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The Hidden Dangers of Large SMSFs: Why Bigger Isn’t Always Better


I was there on Day One for SMSFs or as they were called excluded super funds – all the way back on 1 July 1994.  There were 70,000 on that first day and $10Bn in assets.  Things moved slowly for a long time, and they became a major super vehicle of choice for the Baby Boom generation – the older guard had already retired and did not meet the contribution requirements of the day – a work test.

Dusting off my first SMSF book, the CCH published Guide to Self-Managed Super Funds we find in the year 2000 there were 210,000 SMSFs with $76Bn in assets. Things picked up a lot of steam when the 2007 Simpler Super introduced tax free super for those over age 60. Taking an account-based pension where there was no tax in the fund on those pension assets and also getting tax free income PLUS refundable franking credits was a honey pot for any person over 60.  By 2015, when I called the high point in SMSFs in terms of tax effectiveness, there were 547,000 SMSFs holding $603Bn in assets.  As at March 2024 the latest news is that there are 616,000 SMSFs – a surprising jump of 22,000 in the nine months to March 2024 (Gen X is finally making its move) and assets of $896Bn.


What does this all mean?


Well for starters high-net-worth retirees have been accumulating large balances within their SMSF, with some funds holding well over $2 million in assets and even bigger - see below. Now on the surface, a large SMSF appears to be a smart financial move—more assets under management, more control, the potential for greater returns and lower taxes.

However, beneath the surface, large SMSFs, particularly those with only one or two family members as trustee directors, are a ticking time bomb. While the opportunity to accumulate wealth within an SMSF is significant, so too are the risks. Lack of diversification, inadequate governance, continuous government tax changes, the taxation on unrealised capital gains, liquidity issues, and family disputes are just a few of the dangers that can unravel years of careful planning.

This is a three-part series on the dangers of Large SMSFs and by the end of it, I promise you that you will never look at large SMSFs again the same but more importantly you will start to adjust your strategies to minimise your clients and as an adviser with strict liability under the SIS Act 93, your liability.

Let’s first break down the distribution of SMSFs by asset size to give context to the magnitude of this issue.


SMSF Assets – Number of funds and size

Recent data from the ATO reveals the distribution of SMSFs by asset size, showing a concentration of funds in the $1 million to $5 million range. Here’s how the numbers stack up:

Asset Range

Number of SMSFs

$0 to $50,000

33,000

$50,000 to $100,000

15,000

$100,000 to $200,000

35,400

$200,000 to $500,000

114,600

$500,000 to $1 million

152,400

$1 million to $2 million

132,000

$2 million to $5 million

91,200

$5 million to $10 million

19,800

$10 million to $20 million

5,400

$20 million to $50 million

1,200

Over $50 million

600

Out of 600,000 SMSFs, 40% of funds hold more than $1 - $2 million in assets, and 20% of all funds have over $2 million under management. This concentration of wealth within a few hands, especially in family-controlled funds with one or two trustees, brings several inherent risks.

The Ten Dangers of Large SMSFs with One or Two Older Members

While managing a large SMSF might seem like a dream for control-minded investors, it is important to recognise that bigger isn’t always better—especially if the fund is controlled by only one member.  By that I mean the Mum and Dad funds – one and two member funds make up 94% of all SMSFs and generally only one of the members makes the investment decisions and runs the fund.  Because of that there are a number of potential issues:

1. Lack of Diversity in Decision-Making

When the decision-making power lies in the hands of one individual, there is an increased risk of narrow investment strategies. The absence of diverse opinions can lead to biased decisions that fail to consider all investment options, potentially hampering the fund’s performance. Over the past decade with all asset prices rising investing has been easy but it is on the fall that we see the merits of asset diversification.

2. Overconcentration of Power

In a small SMSF with one dominant trustee, the concentration of power can lead to issues where one person dominates the decision-making process. This lack of balance may result in poor decisions, especially if the dominant trustee does not have sufficient financial expertise.

3. Increased Risk of Mismanagement

Large funds require diligent management to ensure compliance with SMSF regulations. Without proper knowledge or external guidance, one or two trustees may overlook important legal obligations, leading to mismanagement or inadvertent non-compliance, resulting in severe penalties or losses.

