Once you’ve decided setting up a self-managed super fund (SMSF) is the right decision for your future, it’s essential to understand the steps involved in getting your SMSF established. I’ve taken a bit of time to outline five key steps below (which, ideally, your accountant will coordinate for you).
It is worth noting that setting up an SMSF takes time and can be costly. However, depending on your circumstances, buying a commercial property through your SMSF can be a great way to grow your wealth, especially if you have a business.
A self-managed super fund (SMSF) can be great for those who have the time and know-how to manage one because they offer the kind of flexibility and control that retail and industry super funds don’t. On paper, an SMSF sounds like a no-brainer – after all, who doesn’t want total control over how their hard-earned retirement savings are invested?
But an SMSF is a pretty significant investment decision which takes a fair amount of legal knowledge, as well as time and money to set up. You’ll also need a pretty decent super balance (yes, sometimes bigger really is better) and an excellent understanding of the risks involved in managing your super. After all, you can face some pretty severe legal consequences if you breach regulations.
If you’ve been thinking about taking a DIY approach to your super, don’t do it just cos your parents are. Here’s what you need to know about what it takes to manage an SMSF (hint: a lot).
What is a self-managed super fund?
As the name implies, a self-managed super fund is managed by you. So unlike your typical retail or industry superannuation fund where you effectively outsource how your retirement nest egg is invested to a superannuation provider, you’re in charge of where that money is invested.
Sounds good right? So what does that look like? Well, most retail and industry superannuation funds let you choose from a range of basic investment options which usually include growth, balanced, ethical, conservative, cash, etc. But you usually can’t directly pick which shares to invest in or see what shares your investment option is supported in, other than an overview of how much of your super is allocated into different asset classes (e.g. 22% Australian shares, 32% international shares, 4% cash, 15% property, etc.).
But an SMSF allows you to choose your own investments as well as offering a more comprehensive range of investment options that many industries and retail super funds don’t provide. According to Director of Tax Communications at H&R Block, Mark Chapman, “artwork and other collectables, physical gold and investments in some unlisted entities are all permitted within an SMSF”.
An SMSF can have up to four members who are friends or family, all of whom must be trustees and as a result, are equally responsible for decisions made about the fund and the compliance of the fund with super and tax laws.
The first thing to establish is the sort of service you are seeking. If you only want an administration service to look after the compliance, accounting, and tax duties of the trustees, there are plenty of options.
The premier organisation when it comes to SMSFs is the Self-Managed Super Fund Association. It has a website where you can find a specialist, but it does not inform you of the costs involved.
I did a Google search and found a comparison table on the SMSF Review website. I am not sure how up-to-date the costs are, but the shown expenses tend to be around the $2,000 to $2,500 range. These lower costs depend on the number of investments and bank accounts owned by an SMSF and usually includes the audit fee. In some cases, the estimated fee increases when an SMSF is in the pension phase.
Some SMSF administrators follow something of a commission-based service in which the cost is charged at 1 percent of the value of the super fund. In most cases, these extensive SMSF administration services do not provide advice as a part of their service. They possibly would not be available to provide advice should it be needed.
The SMSF specialists you are likely to find through the SMSF Association will more than likely be practitioners, similar to myself. In my practice, we look after all reporting and compliance requirements for SMSFs, and the fees charged are in the same range as that stated above.
In addition to looking after the reporting compliance requirements, we provide clients with tax and superannuation strategic advice, and – because I am a licensed financial adviser – guide portfolio construction and investment selection.
Before commencing your search for a new SMSF administrator, you should first work out which services you want, as this will help you conduct a more accurate comparison of the different services on offer.
Do you think you could have beaten the negative returns that the vast majority of super heavyweight funds recorded over the past year? If your answer is a resounding “yes”, you are far from alone.
Recep Peker, a senior analyst with specialist researcher Investment Trends, says his firm’s research shows that when markets are flat or going backwards for a prolonged time, the number of new self-managed super funds (SMSFs) spikes.
As Peter emphasises, the trustees of many new SMSFs are convinced they can outperform the significant funds. Indeed, 28% of SMSFs surveyed told Investment Trends that one of the reasons they set up an SMSF is a belief that, “I can make better investments than the big fund managers”.
This research appears to be borne out by recently released statistics on SMSF establishments from the Australian Taxation Office, as regulator of self-managed super, and the Prudential Regulation Authority (APRA).
In the year to September 2011, almost 32,000 SMSFs were established – an annual total only exceeded in 2006-07 when the then Federal Government announced it would significantly improve the tax-effectiveness of super. (In short, tax on superannuation pensions and retirement lump sums were abolished from July 2007 – without a limit on the dollar value.)
Despite the GFC and its aftermath, annual SMSF set-up numbers have remained more or less steady since the revamping almost five years ago of the tax treatment of super payouts. And although the world’s financial woes have taken their toll on contributions to self-managed funds, the determination to establish them hasn’t been dented.
What sort of Australian has an SMSF?
