Superannuation is the backbone of retirement and a key tax minimisation lever for Australians. Regardless of whether your superannuation is held in a traditional super fund or you are considering setting up an SMSF (of which the benefits over a traditional super fund can be numerous), the right investment mix and the right fee structure are extremely important to ensure that you are achieving the best possible returns.
If you are investigating ways to get the most from your superannuation throughout your working life, then setting up a Self-Managed Superannuation Fund (SMSF) may be a worthwhile consideration.
In the last decade, over a million investors have made the switch to an SMSF and, according to the Australian Taxation Office (ATO), SMSFs now make up 29% of all superannuation assets in Australia today.
Before setting up an SMSF, though, it is important to determine if an SMSF will help you achieve more from your superannuation. Here are some considerations to help you determine if an SMSF may be right for you.
- Will an SMSF be a cost-effective investment choice?
- Is your existing superannuation a defined benefit?
- Are you intending to combine your superannuation balances?
- Are you considering using an SMSF to borrow?
- Are you considering using an SMSF to invest in property?
- You must have an investment strategy in place
- Are you aware of the responsibilities of running your own Superannuation fund?
- What professional assistance will you need for setting up an SMSF and managing it?
- Are you considering transferring assets from your personal name into an SMSF?
- You will need to consider insurances
1. Will an SMSF be a cost-effective investment choice?
All investment decisions should be cost-effective. If the decision to change from your traditional superannuation fund to an SMSF will result in a lower net return than you are currently achieving, then setting up an SMSF may not be the best thing for you. However, if the costs involved with switching to an SMSF are comparable, then making the change could be very beneficial as it will open the door for greater control, transparency and diversification with your superannuation.
There is no minimum balance required for establishing an SMSF; however, as noted from ASIC on Self-Managed Superannuation Funds, balances of less than $200,000 may not be cost-effective.
With this said, a major benefit that SMSFs have over traditional superannuation funds is that the annual costs are usually charged at a flat accounting rate rather than percentage-based. This means the cost involved with managing your SMSF is not dependant on your superannuation balance, unlike the cost required to run a traditional superannuation fund. You should be aware, however, that circumstances may vary depending on your balance, contributions and retirement goals.
Before setting up an SMSF, it is important that you complete a cost comparison with respect to your circumstances to ensure that it has the potential to be a beneficial option.
2. Is your existing superannuation a defined benefit?
A defined benefit is when your superannuation balance is based on a formula that takes into account your final average salary and the number of years you worked for a company or a government department.
About 10% of Australians have defined benefit superannuation accounts while the other 90% have accumulation accounts.
Although you might be able to rollover portions of your superannuation benefits from a defined benefit super fund into an SMSF, there can be consequences for doing so. If you have a super fund with a defined benefit, it is important to seek advice prior to setting up an SMSF as there are a number of complexities that need to be assessed by a professional with the expertise to help you make an informed decision.
3. Are you intending to combine your superannuation balances?
When setting up an SMSF, you can combine the balances of up to four members (aged 18 or older) in the fund. This can be a cost-effective option as it may reduce the average fee per member.
How combined SMSF balances are managed
There is still a separation of the members’ respective superannuation balances within the SMSF in an accounting context, though the combined balance is invested jointly. The percentage of each members’ holdings is calculated as part of the SMSF’s annual reporting requirements and takes into account the different starting balances as well as the difference in individual contributions to the fund throughout the year. Income generated by the SMSF is allocated according to the proportion of funds held by each member.
If there is a difference in retirement ages between fund members, it is important to note that an SMSF can have a Pension account for 1 or more members while the other members of the fund are still able to contribute to their accumulation account(s). Moreover, this means that 1 or more members can draw a pension stream from the SMSF while the other members continue to contribute to their accumulation account which forms part of the same SMSF.
4. Are you considering using an SMSF to borrow?
Traditional superannuation funds and SMSFs are allowed to borrow through the introduction of the ‘instalment warrant provisions’. This means all superannuation funds are allowed to take on margin loans to invest in equities. The core difference that SMSF brings to the table is the ability to borrow money to invest into direct property through a limited recourse borrowing arrangement (LRBA).
