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The Ultimate SMSF End of Financial Year Checklist 2023


OK, yet again we are with only a few weeks left to the end of the financial year to get our SMSF in order and ensure we are making the most of the strategies available to us. Here is a checklist of the most important issues that you should address with your advisers before the year-end.

It’s been another busy year and I have not had as much time to put this together so if you find an error or have a strategy to add then please let me know. Links were working at the time of writing.

Warning before we begin,

Before we start, just a warning as in the rush to take advantage of new strategies you may have forgotten about how good you have it already Be careful not to allow your accountant, administrator or financial planner to reset any pension that has been grandfathered under the pension deeming rules that came in on Jan 1st 2015 without getting advice on the current and possible future consequences resulting in the pension being subject to current deeming rates if you lose the grandfathering. Point them to this document

  1. It’s all about timing

If you are making a contribution, the funds must hit the super fund’s bank account by the close of business on 30 June. Some clearing houses hold on to money before presenting them to the super fund.

In addition, pension payments must leave the account by the close of business unless paid by cheque in which case the cheques must be presented within a few days of the EOFY. There must have been sufficient funds in the bank account to support the payment of the cheques on 30 June but a cheque should be your very last-minute preference!

Get your payments in by Friday 23rd June or earlier to be sure (yes I’m Irish). This is even more important if using a clearing house for contributions.

  1. Review your Concessional Contributions (CC) options and new rules

The government changed the contribution rules from 1 July 2020 to extend the ability to make contributions from age 65 up to age 67. Read more here. Maximise contributions up to CC cap of $27,500 but do not exceed your limit unless you have Unused Carried Forward Concessional limits and Total Super Balance under $500K as of last 01 July 2022. Guidance on how to check your Unused Carried Forward Concessional limits via MyGov records available here

Some of the sting has been taken out of excess contributions tax but you really don’t need the additional paperwork to sort out the problem. Check employer contributions on normal pay and bonuses, salary sacrifice and premiums for insurance in super as they may all be included in the limit.

  1. Consider using the ‘Unsed Carry Forward Concessional Contribution” limits

Broadly, the carry forward rule allows individuals to make additional CC in a financial year by utilising unused CC cap amounts from up to five previous financial years. Eligibility requires a total superannuation balance just before the start of that financial year of less than $500,000 (across all your super accounts).

This measure applies from 2018-19 so effectively, this means an individual can make up to $130,000 of CCs in a single financial year by utilising unapplied unused CC caps since 1 July 2018. Guidance on how to check your Unused Carried Forward Concessional limits via MyGov records available here

Beware that once your Income including Salary, Investment income, Employer SGC, Personal Concessional Contributions goes over $250,000 you will be subject to Div 293 Tax

  1. Review plans for Non-Concessional Contributions (NCC) options

From 1 July 2022 the NCC contribution rules changed and currently the age limit of 75 (28 days after the end of the month your turn 75) applies to NCCs (that is, from after-tax money) without meeting the work test. Check out ATO superannuation contribution guidance.

NCCs are an opportunity to move investments into super and out of a personal, company or trust names.

Even-up spouse balances and maximise super in pension phase up to age 75. For couples where one spouse has exhausted their transfer balance cap and has excess amounts in accumulation are able to withdraw from the higher balance and recontribute to the other spouse who has transfer balance cap space available to commence a retirement phase income stream. This can increase the tax efficiency of the couple’s retirement assets as more of their savings are in the tax-free pension phase environment.

Make your tax components more tax free by using recontribution strategies. SMSF members can cash out their existing super and re-contribute (subject to their contribution caps) them back in to the fund to help reduce tax payable from any super death benefits left to non-tax dependants. From 1 July 2022 you can do this until they turn age 75 (contribution to be made within 28 days after the end of the month you turn 75).

The Bring Forward Rule for 2022-23 compared to after 1 July 2023

Maximum NCC capCurrentFrom 1 July 2023
$330,000< $1.48M< $1.68M
$220,000$1.48 – $1.59M$1.68 – $1.79M
$110,000$1.59 – $1.7M$1.79 – $1.9M
NIL> $1.7M> $1.9M
Bring Forward Limits affected by TSB

RECONTRIBUTION STRATEGIES

Consider doing the drawdown before 30 June 2023 so that your Transfer Balance Cap and Total Super Balance on 1 July 2023 gets some additional space with the rise in the TBAR and TSB full limits to $1.9m. Note that if you have existing pensions you new limit will be anywhere between $1.6m and $1.9M (Frustrating for Advisers!)

  1. Downsizer contributions

If you have sold your home in the last year and you are over 55, consider eligibility for downsizer contributions of up to $300,000 for each member.

From 1 jan 2023, the eligibility age to make downsizer contributions into superannuation will be reduced from 60 to 55 years of age. All other eligibility criteria remain unchanged, allowing individuals to make a one-off, post-tax contribution to their superannuation of up to $300,000 per person from the proceeds of selling their home. These contributions will continue not to count towards non-concessional contribution caps.