As we’ve already mentioned, over one million Aussies have an SMSF – but they’re not all old white men. According to the Australian Tax Office (ATO), the gender split between SMSF fund members is actually pretty even, with 47.3% of members women and the remaining 52.7% men.
The age ranges of people with an SMSF fund are also pretty evenly spread across both genders, with the lion’s share of SMSF fund members between the ages of 35 and 84.
Not many Australians under the age of 34 have an SMSF.
Key Steps In Making SMSF
Establish a trust
Before you can register an SMSF with the ATO, you need to establish a trust, which needs to have:
- Identifiable beneficiaries; and
- Intention to create a trust.
Obtain the trust deed
The trust deed sets out the rules and conditions under which the SMSF will operate, so it’s vital it’s a well-drafted document. It should be prepared by a qualified legal practitioner who understands superannuation law, and SMSFs in particular, and be designed to give trustees maximum control and flexibility.
When the trust deed is found to be satisfactory, it should be executed by the trustees according to the rules applicable in their state or territory.
Sign a declaration
Upon becoming a trustee or director of an SMSF, you are required to sign a statement stating you understand your obligations, duties and responsibilities.
The declaration must be in the approved form (available from the ATO) and completed within 21 days of you becoming a trustee.
Lodge an election with the regulator
Within 60 days of the establishment of an SMSF, trustees must lodge an election to be regulated with the ATO.
This election is irrevocable and advises the ATO that the SMSF will be subject to the requirements of the relevant superannuation legislation and, therefore, will be entitled to concessional taxation treatment at the rate of 15% as a complying fund.
If an election notice is not lodged, the SMSF will not be treated as a complying fund for taxation purposes, and the SMSF will be taxed at the highest marginal tax rate.
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Open a cash account
The trustee of an SMSF will generally need to set up a cash account so the fund can accept contributions, rollovers and earnings from investments.
This account will also be required to pay expenses, such as annual supervisory levy, accounting fees, taxation liabilities and, importantly, member benefits.
Costs of running an SMSF
Setting up and running an SMSF ain’t cheap.
According to a fact sheet published by the Australian Securities and Investments Commission (ASIC) in October 2019, it costs an average of $13,900 per year to run an SMSF. However, ASIC notes this information is expired but has not yet issued an updated factsheet.
On the other hand, the most recent data from the ATO released in June 2020 states that the median annual expense for operating an SMSF was $3,923 in the 2017/18 financial year – quite a substantial difference!
According to Mr Chapman, typical SMSF start-up costs are around $750 (if you have an individual as trustee) or $1,590 (with a corporate trustee, including the ASIC set-up fee).
“You will also need to pay the annual supervisory levy to the ATO and arrange for an accountant to prepare the financial statements and tax return, and conduct an independent audit,” he said.
“Total annual accountants costs are around $2,350. You may also choose to pay for financial advice and insurance for members, and you may need to pay for valuations of fund assets.”
Advantages of SMSF
- Means to hold your business premises: Many SME owners have their business premises in their SMSFs for tax-effectiveness, asset-protection, succession planning (for family enterprises) and security of tenancy.
Your business would have to pay a commercial rent to your SMSF. In turn, your fund would only pay concessional tax on the rent and typically benefit from many of the usual tax breaks available to landlords – including tax deductions for interest on a property loan.
And subject to anti-avoidance provisions in the Bankruptcy Act, fund-held business premises are generally inaccessible to trustees in bankruptcy should a member get into future financial troubles.
Ability to quickly buy or sell assets: SMSF members can instantly change their investments and/or the asset allocation of their portfolios. With massive funds, there is sometimes a frustrating lag between when investment changes are requested and when those changes are executed.
- Way to invest differently: SMSFs enable members to invest in a way that is generally not available in most large super funds. For instance, SMSFs can hold direct property, unlisted shares, artwork and other exotic or not-so-common investments.
And SMSFs can invest in their selection of investment fund managers and direct shares – which they can or cannot do with a large fund, depending on its investment choice.
Potential to cut costs: SMSFs with larger balances – say, above $200,000 or so – may have lower fees than many large super funds, much depending upon the circumstances.
This is because the administration costs of a self-managed fund are more or less fixed – no matter the fund balance. And SMSFs that invest directly rather than through managed investment funds are not liable for fees based on a percentage of their investments.
- Avoid administrative weaknesses of large super funds: Have you ever had a large fund miscalculate your super balance? Have you ever waited a frustratingly long time for a fund to rollover your super balance to another large fund? And have you had a struggle for a large fund’s call centre to give a satisfactory answer to queries? (It can be potluck about who picks up the phone.)
With an SMSF, the trustees – meaning you and the other members – are very much in control. You can act decisively when making investment decisions, and you can ensure, more or less, that no mistakes are made in the running of your fund.
Manage or eliminate CGT: Many SMSFs have a general policy – subject to investment conditions – of trying to minimise the sale of such assets as real estate and shares – until their funds begin to pay a pension. This is because no capital gains tax (CGT) is payable once an asset is backing the payment of an annuity.