To implement an LRBA, an SMSF must set up a new ‘bare trust’ to facilitate the financing arrangements with the lender. The bare trust will hold the legal interest in the property while the SMSF holds the beneficial interest in the property.
If the borrowing structure is not set up correctly, an SMSF will be in breach of the governing rules which may result in a loss of its complying status. Penalties for such non-compliance can result in the SMSF losing up to almost half the market value of its existing assets. To that end, getting the borrowing structure right in the first place is crucial to protect the members.
5. Are you considering using an SMSF to invest in property?
If an SMSF is investing in direct property, it is prudent to maintain a minimum level of liquidity (cash, bonds, shares) to cover any ongoing costs. If borrowed money is used to purchase investments within an SMSF, there will be minimum liquidity requirements that you will need to satisfy within the fund.
Liquidity requirements can differ based on lenders, with some requiring 10% of the SMSF’s net assets held in liquidity and others requiring 10% of the loan amount. Lenders liquidity requirements are often in addition to deposit requirements. These liquidity and deposit requirements should be factored into your SMSF investment strategy.
Sole purpose test explained
The sole purpose test states that the Self-Managed Super Fund is maintained for the sole purpose of providing retirement benefits to members and/or their dependents. This means that there are restrictions and rules as to what an SMSF can invest in and how these investment assets can be used while they are held by the SMSF.
If you are looking to establish an SMSF to buy a home to live in or purchase a business that you can run, or even purchase a one of a kind AC Shelby Cobra so that you can enjoy the occasional Sunday drive, the reality is that you can’t! Moreover, if a super fund trustee, a super fund member, relative or anyone connected to the fund’s members enjoys a direct or indirect benefit from their superannuation prior to meeting a condition of release, it is likely that there has been a breach of the sole purpose test.
There are exceptions to this rule, such as the business real property exception which allows a related party of an SMSF to purchase a commercial property (with SMSF money) that is rented back to their business. While this can provide an attractive incentive for business owners, it is important when setting up an SMSF to be aware of the specific criteria which must be satisfied to ensure that this exception to the in-house asset and related party acquisition rules is exercised in a compliant way.
6. You must have an investment strategy in place
An SMSF investment strategy is where Trustee(s) consider the objectives they are trying to achieve and the strategies and investments that will be required to achieve them.
Having an investment strategy for an SMSF is a legal requirement under the relevant superannuation legislation. An SMSF investment strategy sets out your fund’s investment objectives and specifies the types of investments your fund can make.
Your SMSF investment strategy must be in writing and should consider:
The members tolerance to risk – This comes down to the ability of all involved to sleep comfortably at night without worrying about the risk of their investments.
The SMSFs liquidity requirements – Personal circumstances and life stages of the members will influence the liquidity requirements of the fund. If borrowed money is used to purchase investments within an SMSF, you will also need to ensure that enough liquidity is available to suit lenders requirements and borrowing costs.
Insurance – After a 2010 Super System Review Panel found that only 13% of SMSFs actually have insurance, changes were made to the Superannuation Industry Regulations 1994 Act requiring trustees of SMSFs to consider whether insurance cover should be held by the fund on the lives of the members. This requirement must be regularly reviewed along with the fund’s investment strategy. This is discussed in further detail below.
Asset Allocation – Different asset classes can have vastly different returns from one another in the short-term; however, over the long-term, these returns generally smooth out with a much tighter spread. This is why it is important to have a diversified portfolio that is invested for the long-term. The asset allocation of an SMSF should reflect your risk profile and your retirement goals so that it is able to give you the right mix of assets to meet your retirement goals with an acceptable level of risk.
7. Are you aware of the responsibilities of running your own Superannuation fund?
There are legal obligations that go with setting up an SMSF and running one, and just like the sole purpose test, these obligations are in place to ensure that your superannuation fund stays compliant while providing you with a benefit in your retirement.
There are responsibilities that need to be handled by the SMSF Trustee, so if you choose to set up an SMSF, you either need to be prepared to do the work yourself or have the right professional support.
