The question of whether investors in self-managed superannuation funds (SMSF) would be better off entrusting their investments to qualified fund managers is a hot topic of discussion.
Self-managed superannuation funds' (SMSFs') marketing message is persuasive: increased financial autonomy, tax reductions, business perks, and flexibility equal financial success.
So why are SMSFs being criticized in some circles? The short answer is that some SMSFs are currently, at least, not matching the returns of MySuper default funds under the Australian Prudential Regulation Authority's supervision (APRA). Given that there are more than 595,000 SMSFs in Australia, which make up roughly one-third of the nation's superannuation market and have combined assets worth about A$712 billion, this is a serious concern.
A growing number of people are considering using a self-managed super fund to invest in real estate (SMSF). I've personally witnessed this because I'm involved in the meticulous administration of the retirement funds of more than 100,000 Australians.
Although an SMSF may be suitable for some, it isn't the greatest option for everyone.
Given this, I have listed three important factors that all investors should think about before establishing an SMSF to buy a property.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
Diversification
Investors must first understand that creating an SMSF to purchase real estate may result in insufficient diversification of their superannuation. Property purchases frequently account for all or the majority of an SMSF's assets.
This strategy may expose investors to the market volatility of a single asset class given that buying a home and investing in superannuation are often the two greatest investments people will make in their lifetimes.
It is possible to reduce or eliminate the effects of these swings on an investor's retirement funds by maintaining a diversified superannuation portfolio.
Costs of Administering
Investors must understand that administering an SMSF can take a lot of effort and money to guarantee that all legal, tax and administrative requirements are followed.
While the majority of SMSFs are created to take advantage of ostensible cost advantages, many SMSF trustees quickly learn that administering their own super is expensive and time-consuming. The Australian Taxation Office may impose significant fines if the regulatory criteria for SMSFs are not met.
Insurance and Reimbursement
I've witnessed innumerable instances demonstrating the value of life insurance and income protection, not to mention the relief that automatic cover provides to so many Australian families.
Investors frequently are unaware that when they switch to an SMSF, they give up automatic insurance coverage. Why? because they are completely unaware that they possess it.
As a result, investors in SMSFs may receive less coverage, no coverage at all, or pay much more to receive the same amount of coverage as they did through their industry- or retail-specific fund. If they are not automatically accepted, they could also need to undergo an underwriting process that may involve blood and bio tests.
Additionally, SMSFs are not entitled to compensation if they experience a loss due to fraud or theft, in contrast to funds that are subject to Australian Prudential Regulation Authority regulation.
The Best Approach
Instead of jumping on the SMSF bandwagon without being sufficiently prepared, investors wishing to engage in real estate without giving up the protection and security offered by a fund structure would be advised to see if their super fund has a direct investment option (DIO).
While SMSFs might be a good option for certain Australians wishing to buy a property, we strongly advise all investors to thoroughly consider the benefits and drawbacks before making a decision.
Keep in mind that these are your retirement savings. To guarantee that you come to a choice, take the time to get professional financial counsel.
How SMSFs compare
Take into consideration the performance of the typical SMSF. The Australian Prudential Regulation Authority (APRA)-regulated funds from 2011 to 2016 had an average return of 7.4% and 8.2%, respectively, according to data that was published in February by Industry Super Australia. During the same period of time, SMSFs with assets worth more than A$2 million earned an average return of 5.6%, whereas those with assets worth A$1 million to A$2 million and those with assets worth A$500,000 to A$1 million underperformed APRA-regulated and industry funds by 4.5% and 3.7%, respectively. The alarming trend of negative average returns for SMSFs with assets of less than A$200,000 per fund was seen.
As a result of the fact that the majority of SMSFs are either already in the retirement phase or are getting close to entering it, they need a higher allocation of stable assets than MySuper funds, which are primarily intended for individuals who are much younger. Because of this, the superannuation landscape at the smaller end and the larger end is actually quite different.
Comparisons could be very different depending on the timeframe used owing to the fluctuating cycles of the market. For instance, Rice Warner's comparison of SMSF and MySuper returns from 2005 to 2016 shows that the former has, on average, outperformed the latter, with average compound returns of 8% and, respectively, 6.20% each year. These figures come from the firm's research on the relative performance of the two funds from 2005 to 2016. In the event that returns are decreased after fees, the margin will be significantly increased.
