The debate rages on whether self-managed superannuation fund (SMSF) investors would be better off handing over their savings to professional fund managers.
The marketing pitch for self-managed superannuation funds (SMSFs) sounds compelling: greater financial control and tax breaks along with the business benefits and flexibility equals financial success.
Then why are SMSFs under fire in some quarters? The short answer is that for now at least, some SMSFs are not matching the returns of default MySuper funds regulated by the Australian Prudential Regulation Authority (APRA). That is a real worry, given that in Australia, there are more than 595,000 SMSFs with combined assets of about A$712 billion, representing about one-third of the total superannuation sector.
There are a growing number of people looking to invest in property through a self-managed super fund (SMSF). As someone involved in the careful management of more than 100,000 Australians’ retirement savings, I’ve seen this first hand.
While an SMSF may be appropriate for some, it’s not the best choice for everyone.
With this being the case, I have outlined three key considerations that all investors should take into account before setting up an SMSF to purchase a property.
First and foremost, investors should be aware that establishing an SMSF to buy property could result in their superannuation not having an adequate level of diversification. In many cases, property acquisitions will make up all, or most, of an SMSF.
Given that the two biggest investments most people will make in their lives are a property purchase and superannuation, this approach can leave investors exposed to the market fluctuations of a single asset class.
Maintaining a diversified superannuation portfolio can limit or mitigate the impacts of these fluctuations on an investor’s retirement savings.
It is important for investors to recognise that managing an SMSF can require significant time and expense to ensure all legal, taxation and administrative requirements are met.
While most SMSFs are established to capitalise on perceived cost savings, many SMSF trustees soon discover that managing their own super is both costly and time consuming. Failure to meet the regulatory requirements around SMSFs can also result in significant penalties from the Australian Taxation Office.
Insurance And Compensation
I’ve seen countless examples of the importance of income protection and life insurance, not to mention the relief that automatic cover brings to so many Australian families.
Investors often don’t realise they forgo automatic insurance cover upon moving to an SMSF. Why? Because they don’t even know they have it in the first place.
This means SMSF investors can end up with less cover, no cover at all or pay significantly more to achieve the level of cover they had through their industry or retail fund. Without automatic acceptance, they may also need to get underwritten, which can involve blood and bio tests.
Additionally, while Australian Prudential Regulation Authority-regulated funds are eligible for compensation if they suffer a loss due to fraud or theft, SMSFs are not.
The Right Strategy
Investors looking to invest in property without giving up the protection and security provided by a fund structure would be wise to check whether their super fund offers a direct investment option (DIO), rather than jumping on the SMSF bandwagon without being adequately prepared.
While SMSFs may be appropriate for some Australians looking to purchase property, I strongly encourage all investors to weigh up the pros and cons before committing carefully.
Remember, this is your retirement savings. Make time to get professional financial advice to ensure you arrive at a decision.
How SMSFs stack up
Consider the performance of the average SMSF. From 2011-2016, APRA-regulated funds earned an average return of 7.4 per cent a year and industry funds 8.2 per cent, which falls in line with data released in February by Industry Super Australia. In the same period, SMSFs with assets of more than A$2 million earned on average 5.6 per cent, while those with A$1 million to A$2 million (4.5 per cent) and A$500,000 to A$1 million (3.7 per cent) also underperformed the APRA-regulated and industry funds. Alarmingly, for SMSFs with balances below A$200,000, average returns fell into the negatives.
What’s happening in super at the small end and the bigger end is really quite different, adding that a significant proportion of SMSFs are in or near retirement phase and therefore need a higher allocation of stable assets than MySuper funds, which are primarily for much younger people.
Changing market cycles also mean that comparisons can differ substantially depending on timeframes. For example, Rice Warner’s analysis of SMSF versus MySuper returns from 2005-2016 reveals that the former has collectively outperformed the latter, with average compound returns of 8 per cent per annum and 6.2 per cent per annum, respectively. The margin is even greater if fees are deducted from returns.
