Self-managed super funds (SMSFs) and unit trusts represent two powerful investment vehicles that, when combined strategically, can create substantial opportunities for building wealth in retirement. For SMSF trustees looking to diversify their portfolios beyond traditional assets like direct property or shares, unit trusts offer a flexible and potentially lucrative option – but one that comes with its own set of complex rules and compliance requirements.
Understanding SMSFs and Unit Trusts
At their core, SMSFs are private superannuation funds that give members direct control over their retirement savings. Unlike retail or industry super funds, SMSFs allow trustees to make specific investment decisions aligned with their retirement goals, risk tolerance, and investment time horizon.
Unit trusts, on the other hand, operate as collective investment vehicles where investors purchase units representing a portion of the trust’s assets. Each unit holder owns a proportional interest in the trust’s investments, similar to how shareholders own portions of a company. Unit trusts are managed by trustees who make investment decisions on behalf of unit holders.
When these two structures intersect – with an SMSF investing in a unit trust – members can access investment opportunities that might otherwise be unavailable or impractical for the SMSF to pursue directly. This combination creates potential for:
- Pooling resources with other investors (related or unrelated)
- Accessing larger assets that might exceed the SMSF’s investment capacity
- Creating more diverse investment portfolios
- Establishing tax-efficient structures for certain investments
As Craig Thompson, a Brisbane-based SMSF advisor, notes: “Unit trusts often provide SMSF investors with the flexibility to participate in investments alongside family members or business associates while maintaining the necessary separation required by superannuation law.”
However, before diving into this investment approach, it’s crucial to understand the framework within which SMSFs can legally and effectively invest in unit trusts.
How SMSFs Can Invest in Unit Trusts
SMSF investing in a unit trust can take several forms, each with distinct compliance considerations. The primary investment structures include:
1. Investment in Unrelated Unit Trusts
SMSFs can invest in arm’s length, commercially available unit trusts without triggering many of the compliance concerns that arise with related party investments. These might include:
- Listed property trusts (A-REITs)
- Managed funds structured as unit trusts
- Wholesale unit trust investments
With these investments, the SMSF simply purchases units like any other investor would, with fewer regulatory restrictions applying compared to related party scenarios.
2. Investment in Related Unit Trusts
Here’s where complexity increases. When an SMSF invests in a unit trust with connections to fund members or their relatives, additional rules come into play. These investments generally fall under two categories:
- Non-geared related unit trusts: These may qualify for exemption from in-house asset rules if they meet specific criteria under regulation 13.22C.
- Geared related unit trusts: These typically cannot access exemptions from in-house asset rules and face more significant restrictions.
Compliance Requirements
When SMSF investing in a unit trust, trustees must ensure adherence to:
– The sole purpose test (investments must be made to provide retirement benefits)
– Investment strategy requirements
– Arm’s length transaction rules
– In-house asset limitations
– Prohibition on providing financial assistance to members
– Acquisition of asset rules from related parties
The Australian Taxation Office (ATO) closely monitors SMSF investments in unit trusts, particularly those involving related parties. The penalties for non-compliance can be severe, including the fund being deemed non-compliant, which can result in a tax rate of 45% applied to the fund’s assets.
“Documentation is absolutely critical when it comes to SMSF investing in unit trusts,” explains financial strategist Emma Wilson. “The ATO expects to see evidence that all investment decisions were made with proper consideration of the regulatory framework and in pursuit of genuine retirement objectives.”
Navigating Regulatory Hurdles: In-House Asset Rules and Regulation 13.22C
The most significant regulatory considerations when an SMSF invests in a unit trust involve the in-house asset rules and their potential exemptions. These rules form the foundation of many compliance issues faced by SMSF trustees in this space.
In-House Asset Rules
Under superannuation law, an SMSF cannot hold more than 5% of its total assets in what are classified as “in-house assets.” In-house assets include:
- Loans to related parties
- Investments in related companies or trusts
- Assets leased to related parties
For unit trusts, the classification of “related trust” is crucial. A unit trust becomes a related trust when:
- The SMSF and its members together hold more than 50% of the units
- The SMSF has significant influence over the trust’s operations
- The SMSF controls the trust directly or indirectly
When an SMSF holds units in a related trust, those units count toward the 5% in-house asset limit unless an exemption applies. Exceeding this limit as of June 30 in any year requires trustees to prepare and implement a written plan to reduce the in-house asset percentage below 5% by the following year.
Regulation 13.22C: The Non-Geared Unit Trust Exception
Regulation 13.22C provides a valuable exception to the in-house asset rules for certain unit trusts. For a unit trust to qualify under this regulation and avoid being counted as an in-house asset, it must meet specific criteria, including:
– The trust cannot borrow money or have outstanding borrowings
– The trust cannot invest in other entities (including other trusts)
– The trust cannot have leases with related parties unless they’re business real property
– The trust assets cannot be subject to charges or liens
– The trust cannot conduct transactions with related parties except in limited circumstances
If a 13.22C compliant trust later breaches any of these conditions, it permanently loses its exempt status and becomes subject to the in-house asset rules.
