the amount

  • is allocated in a fair and reasonable manner to every member; and
  • the amount allocated is less than 5 per cent of a member's account balance before the reserve amount is allocated.2

Concessional contributions are generally made to an SMSF for, or by, a member in a financial year and are included in the SMSF 's assessable income.

You can read more about reserves and contributions caps here.

How does a trustee manage reserve accounts?

There is an implied covenant to manage reserves prudently

Under superannuation law, if the SMSF maintains reserves, then its governing rules must include a covenant by the trustee to formulate, and to give effect to, a strategy for their prudential management, consistent with:

  • the SMSF's investment strategy; and
  • its capacity to discharge its liabilities (whether actual or contingent) as and when they fall due.3

A trustee can defend an action for loss or damage suffered by a person as a result of how the trustee managed a reserve, if the trustee establishes that the management of the reserves was in accordance with this covenant.4

One investment strategy for all reserves?

The investment strategy may be applied to all reserves or alternatively the trustee may have a separate investment strategy for each type of reserve.

Where should the investment strategy be documented?

There are no definitive rules about where the investment strategy should be documented. However, we recommend recording the rules at least by way of trustee minutes covering:

  • the investment strategy;
  • the establishment of any types of reserves; and
  • the processes and rules by which the trustee will maintain those reserves.

The trustee should hold these minutes with any other original documents relating to the SMSF.

The Cleardocs SMSF Deed

The Cleardocs SMSF deed provides that the trustee:

  • may establish or maintain any account for, or reserve of, the SMSF that the trustee thinks necessary or desirable or that is required or permitted by superannuation law;
  • may use those accounts or reserves for any purpose permitted by superannuation law; and
  • may credit or debit amounts from those accounts or reserves as the trustee sees fit.

To confer maximum discretion in relation to this issue, the Cleardocs SMSF deed does not prescribe which types of reserves can or cannot be established. Consequently, the trustee may determine what is appropriate for the SMSF.

What types of reserves can a trust create?

Although superannuation law does not allow or disallow, any particular type of reserve, there are a number of established types of reserves which the trustee can create to accommodate the SMSF's requirements. More common types are:

  • General reserve account

    A general reserve account allows the trustee to allocate the SMSF's investment earnings. The trustee can then distribute these earnings for any number of purposes including making member superannuation benefit payments.

  • Expense reserve

    An expense reserve allows the trustee to set aside amounts and use the reserve account to pay the SMSF's general and specific expenses.

  • Contributions reserve

    A contributions reserve entitles the trustee to "warehouse" contributions for up to 28 days after the end of the month in which the contribution was made.

    A trustee may be able to use or contribute to the reserve to defer and reduce the impact of superannuation contributions surcharge tax. This idea is that while a deduction contribution may be available to an employer in respect of a member, the liability to surcharge does not occur until the contribution is allocated to the member's account.

    The Commissioner of Taxation refers to the use of contribution reserves, in the ruling SCR 1999/1. This ruling sets out the circumstances in which surcharge will apply to contributions and when it will arise.

    The 28 day period in which to allocate the money in the contribution reserve also allows for:

    - deferring a surcharge; and

    - managing a market's contributions caps year to year.

    You can read more about how an SMSF member can allocate a single contribution across two financial years here.

  • Investment reserve

    An investment reserve is used to hold undistributed investment earnings and is often used to smooth investment returns. The trustee may wish to use an investment reserve to ensure that members of the SMSF receive consistent returns over a period of time.

    A trustee does not need to allocate full investment returns to member accounts on a year by year basis. They may choose to maintain an investment reserve for investment returns in excess of a particular rate of return.5 As a result, the trustee then has the flexibility to apply funds from the investment reserve to top up a member's account if an investment falls below the anticipated return.

  • Anti-detriment reserve

    Anti-detriment reserves are also known as 's.279D Reserves'.6 The anti-detriment was introduced when legislation imposing the 15% contributions tax was enacted.

    An anti-detriment reserve is used to accommodate a bonus or additional payment from the SMSF to a dependant of a deceased member or the deceased member's legal estate. The payment is designed to compensate the recipient for any contributions tax paid by the deceased member.

    The trust deed must allow for the funding of an anti-detriment reserve and there must be documentation to support this purpose. This reserve may be allocated from another appropriate reserve account and must be established before the relevant member's death.7 The benefit of an anti-detriment reserve is that it is payable to dependants on the death of a member. The amount paid is equivalent to the 15% tax paid on the deceased member's contributions. This amount must be paid in addition to the member's balance on death.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Superannuation or Tax and Revenue Team.

More Cleardocs information on related topics

Read

You can read earlier ClearLaw articles on a wide range of SMSF topics here.

Order SMSF related document packages

Set up an SMSF
Update an SMSF deed

Change SMSF trustee
Set up an SMSF pension
Arrange SMSF borrowing lending docs:

Set up an SMSF corporate trustee

SMSF Death Benefit Nomination — binding or non-binding
An SMSF Death Benefit Agreement — binding and permanent

Download checklist

Download a checklist of the information you need to order a document package.


[1] section 115 Superannuation Industry Supervision Act 1993 (Cwth) (SIS Act).

[2] Negline, T., Reserves are complex and costly structures, The Australian 23 September 2009, accessed on 11 January 2010, available at http://www.theaustralian.com.au/business.

[3] section 52(2)(g) SIS Act.

[4] section 55(6) SIS Act.

[5] Wasiliev, J., It pays to keep something in reserve, DIY Super, Smart Investor, Australian Financial Review, 1 December 2004.

[6] Section 279D refers to the previous section 279D of the Income Tax Assessment Act 1936. However the relevant provisions are now found in section 295 — 485 of the Income Tax Assessment Act 1997.

[7] Negline, T., Reserves are complex and costly structures, The Australian 23 September 2009, accessed on 11 January 2010, available at http://www.theaustralian.com.au/business.