The $300,000 downsizer limit (or $600,000 for a couple) and the $330,000 bring forward NCC cap allow up to $630,000 in one year contributions for a single person and $1,260,000 for a couple subject to their contributions caps.

PLEASE BE CAREFUL AS THIS IS A ONCE ONLY STRATEGY AND IF YOU WOULD BENEFIT MORE IN LATER YEARS USING THE STRATEGY THEN MAXIMISE NCCs FIRST.

  1. Calculate co-contributions

Check your eligibility for the co-contribution, it’s a good way to boost your super. The amounts differ based on your income and personal super contributions, so use the super co-contribution calculator.

  1. Examine spouse contributions

If your spouse has assessable income plus reportable fringe benefits totalling less than $37,000 for the full $540 tax offset or up to $40,000 for a partial offset, then consider making a spouse contribution. Check out the ATO guidance here.

From 1 July 2022 you can implement this strategy up to age 75 as a Spouse Contribution is treated as a NCC in their account (and therefore counted towards your spouse’s NCC cap).

  1. Give notice of intent to claim a deduction for contributions

If you are planning to claim a tax deduction for personal concessional contributions, you must have a valid ‘notice of intent to claim or vary a deduction’ (NAT 71121).

A notice must be made before you commence the pension. Many people like to start pension in June and avoid having to take a minimum pension in that financial year but make sure you have claimed your tax deduction first. The same notice requirement applies if you plan to take a lump sum withdrawal from your fund.

  1. Consider contributions splitting to your spouse

Consider splitting contributions with your spouse, especially if:

  • your family has one main income earner with a substantially higher balance or
  • if there is an age difference where you can get funds into pension phase earlier or
  • if you can improve your eligibility for concession cards or age pension by retaining funds in superannuation in the younger spouse’s name.

This is a simple no-cost strategy I recommend for everyone here. Remember, any spouse contribution is counted towards your spouse’s NCC cap.

  1. Act early on off-market share transfers

If you want to move any personal shareholdings into super (as a contribution) you should act early. The contract is only valid once the broker receives a fully-valid transfer form so timing in June is critical. There are likely to be brokerage costs involved.

  1. Review options on pension payments

The government has extended the Temporary Reduction in Minimum Pensions as part of the COVID-19 response. Ensure you take the new minimum pension of at least 50% of your age-based rate below. If a pension member has already taken pension payments of equal to or greater than the 50% reduced minimum amount, they are not required to take any further pension payments before 30 June 2023. For transition to retirement pensions, ensure you have not taken more than 10% of your opening account balance this financial year.

Minimum annual payments for pensions for 2022/23 and 2023/24 financial years.

OK we are back to normal rates from 01/07/2023

Age at 1 July2023-24 Back to Standard 

 

Minimum % withdrawal 

2022-23 50% reduced

 

minimum pension

Under 654%2%
65–745%2.5%
75–796%3%
80–847% 3.5%
85–899%4.5%
90–9411%5.5%
95 or older14%7%

If a pension member has already taken a minimum pension for the year, they cannot change the payment but they can get organised for 2023/24. So, no, you can’t sneak a payment back into the SMSF bank account!

If you still need pension payments for living expenses but have already taken the 50% minimum then it may be a good strategy for amounts above the 50% reduced minimum to be treated as either:

  1. a partial lump commutation sum rather than as a pension payment. This would create a debit against the pension members transfer balance account (TBA). Please discuss this with your accountant and adviser asap as some funds will have to report this quarterly and others on an annual basis.
  2. for those with both pension and accumulation accounts, take the excess as a lump sum from the accumulation account to preserve as much in tax-exempt pension phase as possible.
  3. Check your documents on reversionary pensions

A reversionary pension to your spouse will provide them with up to 12 months to get their financial affairs organised before making a final decision on how to manage your death benefit. In NSW this may avoid issues with Binding Death Nominations and the Notional Estate (see Benz v Armstrong; Benz v Armstrong – 2022 NSWSC)

You should review your pension documentation and check if you have nominated a reversionary pension in the context of your family situation. This is especially important with blended families and children from previous marriages that may contest your current spouse’s rights to your assets. Also consider reversionary pensions for dependent disabled children.

The reversionary pension has become more important with the application of the $1.6-$1.9 million Transfer Balance Cap (TBC) limit to pension phase from 01/07/2023.

Tip: If you have opted for a nomination instead then check the existing Binding Death Benefit Nominations (many expire after 3 years) and look to upgrade to a Non-Lapsing Binding Death Benefit Nomination. Check your Deed allows for this first.

  1. Review Capital Gains Tax on each investment

Review any capital gains made during the year and over the term you have held the asset and consider disposing of investments with unrealised losses to offset the gains made. If in pension phase, then consider triggering some capital gains regularly to avoid building up an unrealised gain that may be at risk to legislation changes.

  1. Collate records of all asset movements and decisions

Ensure all the fund’s activities have been appropriately documented with minutes, and that all copies of all statements and schedules are on file for your accountant, administrator and auditor.

