Since 1 July 2021, the maximum number of members that can belong to an SMSF increased from four to six. The ability to have a six-member fund may prompt some SMSF members to consider inviting their children to join their super fund.

As is the case with so many things in life, there’s no right or wrong when it comes to adult children joining the fund. In the right circumstances, it can work exceptionally well. However, there is plenty of examples – and courtroom battles – which highlight potential pitfalls with parent-children funds.

If you’re considering bringing adult children into the fold, or if you’re an adult child contemplating an invitation to join your parents’ fund, there’s a range of factors to consider in deciding whether it’s a good option for you and your family.

What are you hoping to achieve?

Every person involved needs to be crystal clear on why you are bringing your children into the fund. What does each of you hope to achieve? For some families, combining super can enable the fund to build a bigger and more diversified investment portfolio, and buy assets of greater value. Likewise, it might be ideal for facilitating the purchase of property used in the family business.

Other common reasons for inviting adult children into the SMSF include:

  • Reducing overall administrative and management expenses;
  • Building financial literacy for your young adult;
  • Helping them take more control over their super under ‘your watch’ or guidance;
  • Intergenerational transfer of assets (a strategy which needs careful consideration and advice).

Do you all share the same objective, and if not, are you comfortable with any differences?

Avoid making assumptions. The only way to be clear is to have the conversation.

What role will everybody play?

All trustees are responsible for the operation of the whole fund, and all fund members, not just themselves. Even if one member plays a more active role in the day-to-day running of the fund, ultimately, all members should be genuinely willing to take on their role as trustee.

How will decisions be made? Does everyone have an equal say, or will you apply proportional voting based on member balances? What does the trust deed permit?

This is important, because in real life, the parents will generally be closely aligned with each other in their approach to investing, whereas the children may not be.

Family dynamics

Each member of the family is different, and the decision to join the super fund might not be right for everyone. It doesn’t need to be a case of ‘one in, all in’. An adult child who has difficulty (or zero interest in) managing their own finances might be better off in a retail or industry fund.

But how does this sit with the family unit as a whole? Do the excluded siblings have any concerns or issues with the arrangement, and how might that impact the family dynamic? Other siblings might have concerns about the level of control that the adult child can exercise once in the fund, especially when one or both parents pass away. There are some very sad legal cases arising from an adult child taking control of their parent’s super death benefit, at the expense of the other children.

You might think this will never happen in your family, and hopefully you’re right. But it’s important to think through the possible scenarios and have a plan for how they might be managed.

How will the fund operate?

Parents and adult children are typically at very different stages of their financial life cycles. With their different investment horizons and attitudes towards risk and return, their investment strategies could be poles apart.

How do you plan to accommodate different investment objectives and attitudes to risk?

One option is to segregate assets. This means that the investments which support each member’s super balance are segregated. For example, growth-oriented investments may be more suitable for members in accumulation phase and defensive, income-oriented assets may be more suitable for members in pension phase. Therefore, under a segregated investment strategy, the trustees would allocate growth assets (and associated earnings) to accumulation members and income assets to retirement phase members.

But this begs the question, if a key driver for a family-based fund is to pool the assets and open up the possibility of investing differently or bigger, then what has been gained by operating under a segregated investment strategy?

Segregated investment strategies are more complicated to run, as they require segregated bank accounts and investment accounts and your fund’s accountant would need to have the skills and systems to handle segregated assets efficiently and on a cost-effective basis.

Alternatively, with a pooled investment strategy, all SMSF members would have their balance invested identically and each balance would represent a portion of the SMSFs overall assets on a proportional basis.

Although there’s no right or wrong, most SMSF trustees operate under a pooled investment approach. The main reason for this is because it is generally easier and cheaper from an administrative perspective.

What’s your ‘exit strategy’?

While there’s plenty to think about on the way in, it’s essential to think about the possibility that one day the arrangement will no longer suit everyone. What happens then?

Sometimes, it’s simply a case of changing circumstances. What seems like a sensible idea when your adult child is single might become less pragmatic if they find a partner and start a family of their own. They might prefer to operate their super independently of their parents, or perhaps even start their own SMSF with their partner.

Similarly, it might be a case of happy families at the outset, but what if things go pear-shaped? What if the relationship between the parents and the adult child breaks down?

In theory, a member can simply rollover their balance to another fund, be it a self-managed, retail or industry fund, but how will that work in practice? A rollover out of the fund requires trustee consent and involvement. Are the assets sufficiently liquid to make this possible? This could be particularly tricky if property or other lumpy assets form part of the portfolio.

Likewise, what if the parents want the children to exit the fund? Under super law, trustees cannot expel members, or force anyone out. A rollover to another fund (self-managed, retail or industry) requires member consent. What if the only option was for the parents to exit, and leave the adult child behind? Sure, it’s possible, but there will be complications and it will cost money if the parents need to set up a new SMSF and corporate trustee.

Think it through, carefully

Inviting kids into your SMSF can work well where the family members respect each other, and decisions can be made collaboratively in the interests of everyone. But you need to weigh up the potential risks, as well as give serious thought to the practicalities of how the whole arrangement is actually going to work. Be informed, weigh up all the options, be transparent with each other and very importantly, consider your exit plan, just in case.

General disclaimer

This content is intended only to provide a summary and general overview of the subject matter covered. It is not intended to be comprehensive nor does it constitute advice. We attempt to ensure that the content is accurate and current but we do not warrant the content nor its currency. You should seek professional advice before acting or relying on any of the content.

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