In super, size matters
Despite this, Stevens is of the opinion that smaller SMSFs have not been doing very well as of late.
For an SMSF to be considered viable, according to ASIC's recommendations, the asset level should be at least $200,000 if trustees are managing the fund. If, on the other hand, management is outsourced to fee-based accountants and financial advisors, the cost rises to approximately A$500,000.
As he points out, smaller SMSFs typically invest the majority of their funds in cash and term deposits. However, as of late, these investments have not generated the highest returns because the cash rate has been at historic lows.
Although such funds are experiencing difficulties at the moment, in the past they have been quite profitable and have been an important role in the achievement of SMSFs.
In a draught report that was made public in May, the Productivity Commission of the Australian government indicated that it agrees with the concept that the size of SMSFs is directly related to performance. It was found that there is a difference in returns of more than 10% annually between the SMSFs that are considered to be relatively small (those with less than $50,000 in assets) and those that are considered to be relatively large (those with more than $2 million in assets).
The implementation of a more diversified investment strategy, which incorporates interests in both listed and unlisted assets, has undoubtedly proven to be beneficial for larger super funds. APRA-regulated funds and self-managed super funds (SMSFs) have, on the whole, produced results that are comparable to one another in terms of their performance.
In spite of the criticism, there is no denying that SMSFs offer benefits, one of which is for business owners. For instance, they might own a company or factory through their SMSF, which would allow them to enjoy tax breaks and provide protection from creditors in the event that they ran into financial difficulties.
These potential tax benefits could act as a partial compensation for the [decreased] profits on investments.
It is vital to keep in mind that the performance of many APRA-regulated funds fell severely during the global financial crisis. As a result, many investors were encouraged to establish SMSFs and manage their investments on their own.
Diversity is crucial
One of the weaknesses of SMSFs that is widely understood is the poor investment choices made by trustees.
According to data from the Australian Taxation Office (ATO) for the year that ended in June 2016, approximately sixty percent of SMSFs with balances of less than one hundred thousand dollars had at least eighty percent of their assets invested in a single asset class. Examples of such asset classes include cash, term deposits, managed trusts, and domestic listed shares.
The focus of this investment strategy is on locally-based trusts and shares, in contrast to the MySuper funds, which often incorporate a sizeable portion of worldwide equities.
That is a crucial point of differentiation. It makes perfect sense for members of an SMSF to favour investments in which they already have experience.
The problem with this is that it may prevent people from accessing foreign assets, such as biotech companies and "glamorous" blue-chip stocks like Apple and Amazon, which are currently outperforming Australian assets in many cases. This is a problem because foreign assets are currently performing better than Australian assets. To illustrate the extent of the impact, Knox makes use of data covering a period of 12 months, up through the end of February in the current year. The MSCI World Index, excluding Australia, returned 14.7% (hedged) and 16.7% for the year, whilst the S&P/ASX 50 Accumulation Index returned 7.5% for the year. This difference in returns is due to the fact that Australia is not included in the MSCI World Index (unhedged).
What advantages can an SMSF offer?
An SMSF has a lot of advantages. Being a trustee gives you the freedom to decide how to manage and invest your retirement funds. The primary advantages of creating an SMSF and taking control of your own superannuation are covered below.
Investment control
- You select the investments you want to make, which may include stocks, real estate, options, bank notes, and collectibles.
- You decide whether and when to buy or sell.
- Compared to funding managers, you can react to changes in the financial markets far faster.
- You can invest more actively.
- You will have a more specialized portfolio that is personally handled because you are not investing for the ordinary person.
- You have the option of changing investment advisors or consulting several people.
- You are responsible, so you're more likely to maximize your retirement funds.
You can invest in a wider range of assets with an SMSF, such as shares, real estate, options, and collectibles, to mention a few. With direct access to the fund's cash and trading accounts, you can respond much more quickly to developments in the investing markets since you decide when and how to buy and sell investments. You can choose your own special investing approach in accordance with your long-term wealth-building goals, including the option to borrow money to finance some investments.
A more proactive approach to managing your superannuation tax affairs is made possible by the structure of an SMSF. The individual member (you) can be considered when making decisions that have tax repercussions. For instance, depending on your goals, some parcels of shares in an SMSF can be sold to minimize or maximize capital gains. When a member is paying a pension, direct access to dividend franking credits might potentially increase the SMSF's net income. For up to 4 members, an SMSF can also provide both pension and accumulation advantages.