The ATO has now beefed up its requirements for what needs to be detailed in the SMSF Investment Strategy so review your investment strategy and ensure all investments have been made in accordance with it and the SMSF Trust Deed, including insurances for members. See my article on this subject here.

  1. Arrange market valuations

Regulations now require assets to be valued at market value each year, including property and collectibles. For more information refer to ATO’s publication Valuation guidelines for SMSFs.

On collectibles, play by the new rules that came into place on 1 July 2016 or remove collectibles from your SMSF.

  1. Check the ownership of all investments

Make sure the assets of the fund are held in the name of the trustees (including a corporate trustee) on behalf of the fund. Check carefully any online accounts and ensure all SMSF assets are separate from your other assets.

We recommend a corporate trustee to all clients. This might be a good time to change, as explained in this article on Why SMSFs should have a corporate trustee.

  1. Review Estate Planning and loss of mental capacity strategies

Review any Binding Death Benefit Nominations (BDBN) to ensure they are valid, and check the wording matches that required by the Trust Deed. Ensure it still accords with your wishes.

Also ensure you have appropriate Enduring Powers of Attorney (EPOA) in place to allow someone to step into your place as trustee in the event of illness, mental incapacity or death.

Check your Trust Deed and the details of the rules. For example, did you know you cannot leave money to stepchildren via a BDBN if their birth-parent has pre-deceased you?

  1. Review any SMSF loan arrangements

Have you provided special terms (low or no interest rates, capitalisation of interest etc) on a related party loan? Review your loan agreement and see if you need to amend your loan.

Have you made all the payments on your internal or third-party loans, have you looked at options on prepaying interest or fixing the rates while low? Have you made sure all payments in regards to Limited Recourse Borrowing Arrangements (LRBA) for the year were made through the SMSF trustee? If you bought a property using borrowing, has the Holding Trust been stamped by your state’s Office of State Revenue.

  1. Ensure SuperStream obligations are met

For super funds that receive employer contributions, the ATO is gradually introducing SuperStream, a system whereby super contributions data is made electronically.

All funds should be able to receive contributions electronically and you should obtain an Electronic Service Address (ESA) to receive contribution information.

All funds should be able to receive contributions electronically and you should obtain an Electronic Service Address (ESA) to receive contribution information.

If you change jobs your new employers may ask SMSF members for their ESA, ABN and bank account details.

  1. Ensure you are ready for Quarterly TBAR Reporting

From 1 July 2023

All SMSFs will be required to report quarterly, even if the members total super balance is less than $1 million. This means you must report the event that affects the members transfer balance within 28 days after the end of the quarter in which the event occurs.

All unreported events that occurred before 30 September 2023 must be reported by 28 October 2023. This means you cannot report at the same time as your SMSF annual return (SAR) for the 2022–23 income year. More info here

  1. ASIC fee increases from 1 July 2021

ASIC is increasing fees by $4 for the annual review of a special purpose SMSF trustee company $59 to $63. The Government is moving gradually to a “user pays” model so expect increases to accelerate in future years. Before 30 June for $407 you can pre-pay the company fees for 10 years and lock in current prices with a decent discount. There is a remittance form linked here.

  1. HAS NOT PASSED: Relaxing residency requirements for SMSFs– new Government to review.

SMSFs and small APRA funds still do not have relaxed residency requirements through the extension of the central management and control test safe harbour from two to five years as the LNP government failed to pass it before the election. The active member test was also to be removed, allowing members who are temporarily absent to continue to contribute to their SMSF.

  1. HAS NOT PASSED: Legacy retirement product conversions (Under Review By New Government)

Individuals were to be able to exit a specified range of legacy retirement products, together with any associated reserves over a two-year period but the legislation was not passed and is now to be reviewed by the new Government. The specified range of legacy retirement products includes market-linked, life expectancy and lifetime products, but not flexi-pension products or a lifetime product in a large APRA-regulated or public sector defined benefit scheme.

Currently, these products can only be converted into another like product and limits apply to the allocation of any associated reserves without counting towards an individual’s contribution cap.

There is considerable additional detail in this feature so consult an adviser if you are affected, especially to ensure you do not lose other entitlements such as the age pension.

  1. Improving the Home Equity Access Scheme – Social security benefits for you or your mum and/or dad

The Home Equity Access Scheme formerly called The Pension Loan Scheme is now up and running. The Government introduced a No Negative Equity Guarantee for HEAS loans and allow people access to a capped advance lump sum payment.

  • No negative equity guarantee – Borrowers under the HEAS, or their estate, will not owe more than the market value of their property, in the rare circumstances where their accrued HEAS debt exceeds their property value. This brings the HEAS in line with private sector reverse mortgages.
  • Immediate access to lump sums under the HEAS – Eligible people will be able to access up to two lump sum advances in any 12-month period, up to a total value of 50% of the maximum annual rate of Age Pension (currently $13,882 for singles and $20,852 for couples).
  1. Careful if replacing Income Protection or TPD Insurance (Total Permanent Disability)

Have you reviewed your insurances inside and outside of super? Don’t forget to check your current TPD policies owned by the fund with an own occupation definition as the rules changed a few years ago so be careful about replacing an existing policy as you may not be able to obtain this same cover inside super again.

