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There are many reasons why you might want to have your own Self Managed Superannuation Fund (SMSF). The most common ones we see are:
1. You want to buy direct property.
2. You want more control.
3. You have experience in non-standard investments – ie art, collectables, gold, cryptocurrency.
4. Costs – specifically reducing costs.
5. Estate Planning & Family Pooling.
6. You want to own your business premises if self-employed.
We will take a look at the above to help explain if you should consider an SMSF.
Before that we should explain that an SMSF involves risks and obligations, and they are not for everyone.
Unless you have a specific reason for opening an SMSF you should consider your investment knowledge, available time and potential for increased costs. If you are only setting up an SMSF for greater control, then there are many retail funds that allow you to take full control without taking on the additional risks and obligations of an SMSF.
An SMSF is effectively a superannuation fund run and managed by the members of the fund. The members are trustees.
There are two types of trustees that can be used when opening an SMSF. The members can be individual trustees, or they can be directors of a trustee company. Setting up a company is more costly initially but has many benefits.
Which trustee to choose is outside what we are going to cover in this article except to say when it comes to SMSF and costs, sometimes choosing the cheapest option will result in more costs later on. Feel free to contact us directly for more information.
The most important part to understand is that the trustees have the responsibility for ensuring the SMSF is compliant with all the relevant rules and obligations. Whilst the trustees can outsource this to accountants, financial planners etc, ultimately the buck stops with the trustees.
When running an SMSF you don’t have access to the retail compensation schemes or the Australian Financial Complaints Authority (AFCA). Just like lodging your tax return even if you don’t prepare it yourself, you are still liable for any mistakes.
This means you need to put more time into understanding the requirements than if you were in an industry or retail superannuation fund. For this reason, you need to make sure that there are sufficient benefits attached to the opening of an SMSF to justify the additional time and risk that is involved. In another article we will look further at the risks and obligations.
This doesn’t mean you should not consider an SMSF. For many there are benefits in controlling the investments in superannuation. Let’s take a look at the benefits an SMSF can bring.
1. You can purchase property directly.
If you are in a retail or industry fund you can buy property indirectly through A REITs, ETF’s or Managed Funds, but you can’t buy property directly.
This is the biggest difference an SMSF offers (it also offers other investments such as art and collectibles) but property is the one investment that most people have experience with.
You can buy residential or commercial property. Further you can buy this with the money you have, or you are able to borrow funds under a Limited Recourse Borrowing Arrangement (LRBA).
There are some people who worry about the way superannuation is invested. Investing in things you don’t understand can cause fear and make you invest very conservatively. We call this the pillow test; your investments shouldn’t keep you up at night. For many property is an investment that causes less concern.
If this is you (or if you fundamentally believe property is the best investment option) then an SMSF and direct property can be a way to take control. Before proceeding you should understand buying property, especially when borrowing, has more onerous rules and regulations in SMSF’s.
Some of the key issues people are not aware of is you cannot use the property for anything other than renting out to people who are not connected to you (the restriction being a commercial property for business use). Ie You cannot buy a holiday house for personal use. Generally, you can’t develop an SMSF property or change it if you borrow money. Interest rates are higher on SMSF loans and negative gearing only returns 15 cents in the dollar.
The two biggest considerations you should have are:
A. If you put all your superannuation into one asset, ie you buy one property, your entire retirement nest egg is dependent upon that asset doing well. Although it can feel safe, having only one single investment is actually a high risk strategy. When possible you should look to diversify.
B. If you borrow money to invest, you are introducing the concept of leverage. When you borrow money to invest any gains are multiplied but so are any losses. So, per the point above, you need to make sure you do your research. I see so many people treat superannuation money with less care than money outside superannuation and the results can be devastating.
Having said all that, if you do the research and find the right property and borrow to invest the results can help accelerate your retirement savings.
Let's take a look at how that works in very basic terms.
Say you buy a property for $300,000 in cash. And let’s assume a growth rate of 5% in the property. After ten years the property would be worth approximately $465,000. The gain is $165,000.
Let’s assume you borrow $300,000 to now own a $600,000 property. Lets assume 5% growth also. That property would be worth approximately $930,000. That is a gain of $330,000. The gain after ten years is worth more than the initial investment.
Noting with the above example you would pay interest. If we assume again for simplicity the interest rate on the loan was 8% the interest would be $24,000. That is $240,000 over the same period if the loan was not paid down at all.