Size matters in super
Regardless, Stevens agrees that the recent performance of smaller SMSFs has been less than stellar.
ASIC suggests an asset threshold of at least A$200,000 for an SMSF to be viable if trustees are managing it. In comparison, the figure jumps to about A$500,000 if management is outsourced to fee-charging accountants and financial advisors.
Smaller SMSFs typically put most of their money into cash and term deposits, which he notes haven’t been the greatest earners” in recent years because the cash rate has been at record lows.
Those funds do have a bit of a problem, but prior to that they were actually very good earners and one of the reasons why SMSFs were doing very well.”
A draft report released in May by the Australian Government’s Productivity Commission supports the belief that the size of SMSFs is crucial to performance. It found that the difference between returns from the smallest SMSFs (less than A$50,000 in assets) and the largest (more than A$2 million in assets) is more than 10 percentage points a year.
There is no doubt larger super funds have benefited from a more diversified investment strategy, including investments in listed and unlisted assets. SMSFs with assets of more than A$2 million have generally performed on par with APRA-regulated funds.
Criticisms notwithstanding, there are obvious attractions to SMSFs for business owners, among others. They can, for example, own an office or factory within their SMSF and get tax breaks or protection from creditors in the event of financial difficulties.
Those tax benefits might somewhat supplement [lower] investment returns.
It is worth noting, too, that during the global financial crisis, the performance of many APRA-regulated funds fell considerably, encouraging many investors to set up SMSFs and go it alone.
One of the recognised weaknesses with some SMSFs is the trustees’ choice of investments.
Australian Taxation Office (ATO) figures in the year to June 2016 indicate that about 60 per cent of SMSFs with balances under A$100,000 had 80 per cent or more invested in a single asset class such as cash, term deposits, managed trusts or domestic listed shares.
This focus on local shares and trusts contrasts with MySuper funds that often have a large overseas equities component.
That’s an important difference. People in SMSFs tend to favour investments they’re familiar with, which is understandable.
The problem is that this can shut them out of overseas assets such as biotech companies and “glamorous”, blue-chip stocks such as Apple and Amazon, many of which are currently outperforming Australian assets. To underscore the impact, Knox cites figures for 12-month returns to the end of February this year. The S&P/ASX 50 Accumulation Index delivered a return of 7.5 per cent for the year, compared with the MSCI World Index, excluding Australia, of 14.7 per cent (hedged) and 16 per cent (unhedged).
What are the benefits of an SMSF?
There are a number of benefits of an SMSF. Being a trustee means you can choose how to invest and manage your super savings. Below we explore the main benefits of setting up an SMSF and managing your own superannuation.
- You choose your own investments, which can include shares, property, options, bank bills, collectibles.
- You choose if and when to buy/sell.
- You can reach far more swiftly to changes in investment markets as opposed to funding managers.
- You can be a more active investor.
- You are not investing for the average – you will have a more focussed portfolio individually managed.
- You can switch investment advisers, or seek the advice of many.
- You have accountability – so you’re likely to make the most out of your retirement savings.
With an SMSF, you can have a greater selection of investments including shares, property, options and collectibles, to name a few. You choose if and when to buy and sell investments and because of this, you can reach far more swiftly to changes in investment markets, with direct access to the cash and trading accounts of the fund. You have the ability to determine your own unique investment strategy in line with your long-term wealth accumulation objectives, including the ability to borrow in order to finance some investments.
The structure of an SMSF allows for more pro-active management of your superannuation tax affairs. Decisions with tax implications can be thought out and implemented with the individual member (you) in mind. For example, when selling shares in an SMSF, specific parcels can be sold in order to minimise or maximise capital gains depending on your objectives. Direct entitlement to dividend franking credits can also boost the net income of the SMSF, particularly when a member is paying a pension. An SMSF can also cater for both pension and accumulation benefits for up to 4 members.
SMSF benefits also include the flexibility of borrowing within your fund for investment purposes. Also, some small business owners may hold their business premises within their SMSF for a variety of reasons including asset protection, succession planning and security of tenancy.