There were major changes to Income Protection insurance in 2021 so be very careful about switching insurer unless costs have blown out as new cover is often vastly inferior to current covers. Read more here before switching cover.

  1. Large one-off Personal income or gain – Bring forward Concessional Contributions

For those who may have a large taxable income this year (large bonus or property sale) and are expecting a lower taxable next year you should consider a contribution allocation strategy to maximise deductions for the current financial year. This strategy is also known as a “Contributions Reserving” strategy but the ATO are not fans of Reserves so best to avoid that wording! Just call it an Allocated Contributions Holding Account. See my article on this strategy here.

  1. Providing Proof of Crypto Currency Holdings as of 30 June.

You should be using an exchange that is set up for SMSF accounts. They should provide a Tax Summary but it may cost extra. Independent Reserve provides one audited by KPMG for $50. COINSPOT also offer tax reports that meet Australian Audit requirements.

The auditor will also want to verify holdings by checking:

  • An exchange account is set up in the name of the fund
  • Wallet purchased using funds from the SMSFs cash account

Cold Wallet Audit management extra step: For annual audit purposes, take a screenshot of the assets held in your Ledger wallet (e.g.via the Ledger ‘Live’ App or similar) on 30 June 2023 and also on the day you submit your paperwork and email this to the tax agent at tax time.

Don’t leave it until after 30 June, review your Self Managed Super Fund now and seek advice if in doubt about any matter.


One for 1 July 2023 Check your Salary Sacrifice or Concessional Contributions as SG rises to 11%

So busy, I forgot the superannuation guarantee (SG) rate will increase from 10.5% to 11% on 1 July 2023. You’ll need to use the new rate to calculate how much of your $27,500 concessional limit will be available to salary sacrifice or make personal deductible contributions.

Warning before you jump into implementation of any strategy without checking your personal circumstances.

Are you looking for an advisor that will keep you up to date and provide guidance and tips like in this blog? Then, why not contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one-on-one consultation (after 1 February 2023 due to our waiting list). Just click the Schedule Now button up on the left to find the appointment options.

Please consider passing on this article to family or friends. Pay it forward!

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser

 

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Tel: 02 9899 3693, Mobile: 0413 936 299

  • PO Box 6002 NORWEST NSW 2153
  • Suite 40, 8 Victoria Ave, Castle Hill NSW 2154
  • Suite 4, 1 Dight St., Windsor NSW 2756


Corporate Authorised Representative of Viridian Advisory Pty Ltd ABN 34 605 438 042, AFSL 476223

This information has been prepared without taking into account your objectives, financial situation, or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation, and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

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by SMSF Coach - Liam Shorte on June 2, 2023  •  Permalink
Posted in Binding Death Nominations, Centrelink, Checklists, downsizing, education, Estate Planning, Financial Planning, In Specie transfers, News & Stats, Pension Strategies, Pensions, Retirement Planning, Reversionary Pension, Salary Sacrifice, SMSF, SMSF Management, Superannuation Splitting, Tax Planning, Trustee
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Posted by SMSF Coach - Liam Shorte on June 2, 2023

https://smsfcoach.com.au/2023/06/02/the-ultimate-smsf-end-of-financial-year-checklist-2023/

Updated Guide to Tax Benefits of Using an SMSF Withdrawal and Re-Contribution Strategy


No More Tax Free

Depending on the tax components of your Superannuation balance you may leave a nasty tax bill for your ultimate beneficiaries on death. Here, we will review the use of withdrawal and re-contribution strategies, to maximise benefits for eventual beneficiaries and offer some protection against future legislation changes. Seek personal advice before implementing any strategy.

What has changed

The withdrawal and re-contribution strategy has been popular from both a retirement and estate planning perspective to manage tax outcomes for retired members and beneficiaries on the death of a member.

The benefit of the withdrawal and re-contribution strategy should now be reassessed as a result of some of the reforms which took effect incrementally since 1 July 2017:

• the Non-Concessional Contribution (NCCs) cap is now $120,000 ($360,000 using 3 year bring forward rule).
• indexation to $2m of the  Total Super Balance cap (TSB) rule to determine eligibility to make NCCs
• partial indexation to between $1.6 and  $2m Transfer Balance Cap (TBC( applicable to existing and new pensions.
• the abolition of anti-detriment payment (sigh of relief from many professionals!), and

From 1 July 2022, the ability for SMSF members over 67 to continue to make Non-Concessional (NCC) contributions up to age 75. This will help you get the maximum benefit available under the re-contribution strategy.

The basic re-contribution strategy

The re-contribution strategy involves withdrawing an amount from an SMSF member’s balance and making a non-concessional contribution (NCC) back into the SMSF in the same or another member’s name. This effectively enables any taxable component of the lump sum withdrawn to be converted into a tax-free component paying nil tax on death benefits.