Major SMSF Trustee(s) Responsibilities:
- Ensuring that the Self-Managed Super Fund prepares and lodges an annual tax return with the ATO;
- Abiding by the SMSF trustee rules;
- Accurate record-keeping;
- Valuing the fund’s assets at market value;
- Meeting relevant legal obligations and making sure your Self-Managed Superannuation Fund is on track to provide for the retirement needs of its members;
- Putting an investment strategy in place that is maintained and kept up-to-date;
- Considering appropriate insurance cover for the members of the fund; and
- Carrying out and documenting decisions about how the fund invests its money and regularly monitoring investment performance.
Before establishing an SMSF, you may need to meet with a financial advisor who will walk you through the legal requirements and can work with you to put everything in place to ensure that your SMSF remains compliant. It is important to note, however, even with professional support, as a trustee, the responsibility for your SMSF still legally rests with you.
8. What professional assistance will you need for setting up an SMSF and managing it?
When setting up an SMSF, there are a range of professionals that you should consider meeting:
- An accountant to assist you with the tax returns, record-keeping and financial reporting for an SMSF which is essential to maintaining compliance.
- A financial advisor to assist you with the investment strategy and insurance considerations while also providing guidance in respect to making sure that the fund remains compliant.
- A mortgage broker and a property advisor may also be necessary if you are intending to purchase an investment property in an SMSF.
- A solicitor to assist you with preparing the documentation to set up the fund as well as binding death benefit nominations and any other estate planning requirements that may need to be addressed.
Although this may sound like an onerous task to source these professionals individually, there are options available where companies provide an integrated service with most if not all of these professional disciplines working under the one roof.
9. Are you considering transferring assets from your personal name into a Self-Managed Superannuation Fund?
An in-specie contribution is when you make contributions of assets into your superannuation instead of cash. All superannuation platforms are capable of accepting in-specie contributions, but the increased investment options in an SMSF means there are a broader range of asset classes that can be transferred into the fund. For example, an in-specie transfer of a commercial property can be transferred into an SMSF.
Be aware that in-specie contributions are for investment purposes only and, subject to exceptions, the assets cannot be used by the members of an SMSF for personal use and enjoyment (please refer to the sole purpose test outlined above). In-specie transfers can allow you to consolidate investment assets under the Self-Managed Super Fund tax advantaged umbrella which means that, rather than being taxed at your marginal rate, you will only be taxed at the standard SMSF tax rate of 15% on the returns achieved from the investments after the transfer has been completed.
10. You will need to consider insurances
If you set up a Self-Managed Super Fund, you have to make sure that you have considered adequate Life/TPD cover in case of your passing, or if you are permanently unable to work because of an accident, illness or injury. As noted under ‘Investment Strategy’, it is crucial that your consideration for insurance is documented and reviewed with your investment strategy, as this is a requirement to keep your SMSF compliant.
When looking at insurances, it would be wise to consider any significant changes to your health since the insurances were established (or updated) in your current superannuation fund. Also, it is worth looking at the benefits associated with your insurances in your existing fund to determine whether your current cover is better than any replacement cover that you will be able to source. A financial advisor can help you with this and, if you wish to retain your existing insurances, then you can hold a small balance in your current superannuation fund to maintain your insurance cover while moving the majority of your funds over into a newly established SMSF.
Although the 10 considerations outlined above should all be taken into account before setting up an SMSF, as with all superannuation decisions, the determining factor should be whether an SMSF will better enable you to achieve your retirement goals and objectives.
Positioning your superannuation to perform at its best throughout your working life is one of the most important ways you can strengthen your financial position come retirement. There are benefits to an SMSF versus traditional superannuation funds, however the extent of these benefits is dependent on your financial position, investment preferences and investment time frame.
If you do choose to set up an SMSF, it is a great way to achieve more control over your superannuation and tailor an investment strategy that is specifically aligned with your retirement goals and objectives.
All new clients of Wealth Seekers are eligible for a complimentary SMSF Suitability appointment where one of our Financial Advisors will take an hour or so with you to discuss your current superannuation fund and whether or not you are in a position to explore the option of SMSF Setup.