ATO Letter Is your SMSF investment strategy meeting diversification requirements

Is your SMSF investment strategy meeting diversification requirements

The ATO has sent a letter titled ‘Is your SMSF investment strategy meeting diversification requirements’ to 17,700 SMSF trustees highlighting concerns with the lack of diversification and threatening an administrative penalty of $4,200 may be payable if your SMSF fails to meeting the diversification requirements under the relevant superannuation laws.

A sample of this letter is available here (opens in new window): https://www.superfundpartners.com.au/ato-investment-strategy-letter_example/

 

Why have you been sent the ‘Is your SMSF investment strategy meeting diversification requirements’ letter?

The ATO has used data it collects from SMSF annual tax returns to identify 17,700 or more self-managed super funds where more than 90% of the funds investments are held in a single asset or asset class.

The most common scenario where you will be sent this letter is where your SMSF has purchase direct property (with or without a loan) as part of it’s investment strategy.

In addition, the auditor of your SMSF has also been sent a copy of the letter, so when they next audit your SMSF, they will be looking at your SMSF investment strategy documentation very closely. The ATO letter even states: “Have your investment strategy ready to provide to your SMSF’s approved auditor as part of your next audit.”

 

Will you be fined $4,200?

Not likely. Having a correctly documented and compliant investment strategy is part of the operating standards (rules) that SMSF trustees must comply with. Failing to do so will incur 20 penalty units at $210 per penalty unit.

Provided your investment strategy and supporting documentation (trustee minutes) are comprehensive enough and meet the requirements of the superannuation regulations, it’s unlikely the independent SMSF auditor will report your fund to the ATO via an audit contravention report.

An audit contravention report is typically the trigger point for the ATO to look at the compliance of your SMSF in more detail.  Failing to met Regulation 4.09 in relation to your SMSF investment strategy is a breach which must be reported to the ATO.  This could happen where you’ve not provided a correctly document investment strategy and minutes to your auditor.

 

What you need to do

If you’ve received this letter, you need to review your investment strategy and related documents / minutes to ensure it covers the following:

  • Diversification of the investments of the SMSF
  • Risks associated with the lack of diversification in your SMSF investment portfolio (concentration risk)
  • Ensuring investments will help you meet your retirement goals including cash flow requirements (to pay pensions)
  • Liquidity of investments to ensure ongoing costs can be paid as well as pensions
  • Whether insurance should be held for members

Many template investment strategies you may have used or been provided with from your accountant in the past may not meet these requirements.

The following from the ATO provide further information: SMSF – Your Investment Strategy

Please note, you – or your SMSF accountant / administrator / adviser DOES NOT have to directly respond do the letter or so anything about from ensuring you have the correct SMSF investment strategy documentation on file.

Can the ATO force you to diversify your SMSF?

No. The specifics of the applicable regulation doesn’t force your SMSF investment strategy to be diversified, but it does force trustees to specifically consider diversification.

The applicable regulation is Superannuation Industry (Supervision) Regulations 1994 – REG 4.09(2)(b):

The trustee of the entity must formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following: (b) the composition of the entity’s investments as a whole, including the extent to which they are diverse or involve exposure of the entity to risks from inadequate diversification;

The onus is on the trustee of the SMSF to diversify the investments of the fund. If the investments are not diversified, how have the trustees justified or counteracted the risk from being heavily concentrated in a single asset class.

For example is an SMSF has 90% of it’s investments in Australian listed shares, some level of diversification may be obtain by investing in companies that operate across different industries or have exposure to different geographic locations.  It’s for the trustees – hopefully in consultation with an adviser – to determine whether the level of diversification (or lack thereof) is appropriate.

What should be included in your SMSF investment strategy?

In regards to diversification, your SMSF investment strategy should indicate an exposure of a number of different asset classes including:

  • Cash
  • Australian Equities
  • International Equities
  • Fixed Interest
  • Direct Property
  • etc

In addition, the investment strategy document should include details on the trustees approach to diversification.  Our standard investment strategy document that we utilise with trustees includes the following section on diversification:

Is your SMSF investment strategy meeting diversification requirements
Is your SMSF investment strategy meeting diversification requirementsThere are a number of other items that also need to be included as previously mentioned.

Where you have received the letter from the ATO titled ‘Is your SMSF investment strategy meeting diversification requirements?’ it’s also recommended you provide, via a trustee minute or resolution that accompanies the SMSF investment strategy document, additional information and justification on why 90% or more of your SMSF assets are invested into a single asset class.

A trustee resolution template to accompany an SMSF investment strategy can be found here: https://www.superfundpartners.com.au/trustee-investment-strategy-template-minute/ 

The burden of documenting and providing evidence of the reasons behind a lack of diversification is on the trustees.  The easiest way to capture these reasons is to answer the question: “We’ve decided to invest 90%+ of our SMSF monies into xxx (asset / asset class) at this time because…”

If as trustee you are having difficultly answering that question, then it’s essential you take control and seek our some professional advice from a licensed adviser specialising in SMSF.

Summary

  • The ATO cannot force you to diversify your SMSF investments, but the onus on documenting why your SMSF is not diversified is on you;
  • If your SMSF investment strategy is not meeting diversification requirements (i.e. not documented adequately), your independent SMSF auditor is required to notify the ATO via an Auditor Contravention Report
  • If the ATO takes action the penalty is $4,200 per SMSF trustee;
  • You may need to update your SMSF investment strategy and associated trustee minutes;

How Superfund Partners can help

Superfund Partners can assist you document your SMSF investment strategy to ensure it is meeting diversification requirements.

Where you’ve received the ‘Is your SMSF investment strategy meeting diversification requirements?’ letter from the ATO we can also arrange for you to speak to a licensed SMSF specialist adviser who can review your current SMSF investments and provide recommendations.  Even if you consider yourself as self-directed, a fresh set of eyes is always valuable.

Superfund Partners director Mark Beveridge wrote about SMSF diversification in this article last year: Is your SMSF adequately diversified?

If you have any questions, or would like to know more about how we can help, please contact us here, call us on 1300 362 943 or email info@superfundpartners.com.au

Director at Superfund Partners. I love working in the SMSF space. Self-managed super funds are more than just a savings vehicle - they enable people to truly take control of their financial situation which is key to achieving happiness. Leading the Superfund Partners team is a privilege - they are a great crew and they always put others first.