Before you can use the strategy, the SMSF member needs to have met a full condition of release to be eligible to make lump sum withdrawals. Now, if you are under 75 you do not need to meet the work test eligibility to make NCCs but you do have to ensure that your Total Super Balance contribution cap limit will allow a re-contribution of the funds.

We normally suggest using this strategy after meeting a condition of release after age 60 and before age 75 because if this strategy is implemented by a person who is 60 or over, any withdrawal is received tax-free and not included in assessable income.

The re-contribution strategy may help to:

  • reduce the tax to be paid by non-tax dependant beneficiaries (usually financially independent adult children) on any death benefit lump sum after the member passes away.
  • offer some protection against legislative changes to taxing of pensions as NCCs are after-tax contributions where no tax concession has been received.

Case Study Example

Michael, a widower, (aged 60) has $720,000 in an SMSF account. The tax components of his account are split 50:50, meaning that $360,000 of the account is taxable and $360,000 is tax-free. He has fully retired and therefore has complete access to his super benefits.

Michael has two adult children, his daughter Carmel and son Sebastian (neither of whom are financial dependents). Michael has a valid non-lapsing binding death benefit nomination in place in favour of them equally.

If Michael passed away today, $360,000 of his super benefit which is attributable to the taxable component would be subject to tax at a maximum rate of 15% plus Medicare Levy (if not paid to estate) as Carmel and Sebastian are not tax dependants.

Michael could use the re-contribution strategy which may give a better outcome for the kids from a tax perspective saving up to $61,200 ($360,000 x 17%). In addition, assuming Michael has other taxable passive investment income outside super, if Michael was to start an account-based pension, a concessional contribution strategy could also help him to reduce tax payable on his income using funds from the SMSF pension payments until he reaches age 67 and afterward to age 75 if he meets the work test yearly.

Maximum Total Super Balance for additional contributions

A person will not be eligible to make NCCs if their total super balance (across all super funds) on the prior 30 June is equal to or greater than $1.9m depending on their personal limit. If the total super balance is less than$1.9m but more than $1.68m on 30 June of the prior year, the person will be eligible to contribute some NCCs but cannot fully utilise the 3-year bring-forward of $360,000. In relation to the re-contribution strategy, this means that:

TSB on 30 June  of prior financial year Contribution and bring-forward available
Less than $1.76m 3 years ($360,000)
$1.476m to < $1.88m 2 years ($240,000)
$1.88m to < $2m 1 year ($120,000, no bring-forward available)
$2m and above Nil
  • re-contributions, whereby one member of a couple makes a withdrawal from their SMSF account and contributes into their spouse’s member account, may become attractive to the extent that it would enable them both to maintain a member account balance of less than $1.9m, potentially preserving future eligibility to make NCCs.

$1.9 – $2m Pension transfer balance cap

From 1 July 2024, a transfer balance cap rose to $2m (indexed) but somewhere between $1.6 and $2m for those who already have a pension in place. This measure was introduced in 2017 to limit the maximum amount that an individual can transfer into the retirement phase of superannuation. Any amount in excess of the transfer balance cap needs to

  • remain in accumulation, or
  • use a re-contribution strategy where one spouse makes a lump sum withdrawal and contributes the amount into their spouse’s account may also allow the couple to collectively hold more of their wealth in tax-effective superannuation pensions.

The Traps and interaction with Centrelink strategies

When deciding whether to use a re-contribution strategy, it’s important to consider each member’s personal circumstances, as well as any implications the re-contribution strategy may have on their broader situation.

Moving Funds to a Spouse under Age Pension age
A popular Centrelink strategy involves a person who is of Age Pension age cashing out some of his/her super and having the money contributed in the SMSF member account of their spouse who is below Age Pension age. This strategy can enable the older spouse to get more Age Pension, as super in the accumulation phase is not means-tested when held in the name of a person under Age Pension age. It can also enable taxable money to be converted into tax-free money and may result in a Government co-contribution or spouse tax offset.

I hope this guidance has been helpful and please take the time to comment. Feedback is always appreciated. Please reblog, retweet, like on Facebook, etc to make sure we get the news out there. As always please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or via Skype. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

    

Color logo with background smaller

Tel: 02　9899 3693, Mobile: 0413 936 299

PO Box 6002 NORWEST NSW 2153

U40/8 Victoria Ave. Castle Hill NSW 2154

Corporate Authorised Representative of Viridian Advisory Pty Ltd ABN 34 605 438 042, AFSL 476223

This information has been prepared without taking into account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

1 Comment
by SMSF Coach - Liam Shorte on July 7, 2022  •  Permalink
Posted in Centrelink, Contribution Strategies, education, Estate Planning, Financial Planning, News & Stats, Pension Strategies, Pensions, SMSF, SMSF Management, Superannuation Splitting, Tax Planning
Tagged , , , , , , , , , , , , , , , , , , , , , , , , ,

Posted by SMSF Coach - Liam Shorte on July 7, 2022

https://smsfcoach.com.au/2022/07/07/updated-guide-to-tax-benefits-of-using-an-smsf-withdrawal-and-re-contribution-strategy/