- Buy assets you can not otherwise afford: The establishment of an SMSF allows up to four people – commonly family members – to pool their super savings to buy costly assets, such as direct property, that may otherwise be beyond their reach.
And under strict conditions, SMSFs can borrow to invest using instalment warrants or similar arrangements. Gearing is generally not available in large super funds.
- Flexible estate planning: “For example,” writes Stuart Jones book Australian Superannuation Handbook, published by Thomson Reuters, “a member aged 60 or over can quickly withdraw benefits tax-free before death to avoid potential death benefits tax [payable by certain beneficiaries including financially dependent adult children].”
Remember, there are always risks involved.
Despite all the positives involved in investing in commercial properties through your SMSF, there are still some significant pitfalls.
For starters, tax losses from the property cannot be offset against your personal income tax, unlike when investing with your unique name or specific trust structures.
There are also a few conditions to be aware of.
- If you lease the property to a business you run, the lease must be at the market rate (or within 5-10%), so don’t think you can charge rent to your business at an exorbitant rate, as the ATO is on the lookout for this.
- You can’t skip a rent cycle. Payments must be made on time and in full as if you were leasing from a stranger. Again, the ATO is watching for this.
- The property must be independently valued regularly as part of your ongoing SMSF audit process.
- The investment must be for the sole purpose of providing a retirement benefit to the SMSF’s members. Don’t think you can sublet or create a ‘side hustle’ income from the property as you are likely to get pulled up as part of regular audits.
- You also can’t use the property asset as collateral against a future personal or business loan, which is a significant business consideration in the event of a downturn, or if you need to expand or invest.
Disadvantages of SMSF
- Time-consuming: Operating your own SMSF is quite time-consuming even when using a professional SMSF administration service (as most self-managed funds do) and even if paying an excellent financial planner to help guide the fund’s investments.
By contrast, a large fund takes over all of the administration and many of the day-to-day investment decisions – working within your asset allocation or investment choice.
- Need for investment knowledge: Ideally, SMSF members should have a much more thorough understanding of at least the basics of sound investment practices than members of significant funds.
SMSF members should really understand, for instance, how an appropriately diversified investment portfolio can spread their risks and the potential for returns. And members should understand how high investment costs and taxation (perhaps arising from unnecessarily frequent trading) erodes returns. And SMSF members should have enough investment knowledge to quiz their financial advisers.
Ideally, all super fund members – whether in a large fund or SMSF – should have this investment knowledge. However, SMSF members are directly responsible for what happens with their retirement savings. (Under superannuation law, all SMSF members must be trustees of the fund or directors of its corporate trustee.)
- Penalties for non-compliance: The Tax Office, as the regulator of self-managed super, has the power to remove a fund’s complying status, unleashing a tax shocker. This is one of the ultimate sanctions against wayward funds.
The market value of a non-complying fund, less non-concessional (after-tax) contributions, is taxed at the highest marginal rate. This could destroy much of the retirement savings of every member of an SMSF. And trustees can face civil and criminal sanctions for serious breaches.
- Risk of low diversity: Some SMSFs are explicitly established to buy a single valuable asset such as business real estate. This means the fate of the fund depends on the performance of that asset.
Depending on what other superannuation and non-superannuation assets the members hold, they may be inadequately diversified for risk and return – a danger that intensifies if SMSFs sole support is geared.
- High costs for small balances: Before setting up an SMSF, members should compare its likely prices with those of a large super fund. SMSFs with small proportions are generally not nearly as cost-effective as, say, large industry funds.
Whether a self-managed fund is financially feasible will depend, in part, on the types of investments (whether held directly or through managed investment funds), the expected level of future contributions to boost the balance, the size of the existing balance, and cost of gaining professional assistance such as from financial planners.
Hazard of a dominant trustee: Most SMSFs would have one member who is the dominant force in all aspects of running the fund, including its investment decisions.
Apart from signing documents presented to them by the dominant member, passive members typically have no involvement with the fund. And unfortunately, inactive members usually do little to safeguard their superannuation interests.
- Tight control over investment practices: Although an SMSF can provide members with more investment freedom than large funds – much more in certain circumstances – there are stringent restrictions on their investments.
For instance, super funds must be maintained for the sole purpose of providing retirement benefits – not to subsidise pre-retirement lifestyles – and funds are prohibited from providing loans to members and their relatives.
An SMSF is generally barred from leasing or having investments with related parties involving fund assets that are worth in total more than 5 per cent of the fund’s value.
- Risk of losing interest: Many people set-up SMSFs with grand ambitions and then lose interest. Perhaps the funds have not performed to their expectations. Maybe the members have been unable to boost the balance as planned.
And an increasing concern with a rapidly ageing population is that more members will become too frail or ill to adequately look after their SMSFs – particularly after their spouses die.
ATO statistics appear to suggest that countless people are holding onto their self-managed funds well past the funds’ used-by date. In the 12 months to September (the latest figures available), almost 31,960 funds were established yet just 2,320 were wound-up. This means only .5% or so of the 450,000-plus funds in existence ceased to operate during that time.