The freedom of borrowing money from your fund for investments is another perk of SMSFs. Additionally, for a number of reasons, including asset protection, succession planning, and security of tenancy, some small business owners may hold their commercial real estate under their SMSF.
Greater flexibility while investing
The timing of investment purchases and sales is also more flexible for SMSF members. This hands-on approach might, for instance, allow you to react rapidly to changes in the market by modifying your investment portfolio.
Ability to pool your super
The possibility to pool your resources with up to three other members is another advantage of an SMSF. You might be able to take advantage of investment opportunities that might not otherwise be available to your SMSF thanks to the larger pool.
Estate preparation
SMSFs give you a lot of flexibility for your estate planning requirements. Contrary to many public offer superannuation funds, which typically need binding death benefit nominations to be revised every three years, SMSF members may make binding death benefit nominations that do not expire if the fund's trust deed permits it. Members of SMSFs may also have more freedom in deciding how death benefits will be paid.
Effective tax administration
You may be able to manage the tax position of the SMSF more effectively in an SMSF since you have more control over your assets and investment choices.
The current tax rate on profits within a superannuation fund is 15%, although there is no tax due within the fund if the income is generated by assets that are entirely sustaining an income stream, like a pension.
Due to the different tax rates, controlling how assets are sold may allow you to minimize or even completely avoid paying capital gains taxes.
Increasing the value of the property
Another option to increase your super is to add a property to your SMSF. When you own property through your SMSF, the fund often buys a rental home or business that it leases to unaffiliated tenants. Due to the in-house assets test, fund members or family members cannot rent a residential property from an SMSF.
Always consider the risks
SMSFs are subject to stringent laws and rules. You are accountable for your investments and observing tax and superannuation regulations as a trustee of your own super fund. Before creating an SMSF, make sure you are aware of the hazards to take into account.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
A Few Potential Pitfalls
You have authority over your retirement planning with an SMSF, but there are obligations as well. Not everyone will enjoy it. Before establishing an SMSF, it is usually advised that you consult a professional because tax and superannuation rules can be challenging.
The expenses associated with establishing an SMSF include the cost of the trust deed, a legal document that specifies the terms under which the SMSF will function, general advice to assist in the establishment of the SMSF, and ATO application fees. If a corporate trustee is required, there will be additional charges to set up the corporate trustee.
It takes effort and expertise to maintain an SMSF. You must form the fund, make an investment plan, keep track of your investments, and fulfil all tax, accounting, and audit requirements. You will need to be aware of key dates and stay current with the law that is constantly changing because it will have an impact on your duties as the trustee.
A specialist SMSF administrator, financial advisor, or accountant might be hired to handle some of the administrative responsibilities. There are several service providers (in addition to the basic requirement of compliance administration). Investment accounting, online investment platforms access, investment analysis, and reporting are a few of the services that may be offered.
If you only have a little superannuation amount, it may be challenging to afford the annual expenditures of running an SMSF. A variety of expenses are inescapably incurred when running an SMSF.
An SMSF must pay the supervisory (ATO) charge and an independent audit each year. The majority of SMSFs additionally pay for extra assistance, like:
- the annual SMSF return preparation;
- asset values for the SMSF;
- actuarial certificates for SMSFs paying pensions and other income streams;
- guidance on finances;
- legal costs, such as those incurred should the trust deed need to be changed;
- support with managing funds;
- insurance for members.
Despite the fact that expenses might vary, it is widely agreed that you will require about $200,000 in superannuation to cover the costs of starting and managing a fund on your own.
Developing and maintaining an investing plan. For people without investment knowledge and expertise, this might be a challenging process. If so, it is wise to obtain outside counsel and arrange frequent meetings to update strategy, assesses investment performance, and maybe make changes to the investments themselves.
Self-managed super funds (SMSFs) do have some essential benefits and drawbacks to take into mind, including the amount of control you have access to, your obligations and accountability, legal and regulatory requirements, fees and costs, and, of course, investment performance.
Lower balance funds have proportionally greater SMSF expenses. SMSF expenses for the establishment, maintenance, and winding up are all included. The advantages of an SMSF must outweigh these expenses.