Evans Dixon US Masters Residential Property Fund URF under scrutiny – Warnings were given 3 years ago


The Australian Financial Review has released an article (behind paywall) today focusing on poor performance of Evans Dixon’s internal funds marketed heavily to many of their clients. The main focus is on the fall in value of their own stock but equally on the heavily fee laden products such as US Masters Residential Property Fund (URF).

source AFR and Bloomberg

Well that’s almost exactly 3 years after another finance website, EVISER,  that I was very proud to be apart of, called out the fund as “A magic pudding, just not for investors” and “one of the most expensive managed funds we’ve ever laid our eyes on”. Here is that full extensive article written by John Nunan and Richard Livingston for Eviser in MAY 2016 and bear in mind that the fund was showing positive returns at the time but hiding its true colours. All data on fees and charges were relevant as of May 2016 but may have changed in the last 3 years.

US Masters Residential Property Fund: A magic pudding, just not for Investors

We explain why the US Masters Residential Real Estate Fund is one of the most expensive managed funds we’ve ever laid eyes on.

KEY INFORMATION

Fund: US Masters Residential Property Fund

Fund manager: URF Investment Management Pty Ltd (part of Dixon Advisory Group)

Closing date: N/A (fund is listed on the ASX)

Website: http://www.usmastersresidential.com.au/

PRODUCT SUMMARY

Product type: ASX listed managed fund

Investment type(s): International real estate

Performance benchmarks: None

ASX code: URF

Minimum investment: N/A

Distributions: Semi-annual

Fund size (at 31 Mar 2016) $622m (market capitalisation)

Inception date June 2011 (listed on ASX in July 2012)

Performance (since inception) at 31 Mar 2016 11.7% per annum (calculated by Dixons based on share price performance, including dividends and adjusted for rights issues).

FEE SUMMARY

Investment management fee: 1.24% pa (plus GST)

Administration fee:  0.25% pa (plus GST)

Responsible entity fee: 0.08% pa (plus GST)

Custodian fee: 0.02% pa (plus GST)

Other:  listing fees, salary and wages recharges, office admin recharges, asset disposal fees, asset acquisition fees, structuring and arranging fee, debt arranging fee and handling fee (see table in article for more information)

Performance fee: None

Buy/sell spread: N/A (traded on ASX)

The Magic Pudding is a classic Australian children’s book that tells the story of a pudding that, no matter how often it’s eaten, is always available for its owners to eat next time they’re ready for a meal.

The US Masters Residential Property Fund (ASX Code: URF) is the magic pudding of investment vehicles – a continuous buffet of fees for the manager and promoter, Dixon Advisory Group (now Evans Dixon) and its associates. When we first read the fund’s financial statements we were amazed at the number of different fees Dixon and its associates (which we’ll refer to simply as ‘Dixon’) were able to charge to the fund. However, buried deep in the balance sheet or related party notes, we’d find yet another fee.

But it’s not just the fees that worry us about this fund. We have so many questions about the fund, its strategy, the strength of its balance sheet and the risks, that even if we were to ignore the fee load, we’d be unlikely to ever get comfortable making an investment.

The fund and its investment strategy

Launched in 2011, and listed on the ASX in 2012, the fund was initially presented as an opportunity for Australian investors, with the benefit of a strong Australian dollar, to invest in residential real estate in the New York metropolitan area (mainly Hudson County, New Jersey) at attractive valuations. Rental yields were expected to be greater than 8 per cent a year.

Over time the investment strategy has morphed into what is today, a strategy of buying and renovating properties in neighbourhoods undergoing rapid growth and gentrification, with the intention of ultimately leasing them. This has transformed the fund into less of a passive, rent earning investor and more of a property speculator, with a large proportion of the fund’s earnings coming from revaluations of the properties it owns (more below).

Property investors know that managing (and renovating) a property isn’t a simple or cheap exercise and this shines through in the portfolio owned by this fund. The fund requires a large range of services, with the key ones provided by Dixon. In addition to being the investment manager, Dixon provides the following paid services: the responsible entity; administration and accounting; architecture, design and construction; property management and leasing; property acquisition and disposal; execution, structuring and arranging (capital raisings); and debt arranging. Dixon also charges a handling fee when it raises new capital from its clients.

You won’t be surprised to learn this shopping list of services isn’t cheap. Details of some of the services and the fees charged can be found in the Services and Fees  section of the fund’s website. In Table 1, we’ve summarised these and the others we’ve found scattered throughout the financial statements and the Product Disclosure Statement (PDS).

We’ll return to the smorgasbord of fees in a moment. First let’s take a quick look at what the fund owns and where the money comes from.

The portfolio

Pictures of funky Brooklyn, Manhattan and Hoboken townhouses are scattered throughout the regular quarterly updates (click here for the 31 March 2016 update). However, it’s not what the properties look like, or where they’re located that’s of interest to us. We’re focused on whether they’re being leased or not.

