What happens when your SMSF can't pay its bills?
Failing to meet the financial obligations of a self managed super fund (SMSF) can trigger an unintended domino effect of financial problems, that could be impossible to stop.
Read in this article
- As an SMSF trustee, there are some things you can never get wrong; managing the liquidity risks of your SMSF is one of them
- Managing the liquidity needs of an SMSF
- What happens if an SMSF has a liquidity crisis?
- Managing SMSF liquidity is a legal obligation; not an option
- Managing liquidity and lumpy investment assets in an SMSF
- Liquidity and Limited Recourse Borrowing Arrangements (LRBA)
- Using Insurance to help reduce liquidity problems
- FAQ's
- What exactly is "liquidity risk" in the context of my SMSF? I thought as long as my assets are valuable, my fund is fine.
- Why is the ATO suddenly so focused on the liquidity of my fund?
- My SMSF holds a single property, and that's it. How am I supposed to pay my pension and other expenses?
- The article mentions my investment strategy needs to consider liquidity. What does that mean I need to write down?
- What is the most practical step I can take today to get control of my fund's liquidity risk?
- Sources & Further Reading
As an SMSF trustee, there are some things you can never get wrong; managing the liquidity risks of your SMSF is one of them
At its most basic level, liquidity is the ability to access cash when it is needed; from meeting taxes, paying mortgage repayments and to being able to payout a member's disability claim as well.
Managing liquidity is a core financial skill we all need to learn, and an essential financial skill for a self managed super fund (SMSF) trustee.
Managing the liquidity needs of an SMSF
Super ‘preservation rules’ require that member benefits are retained within the superannuation system until;
- members reach their retirement age,
- members meet a condition of release, like death or total disability or
- upon compassionate grounds or instances of severe financial hardship.
What happens if an SMSF has a liquidity crisis?
If liquidity is not managed well, an SMSF may be forced to sell their investment assets quickly, (potentially for less than expected) or in extreme situations, fail to honour member obligations, including requests for portfolio changes, disability payouts, and even death and terminal illness payouts. In these circumstances, a fund may have no option but to immediately sell the investment assets, even at a net loss.
Managing SMSF liquidity is a legal obligation; not an option
SIS Regs. require SMSF Trustees to consider the insurance needs of their members and so they have a legal obligation to consider whether to hold a contract of insurance that provides life and TPD cover for one or more of their members and renew it annually as part of the investment strategy. In addition, the Trustees are required to review the SMSF investment strategy at least once a year. - Self Managed Superannuation Guide, 2nd edition, Smith, Koken & Davies 2023 CCH
Managing liquidity and lumpy investment assets in an SMSF
Problems with lumpy investment assets can destroy a super fund if not managed. Lack of diversification leaves you open to concentration risk. It’s like putting all of your eggs in one basket — if something happens to that basket, all of your eggs will be affected.
SMSF trustees who invest using a single asset strategy and in direct property need to carefully consider not only their requirements under superannuation law, but also what happens to the property upon the sudden death or disablement of a member. And is there an exit strategy for the surviving fund member(s)?
Liquidity and Limited Recourse Borrowing Arrangements (LRBA)
Where an SMSF has allocated the majority of its funds to acquire a large lumpy asset (such as residential or commercial property), and perhaps using a Limited Recourse Borrowing Arrangement (LRBA) as a part of its investment strategy, it may not have the liquidity necessary to pay out a lump sum death or disability benefit to an SMSF member, if suddenly required.
It’s important to note that while a single asset strategy is not prohibited, the grounds for investing solely in property — or any other asset class — must be justified and documented in your investment strategy to demonstrate your fund is complying with legislation.
Both these aspects require a strategy to manage the risks.
Using Insurance to help reduce liquidity problems
Life Insurance and Total & Permanent Disability Insurance can be useful in helping SMSF trustees who use an LRBA to acquire property and manage liquidity problems if a member dies or becomes incapacitated.
- An injection of cash from insurance proceeds can service LRBA debt, or pay it out completely, and pay a death or TPD benefit.
- A super death benefit pension could then be commenced for the surviving partner where less liquidity is required to fund minimum death benefit pension payments and other ongoing expenses.
Are you the trustees of an SMSF? Has your SMSF purchased an investment property and utalised an LRBA? Make sure your investment strategy continually reviews your funds liquidity needs and download our free SMSF Liquidity Worksheet here.
