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.
- SMSF Trustees: Are You Exposed to Personal Liability?
- 1. The Duty is a 'Covenant'
- 2. Trustees Can Be Sued for Loss Personally
- 3. Penalties are Personal, with an Updated Amount
- FAQ's
- My SMSF holds a large property, which is great for growth. Why do I need to worry about liquidity?
- Okay, but can't we just sell the asset if a payout is needed?
- I've heard about 'considering insurance'. Is that just a box-ticking exercise for my annual strategy?
- So, what's the real risk to me personally if I get this wrong?
- If there's a penalty from the ATO for not complying, can't the SMSF just pay the fine?
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.
FAQ's
Your SMSF Liquidity Questions, Answered. Here’s a quick summary of what you need to know about maintaining teh liquidity of youir SMSF for its members.
My SMSF holds a large property, which is great for growth. Why do I need to worry about liquidity?
That's a great question, and it gets to the heart of the issue. Holding a big, valuable asset like a property is fantastic for building wealth, but it's what we call a 'lumpy' asset—it's not easy to sell off just a small piece of it when you need cash. If a fund member passes away or needs a payout, you might have to sell the entire property, probably in a hurry. This could mean accepting a lower price and losing years of growth, just to get the cash you need. Liquidity insurance provides the necessary funds so you never have to be in that forced-sale position.
Okay, but can't we just sell the asset if a payout is needed?
You can, but that's a risky strategy. Selling a major asset like a commercial property isn't like selling shares; it can take months, or even longer, to find the right buyer at the right price. If you're under pressure to pay out a death benefit, you lose your negotiating power. A 'fire sale' almost guarantees you won't get what the asset is truly worth. The whole point of liquidity insurance is to give you cash when you need it, so you can sell your assets on your own terms, when the time is right.
I've heard about 'considering insurance'. Is that just a box-ticking exercise for my annual strategy?
Not at all, and it's dangerous to think of it that way. The requirement to consider insurance for your members under Regulation 4.09 is a legally binding duty, known as a 'covenant'. This means you, as the trustee, have made a formal promise to your members to take it seriously. Simply writing a one-line note in your investment strategy that you've 'considered it' won't be enough if something goes wrong. You need to show that you've genuinely assessed the needs of your members.
So, what's the real risk to me personally if I get this wrong?
This is the most critical part to understand—the risk is entirely personal. Because the duty to consider insurance is a legal covenant, if you fail to do it and a member's family suffers a financial loss as a result, they can sue you directly. You can't hide behind the fund; any liability or penalty is your personal responsibility.
If there's a penalty from the ATO for not complying, can't the SMSF just pay the fine?
Absolutely not. The ATO is very clear on this. Any administrative penalties for breaching your trustee duties—which can be a hefty $19,800 per trustee—must be paid from your own pocket. You are not allowed to use the funds from the SMSF to pay the fine. It’s a direct financial penalty on you as an individual, which is why getting this right is so important.
Call us today on 1300 137 403 or email us here for a no-obligation private chat about your situation.
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.