Table 2 shows the fund’s portfolio at 31 March 2016, including both freestanding properties owned directly and multi-family buildings owned through various joint venture entities. The status of these properties is as follows:

Occupied (leased) – 63 per cent
Renovation/turnover – 34 per cent
For lease – 3 per cent

Due mainly to renovation works, effectively a third of the fund’s assets aren’t available for lease. Combined with rising valuations and falling rental yields, this means the days of the fund being a high yielding investment are gone, at least for now.

In the year ended 31 December 2012, the fund earned $4.2 million of rental income on an average investment property balance of $67 million. Given the rapidly growing nature of the fund it’s a very rough estimate, but this equates to an average rental yield of over 6 per cent. Revaluations of properties contributed another $5.7 million of profit (a little more than the rent).

Fast forward to 31 December 2015 and the (now much larger) fund earned almost $22 million of rental income on an average investment property balance around $703 million. That equates to an average yield just over 3 per cent. Meantime, property revaluations contributed almost twice as much as rent – about $40.8 million.

These figures highlight the increasingly speculative nature of the fund’s investment portfolio and also why the fund has struggled to generate positive operating cash flow since its inception. Even if the fund shifts to a position where the portfolio is fully (or almost fully) leased, this basic proposition is unlikely to change, at least anytime soon.

In the 31 March 2016 update Dixon estimated that the fund would earn another USD11.4 million in rent from the properties currently being renovated. While this might eliminate last year’s $14.4 million ‘core’ loss (see Table 4 and related discussion below) it would only reduce the negative $30.6 million operating cash flow, not turn the fund into a positive operating cash flow producer.

The fund has a low level of income, high level of expenses and relies on non-cash items to turn a profit. This, together with its growing acquisitions, means that it has had to continually tap unitholders on the shoulder for further capital and borrow from a variety of sources.

The current funding structure for the fund is set out in Table 3. A key feature is the two tranches of URF Notes that were issued in 2014 and 2015 and pay a fixed interest rate of 7.75 per cent.

The use of borrowing adds to the speculative nature of the fund’s portfolio. In the case of the URF Notes, often the fund is effectively borrowing money at 7.75 per cent to buy assets which won’t earn a cent initially, will have substantial sums spent renovating them and then will be put out to lease to earn rental income at a rate of say 3 to 4.5 per cent (although hopefully calculated on an upgraded book valuation).

Put this way, it’s fairly obvious why the fund’s strategy is such a cash drainer in the early years and how it could come unstuck. A downturn in the New Jersey or Brooklyn property markets (where most of the fund’s assets are located) could place pressure on both the ability to revalue the properties upwards (post renovation) and flat or falling rents. In this scenario the ability of the fund to pay its interest bill and generate a reasonable profit for unitholders, could be pushed a long way into the distant future.

Depending on the severity, a property downturn could cause the fund to have to sell properties in order to repay the URF Notes (which mature in 2019 and 2020) and other debts, exacerbating the fund’s problems in generating cash.

The early year cash flow drought associated with the underlying portfolio is magnified by the substantial levels of fees and other expenses incurred by the fund.

Let’s take a look at them in more detail.

Financial analysis

To put it bluntly, we’ve seen very few fee-fests like this fund. Perhaps some of the crazy tax deals beat it – for instance, managed agricultural schemes – but we struggle to recall a more traditional investment fund that’s paying fees in the order of five per cent or more (calculated as a percentage of the net asset base), year-in, year-out.

Admittedly, it’s not an apples for apples comparison to something like an Australian share fund, since property is typically a more expensive asset class to manage. But asset class alone doesn’t explain the continually high fee load being borne by this fund.

Table 4 shows the fund’s accounting results for each year since it was launched, and Table 5 shows some key financial ratios. We’ve used our own display format as it better demonstrates how the fund loses money on a ‘core’ basis each year, but generates a profit through renovating and revaluing the properties and, perhaps even more importantly, foreign exchange (FX) gains. It also highlights the amount of fees that have been paid by the fund since it was created.

At 31 December 2015, the fees totalled almost $100 million, and there’s a chance we’ve missed some as the fund’s disclosure of fees is both complicated and in a constant state of flux. If there’s an easily digestible summary of the fees paid by the fund somewhere on the Dixon website, we haven’t found it.

We’ve already discussed the fund’s low level of income and high levels of URF Note interest. When you add in the fees, it explains the large operating cash outflows the fund has experienced since launch. Cumulatively, the fund has burned through almost $50 million in operating cash flow between launch and 31 December 2015.

Fees on borrowed money

Dixon is paid an extraordinary array and volume of fees, but that’s not the only issue. Despite earning fees for managing and renovating the portfolio, making
purchases and sales and raising money, Dixon is paid an investment management fee of 1.24 per cent (for whatever aspect of the fund’s investment management that hasn’t been paid for already), together with administration (0.25 per cent), responsible entity (0.08 per cent) and custodian fees (0.02 per cent). Added together, these percentage fees add to 1.59 per cent, plus GST.