“The 13.22C exception creates a pathway for SMSFs to invest in related unit trusts beyond the 5% limit,” says SMSF specialist David Chen. “However, trustees must be vigilant in maintaining compliance with all criteria, as a single breach can have permanent consequences.”
Related Party Investment Considerations
When SMSF investing in a unit trust involves related parties, additional considerations come into play:
- Assets must generally be acquired from related parties at market value
- Business real property is one of the few assets that can be acquired from related parties
- Ongoing transactions between the unit trust and related parties must occur on arm’s length terms
- Documentation of valuation and commercial terms becomes especially important
Recent ATO scrutiny has focused on non-arm’s length income (NALI) concerns in unit trust arrangements, particularly where SMSFs receive distributions on more favorable terms than would be expected in arm’s length transactions.
The Strategic Advantages of SMSF Investing in Unit Trusts
Despite the regulatory complexity, there are compelling reasons why SMSF trustees might consider unit trust investments as part of their retirement strategy.
Diversification Benefits
Unit trusts enable SMSFs to diversify their investment portfolio beyond traditional assets. Through unit trusts, an SMSF can gain exposure to:
- Commercial property developments
- Large-scale property investments
- Private equity opportunities
- Infrastructure projects
- Specialized investment assets
This diversification can help spread risk while potentially accessing investments with higher returns than conventional SMSF investments.
Co-Investment Opportunities
One of the most powerful advantages of SMSF investing in a unit trust is the ability to pool resources with other investors. This approach allows:
- Family members to invest together while maintaining separate ownership structures
- Business partners to acquire business premises through combined resources
- SMSFs with limited capital to participate in larger investments
- Blending superannuation and non-superannuation money in the same underlying assets
“We’re seeing increasing interest in unit trust structures that allow family groups to collectively invest while keeping their superannuation interests appropriately segregated,” notes Sarah Johnson, an SMSF lending specialist at Aries Financial. “This approach aligns perfectly with our philosophy of empowering clients to build strategic wealth through innovative structures.”
Tax Advantages
When structured correctly, the unit trust arrangement can create tax efficiencies that enhance overall returns:
- Income from the unit trust is taxed at the concessional 15% rate within the SMSF (or potentially 0% in pension phase)
- Capital gains may receive further discounts when assets are held long-term
- Franking credits from investments within the unit trust can flow through to the SMSF
- Different tax entities (individuals, companies, trusts, and SMSFs) can participate in the same investment but with tailored tax outcomes
Control and Flexibility
Unit trusts provide a level of control and flexibility that aligns well with the self-directed nature of SMSFs:
- Trustees can design trust deeds to suit specific investment objectives
- The trust can hold assets that SMSFs might not be able to hold directly
- Investment decisions can be tailored to the specific needs of all unit holders
- The structure allows for entry and exit of investors without necessarily selling underlying assets
This control element resonates strongly with Aries Financial’s core philosophy of empowerment – giving SMSF trustees the tools and structures to make informed investment decisions that maximize their financial future.
Navigating the Maze with Expert Guidance
The complexities of SMSF investing in a unit trust cannot be overstated. The regulatory landscape is constantly evolving, with the ATO regularly updating its guidance and focusing compliance activities on areas of perceived risk.
For SMSF trustees considering this investment approach, expert guidance is not just helpful – it’s essential. The most successful implementations of these structures typically involve collaboration between:
– SMSF specialists
– Tax advisors
– Legal professionals
– Financial planners
– Lending experts who understand SMSF requirements
At Aries Financial, we believe that understanding the rules is just the beginning. True empowerment comes from knowing how to navigate these rules strategically to create wealth-building opportunities that align with your retirement goals.
“The intersection of SMSFs and unit trusts represents both challenge and opportunity,” explains Michael Roberts, Director at Aries Financial. “Our approach is to help clients cut through the complexity while maintaining absolute integrity in compliance. When done right, these structures can dramatically enhance retirement outcomes.”
Conclusion: Strategic Opportunity Through Understanding
SMSF investing in a unit trust offers a pathway to diversification, co-investment, and potentially enhanced returns for retirement portfolios. However, this pathway is lined with regulatory considerations that require careful navigation.
The key to success lies in understanding both the opportunities and constraints – approaching these investments with clear strategies that maximize benefits while ensuring steadfast compliance with superannuation laws and ATO guidelines.
At Aries Financial, we’re committed to supporting SMSF trustees through this maze with expertise, integrity, and a focus on empowerment. We believe that well-structured investments in unit trusts can form an important component of a robust retirement strategy, particularly for those seeking to build wealth through strategic property investment.
By combining deep regulatory knowledge with innovative financial solutions, SMSF trustees can confidently explore the potential of unit trust investments to supercharge their retirement portfolios while staying firmly within the boundaries of compliance.
