Managing an SMSF involves more than choosing investments, it requires a clear understanding of how income is earned, which expenses can be paid by the SMSF, and how both are treated for tax and compliance purposes. For Trustees, getting these fundamentals right is essential to keeping the Fund compliant and running smoothly.
Apart from capital growth, the objective of investments is to gain a yield on investments. With a bank account, an SMSF will receive interest and pay bank fees. Similarly, for shares an SMSF will receive dividend income, both franked and unfranked, pay brokerage and gain realised and unrealised capital gains. For property, a similar thing, an SMSF will received rental income and pay repairs and maintenance, managing agent fees and body corporate or council rates. For gold and precious metals there’s no regular income stream but the capital is well protected and for crypto its generally only realised and unrealised gains unless you do mining.
The risk appetite, age of Members and the Investment Strategy of the SMSF will guide Trustees what type of investments to make with their SMSF. Trustees can obtain financial advise to help select investment options but this is not a requirement for having an SMSF.
We are an accounting firm and most funds we act for do not use a financial advisor and it’s a expensive option and Trustees generally take responsibility for their Fund investments – the is the “self” in a Self Managed Fund.
Why Understanding SMSF Income and Expenses Matters
Trustee’s understanding how their income and expenses work in their SMSF is one of the most important factors when it comes to Trustee responsibilities. This is because not having good knowledge for their income and expenses can lead to compliance issues, unexpected tax and penalties from the ATO. As a Trustee, you’re legally responsible for ensuring that all income earned by the Fund is correctly reported and that expenses paid from the SMSF are allowable under superannuation law and meet the sole purpose test. Trustees should aim to build an understanding of their SMSF income and expenses, as they will become better equipped to stay compliant and make informed decisions that support long term retirement goals.
In addition make sure the investments you make with the SMSF is suited to your long term investment objectives, gives a decent yield and your capital is safe. For example, issuing a loan to an unknown company may seems like good interest returns but may put the capital at risk. So Trustees really have to take full responsibility for their SMSF and safeguarding their retirement income. Although there is a government backed Compensation Scheme of Last Resort, this is really a last option.
Understanding SMSF Income
What Is Considered Income in an SMSF?
Income in an SMSF generally refers to any money the Fund earns from its investments or activities. In simpler terms, income in an SMSF is anything that increases the value of the Fund. Income in an SMSF includes regular earnings such as interest, dividends, rental income (if the SMSF holds property) as well as capital gains when an asset is sold. From a tax perspective, income is split into two categories. Ordinary income, which is recurring income such as rent or investment returns, while statutory income includes amounts such as capital gains.
Types of SMSF Income
There are common types of income in an SMSF, these include investment income, which also includes interest earned on cash or term deposits, dividends from shares and rental income from investment properties held by the SMSF. In addition, an SMSF may also earn capital gains when it sells assets such as shares or property for more than what they were purchased for.
Another type of income in an SMSF is contributions. Members are able to make Concessional contributions, which have a cap of $30,000 every financial year, as well as non-concessional contributions, which have a cap of $120,000 every financial year. Some SMSFs may also receive government co-contributions, where the government contributes additional amounts to the fund for Members on low income making non-concessional contributions.
When Is SMSF Income Taxed?
When an SMSF is taxed depends on the phase that the Fund is in when the income is earned. During the accumulation phase, any income that is generated by the Fund including the common types as well as concessional contributions, are generally taxed at a rate of 15%. There is also CGT discount of 10% for assets that are held by the Fund for 12 months or longer. However, once the Fund moves into pension phase, where Members begin to draw retirement income streams, all of income generated by investments will become tax free. The timing of the income earned plays a important role, as income is usually taxed in the financial year that it was received by the Fund.
Remember that capital gains in the pension mode are tax free. So tax planning can give Members a tax advantage if they wait to start a pension before selling an asset for a gain. Also remember that pensions received are not taxed and do not have to be shown on your personal tax return.
SMSF Withdrawal Rules
When Can Members Withdraw Money from an SMSF?
Members can only draw money from an SMSF when the specific legal requirements have been met. These are known as the conditions of release. These conditions are implemented to ensure that superannuation is used for retirement purposes and not accessed early. Conditions of release include reaching age 65, being 60 and retired or meeting circumstances such as severe financial hardship or terminal illness.
Types of SMSF Withdrawals
When a Member becomes eligible to access their super, there is generally two ways they can access super. Lump sum withdrawals, this involves taking out a one-off amount from the Fund, either the full Member balance or a partial withdrawal. You are generally able to access the Lump sum options once you have reached age 65 or 60 years of age and you are
retired. These are often used to pay off debts or cover large expenses. The other options is income stream payments, where the SMSF pays Members regular amounts overtime. These payments must meet minimum payment requirements each financial year and are often used to provide a steady income in retirement. It starts at 4% for ages under 65, then 5% for ages to 74 and increase with age over this limit.