Greater investment flexibility
SMSF members also have greater flexibility on when they acquire and sell their investments, and this hands-on approach can mean, for example, as market conditions change, you can quickly respond by adjusting your investment portfolio.
Ability to pool your super
Another benefit to an SMSF is the ability to pool your resources with up to three other members. This increased pool may allow you to access investment opportunities that may not be available otherwise to your SMSF.
SMSFs offer great flexibility with your estate planning needs. If the fund’s trust deed allows it, SMSF members can make binding death benefit nominations that do not lapse, unlike many public offer superannuation funds which tend to require binding death benefit nominations to be updated every three years. In addition, SMSF members may have greater flexibility in specifying how death benefits are to be paid.
Effective tax management
In an SMSF, you have greater control of your assets and investment decisions, which may allow you to manage the tax position of the SMSF better.
The current tax rate on earnings within a superannuation fund is 15%, but where the income is produced by assets wholly supporting an income stream such as a pension, there is no tax payable within the fund on that income.
This difference in tax rates means that by having control over the disposal of assets, you may be able to reduce, or potentially eliminate a capital gains tax liability.
Adding value with the property
Adding to your SMSF with property can be another way to grow your super. Owning property through your SMSF typically involves the fund acquiring a residential or commercial rental property which is leased to unrelated tenants. Fund members or relatives can’t rent a residential property from an SMSF because of the in-house assets test.
Always consider the risks
There are strict laws and regulations that govern SMSFs. As a trustee of your own super fund, you’re held responsible for your investments and complying with superannuation and taxation laws. Make sure you’re aware of the risks to consider before setting up an SMSF.
Some Of The Pitfalls
An SMSF gives you control over your retirement planning but also comes with responsibility. It is not for everybody. Tax and superannuation law can be complicated, and it is always recommended that you seek professional advice before establishing an SMSF.
The costs of establishing an SMSF: There is an initial cost in establishing an SMSF to cover things such as the trust deed (a legal document that provides the rules under which the SMSF will operate), general advice to help establish the SMSF, and ATO application costs. If a corporate trustee is required, then additional costs in establishing the corporate trustee will be involved.
An SMSF takes time and skill to manage: As well as establishing the fund, you need to create an investment plan, monitor investments and complete tax, accounting and audit requirements. You will need to stay on top of important deadlines and stay up-to-date with ever-changing legislation that will affect your responsibilities as the trustee.
Some of the administrative burdens can be outsourced to an accountant, financial adviser or specialist SMSF administrator. Many service providers offer services (in addition to the basic requirement of compliance administration). These services can include investment accounting, access to online investment platforms and investment analysis and reporting.
The annual costs of running an SMSF: The annual costs to run an SMSF can be difficult if you only have a small superannuation balance. There is a range of costs that are necessarily incurred in operating an SMSF.
Annually an SMSF will need to pay for an independent audit and the supervisory (ATO) levy. Most SMSFs also pay for additional help, such as:
- preparing the SMSF annual return
- valuations of the SMSF’s assets
- actuarial certificates for SMSFs paying income streams (pensions)
- financial advice
- legal fees, for example, if the trust deed needs to be amended
- assistance with fund administration
- insurance for members.
While costs can vary, it is generally accepted that you will need around $200,000 in superannuation to justify the costs of establishing and running a fund yourself.
Creating and monitoring an investment strategy. This can be a difficult task for those without investment knowledge and skills. If this is the case, it is advisable to seek external advice and to schedule, regular meetings to update strategy, review investment performance and perhaps alter the investments themselves.
There are important pros and cons to consider with self-managed super funds (SMSFs), however, including issues such as the level of control you can have, your responsibilities and accountability, legal and compliance requirements, fees and costs, and, of course, investment performance.
SMSF costs are proportionally higher for funds that have lower balances. Costs associated with SMSFs include establishment, ongoing and wind-up expenses. The benefits of an SMSF need to outweigh these costs.