4. Liquidity Issues

Large SMSFs with significant holdings in illiquid assets such as property may struggle to meet pension obligations or fund members' needs as pension valuation factors increase with age. With only one or two trustees, finding a solution for liquidity issues often results in forced asset sales at unfavourable times, leading to potential financial loss or worse still not making minimum pension payments.

5. Inadequate Succession Planning

One of the most common oversights in small family-controlled SMSFs is the lack of proper succession planning. If a trustee passes away or becomes incapacitated, the remaining trustee may not have the skills, knowledge, or resources to manage the fund, leaving the SMSF vulnerable to mismanagement or forced winding-up. As we will see later, if the last member dies, the fund can be in real legal problems.

6. Running Accumulation and Pension Accounts

The larger the fund the more chance that the Trustee is running accumulation and pension accounts for members of the Fund.  This is not an easy process and to do it correctly separate investment strategies should be used for either account as the accumulation account is for estate planning while the pension account is for retirement income – two completely different styles.

7. Vulnerability to Family Disputes

Family-run SMSFs are highly susceptible to disputes, especially when there are only one or two trustees involved. Conflicts over investment decisions, contributions, or benefit payments can lead to long-term issues, including the breakdown of relationships and costly legal battles. This can also be the case where there are blended families – who gets what and when.

8. Greater Taxation and Compliance Risks

Large SMSFs are subject to strict tax rules and reporting requirements. One or two trustees may struggle to keep up with the complexities of SMSF taxation, resulting in inadvertent tax breaches or costly penalties particularly as they get older. The larger the fund, the higher the stakes when errors occur and more often than not the accountant or auditor do not find out until too late.

9. Higher Audit and Compliance Costs

Larger SMSFs often face greater scrutiny from auditors and regulators. The risk of an audit increases with the size of the fund, and the complexity of managing such a fund can lead to higher compliance costs. For trustees with limited resources or expertise, this can be a significant burden on the fund’s overall performance.

10. Is the Fund a SMSF on death of the last member?

This is a complex and dangerous issue.  Where the last member of the Fund passes away and is a director of the corporate trustee who will take over.  We will look at the importance of the Successor Director solution for the executor of the Will, but if there is no company, then when the trustee dies, their additional trustee pursuant to section 17A(2) of SISA 93is no longer valid.  Also, where the period of no trustee extends too far there is a danger under section 19 of SISA 93 that the fund is able to be regulated so all tax concessions are lost.


The Big Ones for you to think about

In the next instalment we are going to look at the death of the last member in detail and how the majority of accountants are not aware of the legal mechanics on death, in fact we still see the preponderance of the use of BDBNs despite their on-going courtroom battles, which will intensify with the larger SMSFs.


So what are the big ones?

1.      If both members have hit their pension TPB maximums how are you going to work out what to do and get the numbers right?  There can be significant tax consequences if a mistake is made which is why we see many funds missing the one year deadline for decision making.

2.      If the assets are going to be paid out on the death of the last member, where there is no reversionary to the pension, then capital gains tax is to be paid on the sale of assets AND the non-tax dependant beneficiaries will be up for tax at 17%.  You could pay it to the estate and reduce that to 15% but that is a walk in the family provision trap park.

3.      Of course the $3M unrealised capital gains tax disaster is almost upon us.

Plus there is a lot more for us to unpack, build models for and get right. 


Conclusion

While large SMSFs with over $1 million or even $5 million in assets may seem like the ideal vehicle for maximising control and wealth-building, the reality is that size brings complexity—and complexity brings risk. These risks are further exacerbated when only one or two family members are left in the fund. And you cannot stop age and infirmity.

It is essential for trustees to recognize these dangers and take proactive steps to mitigate them. Whether through seeking professional SMSF advice, establishing robust governance frameworks, or creating clear succession plans, SMSF trustees must ensure that they are not only growing their wealth but also protecting it for the long term.

In the end, the true value of an SMSF is not just in its size but in how well it is managed, safeguarded, and passed down through generations.

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