Pro tip: Insurance premiums paid from an SMSF are usually tax deductible and result in a 15% reduction in insurance costs. There’s a restriction preventing transferring an existing life insurance policy from an individual's member's hands, into an SMSF. Such an existing policy has to be canceled and re-issued with the SMSF being the new policy owner. This creates a problem where a fresh insurance underwriting assessment needs to occur; where any changes in the health or occupation of an SMSF member, will need to be re-assessed. This could increase the costs of premiums, or worst case, may result in the member not being able to be re-insured.
Speak with Sapience Financial for a confidential chat about your circumstances.
FAQ's
Your SMSF Liquidity Liability Questions, Answered. Here’s a quick summary of what you need to know about failing to meet the financial obligations of a self managed super fund (SMSF).
What exactly is "liquidity risk" in the context of my SMSF? I thought as long as my assets are valuable, my fund is fine.
That's a useful question because it gets to the heart of a common misunderstanding. While having valuable assets is great, "liquidity" refers to your fund's ability to access cash to pay its bills when they fall due. Your fund has regular expenses like the ATO supervisory levy, accounting fees, and insurance premiums. More significantly, once a member enters the retirement phase, the fund must be able to make the required minimum pension payments in cash. Liquidity risk is the danger that your fund's assets are so "locked up"—for example, in a single property—that you can't get the cash you need, when you need it, without having to sell a major asset at a potentially bad time.
Why is the ATO suddenly so focused on the liquidity of my fund?
The ATO's focus has sharpened significantly, especially as more SMSF trustees move into the retirement phase. They've seen situations where funds hold a single, lumpy asset like a property and have no clear plan for how to make the legally required pension payments. The regulator's concern is that trustees aren't thinking ahead. They want to ensure your fund can meet its obligations without being forced into a fire sale of its assets, which could jeopardise your retirement savings. It's a key part of your duty as a trustee to manage this risk properly.
My SMSF holds a single property, and that's it. How am I supposed to pay my pension and other expenses?
This is the classic liquidity challenge. If your fund's only significant asset is a property, you are highly exposed. Your primary source of cash is the rental income. If that income is only just covering the loan repayments and expenses, or if you lose a tenant, you have a serious problem. To meet your pension and other payment obligations, you may have no choice but to sell the property. This is why your investment strategy must explicitly document how you will manage cash flow, especially in the lead-up to and during retirement.
The article mentions my investment strategy needs to consider liquidity. What does that mean I need to write down?
It means your investment strategy document can no longer be a generic template. The ATO and your auditor will expect to see that you have specifically thought about and documented how you will manage cash flow. You should detail the fund's expected expenses—pension payments, insurance, fees, and taxes. Then, you need to outline how you will ensure there is enough cash or liquid assets (like shares or cash accounts) on hand to meet those obligations for the foreseeable future, at least for the next 12 months. For a fund holding property, this might include a plan for building up a separate cash buffer.
What is the most practical step I can take today to get control of my fund's liquidity risk?
The most practical step is to conduct a simple cash flow forecast for your fund for the next one to three years. Sit down and list all your fund's committed outgoings: the minimum pension payment you'll have to draw, insurance premiums, accounting fees, loan repayments, and potential tax liabilities. Then, list all your expected income, primarily rent and contributions. If there's a significant shortfall, you've identified your liquidity risk. The next step is to document a clear plan to address it, whether that's increasing contributions to build a cash reserve or establishing a clear timeline for selling an asset. This proactive planning is exactly what the regulator wants to see.
Sources & Further Reading
- For Investment Strategy Requirements: The legal requirement for SMSF trustees to formulate, regularly review, and give effect to an investment strategy that considers liquidity is mandated by the Superannuation Industry (Supervision) Regulations 1994.
Superannuation Industry (Supervision) Regulations 1994 - REG 4.09 - For Official ATO Guidance on Investment Strategies: The Australian Taxation Office provides explicit guidance for trustees, emphasizing that their investment strategy must address the cash flow requirements of the fund.
Australian Taxation Office (ATO), "Your investment strategy" - For Minimum Pension Payment Rules: The requirement for funds to pay a minimum annual amount for super income streams (pensions) is a key driver of liquidity needs. The ATO outlines these rules and the calculation methods.
Australian Taxation Office (ATO), "Minimum pension standards" - For Auditor Scrutiny of Liquidity: SMSF auditors are required by professional auditing standards to obtain sufficient appropriate evidence that the fund is complying with the investment strategy requirements under SIS Regulation 4.09, which includes liquidity. The ATO reinforces this expectation in their guidance for auditors.
Australian Taxation Office (ATO), "Approving the investment strategy"
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Drew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses. He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn. Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.
