Avoid a Fire Sale: Solving Liquidity in Your SMSF
Without liquidity insurance, the biggest threat to your family's financial future isn't a market crash, but a forced fire sale of your most valuable assets in your SMSF.
Read in this article
Don't Get Burned: Why Your SMSF Needs a Fire Escape.
When managing your SMSF, it's easy to focus on investment performance and annual compliance. But one of the most critical legal duties - and one of the most overlooked - carries severe personal financial penalties. (you may wish to go back and check the words 'personal financial penalties')
We're talking about the legal requirement to regularly consider life insurance for your fund's members. This is not just a suggestion in the guidelines; it's a fundamental 'covenant' under Australian superannuation law and this has specific legal consequences that, if you're a SMSF Trustee, you may have missed. Failing to meet this covenant obligation can expose you, the trustee, to significant personal liability that cannot be paid from your fund. Let's verify exactly what this means in practice.
SMSF Trustees: Are You Exposed to Personal Liability?
Here are the straightforward legal requirements (and the personal penalty) of non compliance with Regulation 4.09 of the SIS Regulations.
1. The Duty is a 'Covenant'
The requirement for a trustee to formulate, review regularly, and give effect to an investment strategy is a legally binding covenant imposed by the Superannuation Industry (Supervision) Act 1993 (SIS Act).
- Legislation: This duty is specifically listed in Section 52B(2)(f) of the SIS Act. The Act states that if the fund's trust deed doesn't contain this covenant, it is taken to be included anyway.
- Insurance Consideration: The detailed requirements of the investment strategy, including the specific need to "consider whether the trustees of the fund should hold a contract of insurance" for members, is detailed in Regulation 4.09 of the SIS Regulations.
Because the requirement to consider insurance is part of the investment strategy, it is covered by this legally enforceable covenant.
2. Trustees Can Be Sued for Loss Personally
If a trustee breaches a covenant and a member (or their beneficiary) suffers a financial loss as a result, they have a right to take legal action against the trustee personally to recover that loss.
- Legislation: Section 55(3) of the SIS Act grants a person who has suffered loss or damage due to a contravention of a covenant the right to recover the amount of that loss from the person involved in the contravention.
For example, if a trustee failed to consider insurance for a member who subsequently died, and their dependents were left without funds that an insurance policy would have provided, the dependents could sue the trustee personally for that financial loss.
3. Penalties are Personal, with an Updated Amount
The ATO can impose a formal administrative penalty for a breach of the investment strategy rules.
This penalty is a personal liability and cannot be paid or reimbursed from the assets of the SMSF. And if you're a co directors of a Corporate Trustee, you can expect the personal penalty to be shared between all directors.
Legislation: Breaching the investment strategy rules (including the requirement to consider insurance under Regulation 4.09) is a contravention of a specific operating standard.
Current Penalty: This breach attracts a penalty of 60 penalty units. As of October 2025, the value of a Commonwealth penalty unit is $330.
- Therefore, the current penalty (October 2025) is 60 x $330 = $19,800.
- This penalty is applied to each individual trustee. If your fund has two individual trustees, they could each be fined $19,800 (a total of $39,600).
- If the fund has a corporate trustee, the company is liable for a single fine of $19,800, for which the directors are jointly and severally liable.
Frequently Asked Questions: SMSF Liquidity & Trustee Duties
My SMSF holds a large property. Why do I need to worry about liquidity?
Property is a "lumpy" asset—meaning it’s not easy to sell a small piece of it to get cash. If a member passes away or needs a payout, you may be forced to sell the entire property in a hurry to provide the funds. This "fire sale" can result in a significantly lower price and loss of growth. Liquidity insurance provides the cash needed so you never lose your negotiating power.
Can't we just sell the asset if a payout is needed?
You can, but it’s a high-risk strategy. Major assets like commercial property can take months to sell. If you are under pressure to pay a death benefit, you are at the mercy of the market. Liquidity insurance (Life or TPD) provides an immediate lump sum, ensuring the payout is handled while you retain the ability to sell assets on your own terms when the time is right.
Is 'considering insurance' just a box-ticking exercise?
No. Under Regulation 4.09, this is a legally binding "covenant"—a formal promise to members. Simply noting you "considered it" in a strategy document is insufficient. You must be able to demonstrate a genuine assessment of member needs. Failing to do so is a breach of operating standards and carries significant legal weight.
What is the real risk to me personally if I get this wrong?
The risk is personal and unprotected. Under Section 55(3) of the SIS Act, if a breach of covenant causes a financial loss (e.g., a family is left without a payout because insurance wasn't held), they can sue the trustee personally. You cannot use fund assets to defend yourself or pay a settlement; your personal wealth is on the line.
Can the SMSF pay the ATO fine if I'm non-compliant?
Absolutely not. The ATO administrative penalty—currently $19,800 per individual trustee—is a personal liability. You are legally prohibited from using the funds within the SMSF to pay or reimburse yourself for this fine. It must be paid from your own pocket, making compliance with the insurance covenant a critical priority for every trustee.
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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.