Common Mistakes with SMSF Withdrawals
Remember to have liquid cash available to pay the pension amounts. If there are lumpy or illiquid assets and not enough cash available to pay minimum pension amounts, the Fund will have to sell assets to restore liquidity. This can be applicable for property or precious metals. Say there’s residential property that delivers a 3% annual yield and you have to take 4% from the SMSF, at some stage to SMSF will have to generate cash to pay the pension or potentially revert back to the accumulation phase.
Managing SMSF Expenses
What Expenses Are Allowed in an SMSF?
An SMSF should only pay for expenses that meet the sole purpose test, meaning expenses must be investment related, administrative or compliance natured and operating expenses. For investment related expenses, these are associated with expenses incurred with acquiring an asset, managing investments and the disposal of assets. For example, with a property investment, management costs such as hiring a real estate agent to manage the property would be an investment related expense. Along with any repairs related to the property.
Operating expenses are typically bank fees and insurance premiums paid as they are categorised under expenses incurred by the functional side of the SMSF. Meanwhile Administration and Compliance costs are in relation to the running of the SMSF and are typically compulsory. Administration costs would be fees paid to lodge the SMSF’s Tax Return and prepare its Financials as this is required by the ATO. Additionally, compliance costs are generally related to acquiring documents. For example, if an SMSF holds a property investment then the Trustees are required by the ATO to provide a Title Search and Valuation Report. The cost to acquire these documents can be paid by the SMSF as they ensure compliance with the ATO.
Make sure expenses paid are paid from the SMSF bank account and supported by an invoice in the name of the Fund. When we prepare the annual financial statements and tax return for the SMSF, we will claim these as a tax expense for the Fund.
Expenses That Are Not Allowed
It is important to note that the SMSF should not pay for any expenses that are personal in nature or where Members derive a current day benefit. This means that although, you can use your SMSF’s funds to pay for travel expenses incurred when travelling to inspect an
existing SMSF investment property it must be for the sole purpose of the SMSF. For instance, you cannot use the SMSF’s funds to pay for your McDonald’s during your trip to inspect your SMSF investment property as you are deriving a current day benefit and it does not meet the sole purpose test. Remember that expenses paid by the SMSF must be reasonable.
SMSF Tax Deductions
What SMSF Expenses Are Tax Deductible?
Becoming knowledgeable of which SMSF expenses are tax deductible and what you can claim in your SMSF is essential for Trustees to get the most out their hard-earned retirement savings. A general rule of thumb is that any investment management fees, administration fees and compliance fees are tax deductible as they are expenses incurred by running the SMSF. These fees are tax deductible on the basis its not capital, domestic or private in nature. For example, an expense which is capital in nature would be when an SMSF is acquiring investments, such as shares, property or bullion. Private expenses would be personally travelling to inspect a residential property which is not tax deductible. However, travelling to inspect a commercial property is tax deductible and engaging a third party such as a property manager to inspect your property whether it be residential or commercial is tax deductible. This is because with a commercial property, it is related to business operations which is different from being private in nature.
For Members that have their full balance in pension phase, expenses that are tax deductible will not apply as all earnings in a pension account are tax-free. Hence, there is no tax to deduct.
Common Compliance Issues with SMSF Income and Expenses
Trustees often find themselves in trouble with the ATO and auditors regarding ensuring investments acquired and expenses incurred are in the name of the SMSF. It is important that Trustees keep personal transactions and SMSF transactions separate from each other by having separate Bank accounts and Trading accounts. As mixing transactions is not only a compliance breach but can lead to confusion on which assets are held by the SMSF and therefore what income and expenses are related to the SMSF.
A common mistake Trustees also make is the belief that if an investment opportunity will benefit the SMSF that it should be compliant with the ATO despite it being income earned through a related-party to the Fund. This is not the case, as the ATO states investments need to be on an arm’s length basis, meaning for example you cannot rent a residential property to a Member or related party. This is because the Member would be deriving a current day benefit from their retirement savings.
For Trustees to remain compliant with the ATO, it is typically best practice to engage an SMSF accountant as they will record income and expenses accurately and help prevent any compliance breaches.
Final Thoughts: Staying Compliant and Maximising Your SMSF
Managing an SMSF requires a clear understanding of how income is earned and when it is taxed. Trustees should be knowledgeable on the types of income their Fund can receive, including investment income, capital gains and contributions, as well as the distinction between accumulation and pension phases. Trustees should also be aware that withdrawals are just as important. Understanding when Members can withdraw Funds and the types of withdrawal options is key for Trustees to not make any of the common mistakes that can lead to compliance issues. Alongside this, Trustees must carefully manage SMSF expenses, ensuring only allowable costs are paid from the fund and that eligible expenses are correctly claimed as tax deductions.