However we also need to factor in rental. Assume both achieved a 4% rental return (again for simplicity) then the first property would receive $12,000 per annum in rent, the second property would receive $24,000. So even after allowing for interest the second property would create more wealth. This is especially true if the loan was paid down and the rental on each property was increased, the second property would increase the rental by more in dollar terms.
Of course it works in reverse. If the value of the property falls, borrowing to buy a property creates bigger losses, and can in a worst case scenario loose more than the initial investment.
One of the big advantages with this strategy is that you can when your retire (over the Age of 60) sell the property without any capital gains tax. If you do sell the property earlier then the capital gains tax is only 10% in any case.
2. You Want More Control.
Whilst you don’t need to open an SMSF to get greater control (there are many retail options where you can choose all the investments and invest directly in Australian and US shares) SMSF’s are a way to achieve control over your superannuation.
Some of the reasons people want control is the choice of investments. For instance you might want to make sure your investments don’t contain oil or firearms. You might want to specifically invest in an geographical area, or a company you have researched or even invest in some early stage companies or IPO’s. For some of our clients they simply want a say in some of the investments, but not all. Whatever control means for you an SMSF is a way to achieve more control, but as mentioned you can gain control by simply choosing a different retail fund.
3. You have experience in non standard investments – ie art, collectables, gold, cryptocurrency.
It can make sense if you have specialised experience that you open an SMSF to allow you to invest in that asset class. It might be in early stage companies that have growth potential, in art, or wine where you specific expertise.
In order to invest in these assets you should be confident of producing greater returns than a retail or industry fund would.
It is important to note like the property example above you cannot personally benefit from the investment. So if your dream 1950’s car is owned by your SMSF – you need to keep it in a garage somewhere away from your residence and Sunday drives are out. As always whatever you purchase in your SMSF should be with the aim of creating retirement wealth and income.
4. Costs – specifically reducing costs.
As a general rule we don’t advocate opening an SMSF with a balance less than $500,000. Whilst there is nothing stopping you opening an SMSF with a lower balance, some of the SMSF costs are fixed. This means for smaller funds the cost can be prohibitive.
The costs include accounting, auditing, and advice. There are also costs to open an SMSF, and costs associated with borrowing.
Once your fund gets larger though and especially once you are over $1 million (remember this is combined balances and you can have six members) the fixed costs can make an SMSF cheaper than the retail or industry alternative.
You can also have up to six members in the fund to spread the cost over. Adding more members can reduce costs, but adding your kids to the fund can also present investment challenges. You might want to be conservative whilst your kids might want to be aggressive in the investment selection.
5. Estate Planning & Family Pooling.
As the members are trustee’s you can control the trust deed. This means you can ensure the trust deed allows the payments to beneficiaries in a manner that may not be available in all retail funds.
By having all members of the family in an SMSF it can allow investments to be passed tax effectively to the next generation. Utilising an SMSF can also allow benefits to be paid in-specie which means illiquid assets can be more easily transferred.
There are of course risks – you need to make sure the trustee’s will honour your wishes after you pass. This means planning to make sure there is more than one trustee at any point in time. Leaving only one trustee after you pass allows that trustee sole discretion as to who the funds are paid to.
6. You want to own your business premises if self employed.
This option is becoming more popular. The rules allow you to purchase a commercial property using an SMSF and rent it to your business as long as the rental is at market rates.
If you are renting a business property and paying rent to someone else, the idea of that rent going to your SMSF can be quite appealing. Of course you now have all your assets – business and SMSF tied up together and the diversification of the portfolio is not ideal. It is important to invest in other assets in your SMSF not just the property.
Ideally also you would select a property that has a wide range of uses, not one that can only be used for your business type.
In summary SMSF’s have benefits but there are more risks and pitfalls than might first be apparent. You need to put the time into understanding those and making sure you receive good advice to keep the fund compliant with the changing rules.
This article is in no way intended to be advice on the setting up of an SMSF, nor is it comprehensive in covering everything you need to consider before setting up and SMSF.
Setting up an SMSF should only be done after receiving detailed advice. We want to highlight that unless you have a specific reason to setup and SMSF - there are many low cost alternatives in retail superannuation that allow you to invest in most things an SMSF does and achieve greater control and transparency over your superannuation investments.