Scarily, these fees are paid on the gross assets of the fund, so it currently works out at around 3 per cent based on the unitholders equity (with all the transaction based fees on top). This is a massive fee load but even worse, the fact the fees are on gross assets gives Dixon a strong disincentive to deleverage the fund (at least, by diverting income or asset sale proceeds to paying down debt) since they’d effectively be costing themselves a substantial amount of money. A perverse incentive like this is the very reason we don’t like geared investment vehicles paying fees on gross assets.

So there you have it: the fund is an extraordinarily expensive cash burner. However, the fund has survived and prospered, largely on the back of three critical factors: property revaluations, foreign exchange gains and the ability to regularly source new capital and borrowings.

Performance

Table 4 demonstrates how the fund relies on property revaluations and foreign exchange gains to compensate for large ‘core’ losses. While the gains on  revaluations may ultimately be reflected in a higher level of rental income (or asset sale proceeds) the FX gains are ‘one-off’ profit items that may not be  repeated, or may even reverse themselves in future years.

Worryingly, through to 31 December 2015, FX gains on translation contributed almost 100 per cent of the cumulative post-tax accounting profits of the fund.
Effectively, for all of the fund’s activity and the substantial revaluation gains made as a result of renovations, the fund’s accounting profits to date have more to do with the recent depreciation of the AUD against the USD than anything property related.

In the 31 March 2016 update, Dixon reported that the fund has produced returns of 11.7 per cent a year since its launch in June 2011. However, over that same period, the US dollar itself has returned over 7 per cent a year (measured in AUD returns) and a simple US property , such as the Vanguard REIT (NYSE Code:  VNQ), has returned around 11.5 per cent.

In AUD terms, that works out at almost 20 per cent a year for a simple real estate , that doesn’t have the development risk or financing risk associated with URF. URF is a great example of reasonable absolute performance hiding terrible relative performance.

Risk

More worrying than the lacklustre performance is the amount of risk taken to achieve it. At first glance, a debt-to-equity ratio for a property trust of just under 50 per cent (at 31 March 2016) is nothing to get too worried about. But this fund is no ordinary property trust. It’s part property owner, part developer, part FX speculator (due to the fact it has issued the URF Notes in Australian dollars) and part guarantor of the juicy Dixon fee arrangements.

Without knowing whether Dixon intends to ease off the ‘buy and renovate’ strategy, repay the URF notes, or restructure some of the fee arrangements it’s difficult to tell when this fund may produce positive operating cash flow, or indeed whether it will ever do so. That means it’s relying on being able to raise further capital, borrow, or sell assets at a profit in order to pay the bills.

The problem with this type of approach is that everything can come unstuck at once. A downturn in the property market would make it difficult to sell assets
at a profit and tough to borrow or raise capital (except at a large valuation discount). In that scenario, the fund may be forced to sell assets at discounted
valuations to raise cash and if that happens the debt to equity ratio can increase rapidly.

If the fund had a property portfolio generating, say, a 5 per cent rental yield, with expenses running at 2 per cent a year, the story might be very different. In that case, it might be able to sit tight, pay its interest bills and wait for a recovery. However, the fund’s constant operating cash outflows means it has to continually tap unitholders and lenders for more cash and if that dries up, the conservative approach is to assume it will have big problems.

Summing it up

We could dig further into the property portfolio – for instance, analyse per square metre lease rates for Hoboken rental properties – but it really doesn’t matter. This fund has produced relatively little for investors versus alternative investments, largely because it suffers under a crushing fee and expense load that has eroded a lot of the gains produced by FX movements and a buoyant underlying property market.

Looking forward, with FX gains more difficult to come by, unitholders are taking on an enormous amount of risk since the fund is now substantially leveraged and has an expense load that keeps on increasing. It’s unclear exactly how a property downturn might play out, but our concern is that this fund could end up suffering a crunch and suffer massive losses from having to sell assets on the cheap.

If you know enough about New Jersey property to be bullish on freestanding Hoboken houses, buy one directly, or team up with some fellow investors to do so. But if you’re simply an Australian SMSF trustee looking for some exposure to global property and infrastructure, there are plenty of better options available. You simply don’t need this fund, or the expense and the risk that comes with it.

Disclaimer: This article is general in nature and does not take your personal situation into consideration. This article is not a recommendation of any investment or facility mentioned in it, and you should seek financial or legal advice specific to your situation before making any financial and/or investment decision. This  disclaimer is in addition to our standard Terms and Conditions. The Product Disclosure Statement (Offer Document) for this fund can be found here.

Are you looking for an advisor that will keep you up to date and provide guidance and tips like in this blog? Then why not contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

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Verante Financial Planning

Tel: 02　98941844, Mobile: 0413 936 299

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This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

1 Comment
by SMSF Coach - Liam Shorte on June 7, 2019  •  Permalink
Posted in education, International Investing, Investment Strategies, Investor Education, Property, SMSF

Posted by SMSF Coach - Liam Shorte on June 7, 2019

https://smsfcoach.com.au/2019/06/07/evans-dixon-us-masters-residential-property-fund-urf-under-scruitiny-warnings-were-given-3-years-ago/

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