Introduction
Chapter One What’s it all about?
Chapter Two Thinking about the benefits
Chapter Three Getting the foundations right
Chapter Four Build your wealth and save tax
Chapter Five Money in and money out
Chapter Six Who’s got you covered?
Chapter Seven Growing your super nest egg
Chapter Eight Borrowing within your SMSF
Chapter Nine Reaching the end of the road
Chapter Ten Where to from here?
Chapter Eleven The final word
About the author
03
05
14
21
28
36
46
51
62
68
73
79
81
Doing it yourself with a Self Managed Super FundTable
Introduction
Self Managed Superannuation Funds (SMSF) – it seems everywhere you go people are espousing the benefits of do-it-yourself super. It is all made to look so easy that it is no wonder that an ever increasing number of individuals are jumping on the SMSF bandwagon. With “experts” springing up all over the place and a plethora of so called “self help” books making it appear straight forward there is a real danger that SMSFs ultimately prove to be a minefield for those deciding to manage their own retirement nest egg.
What makes this eBook different?
With so much information available about SMSFs, you might ask yourself what makes this eBook different. What I’ve attempted to do with this eBook is to step back and take a balanced view of the pros and cons of SMSFs and the questions you need to consider as you decide whether an SMSF really is the right structure for you.
Over the following chapters we’ll look at key questions you should be asking yourself, things to consider when establishing your SMSF and what goes into running your own fund. What you will discover as we cut through the hype, is that an SMSF is definitely not for everyone. As with all investments and investment structures it is important to consider the positives and negatives and then make an informed choice as to what is the best option to help you reach your financial goals and lifestyle aspirations.
“As with all investments and investment structures it is
important to consider the positives and negatives and then
make an informed choice as to what is the best option to
help you reach your financial goals.”
WHAT’S
IT ALL
Growth in SMSFs
June 2009 399,474 June 2010 414,379 June 2011 440,815 June 2012 475,297 June 2013 509,992Self managed hype
One of the hottest growth sectors in financial services in Australia over the past decade has been the growth in Self Managed Superannuation Funds (SMSFs). The total amount invested in SMSFs is now estimated to be over $500 billion dollars* out of a total estimated superannuation pool in Australia of $1.75 trillion dollars*. There are more than 500,000* funds in Australia with over 1 million* members. This makes SMSFs the largest type of superannuation vehicle in Australia and it’s growing by about $30* billion a year!
Chapter One: What’s it all about?
*Data extracted on 7 October 2013. Source: Australian Taxation Office Self-managed superfund statistical report – September 2013
$500
$1.75
$30
*
TOTAL AMOUNT INVESTED IN SMSFs IS NOW ESTIMATED TO BE OVER TOTAL ESTIMATED SUPERANNUATION POOL IN AUSTRALIA OF TOTAL AMOUNT INVESTED IN SMSFs IS NOW ESTIMATED TO BE OVERBILLION
TRILLION
BILLION
A YEAR!
41,057
39,300 33,207 29,929
Financial Year Establishments *Total number of SMSF
So what is causing this tremendous growth in people’s
desire to “run their own fund”?
There are a number of theories but fundamentally I believe it comes down to people wanting to regain control of their money.
For too long people have felt detached from what is usually their second largest asset after their family home. They have viewed their superannuation as something they will get when they retire and they generally haven’t had much interest in or control over it until then. An SMSF helps people get far more involved with their future retirement nest egg and enables them to feel more in control of their future.
I have a theory that one of the main reasons people want to regain control over their superannuation is that they just don’t trust the “system” anymore.
What do I mean by the “system”? I mean the legislators (the government), the regulators such as the Australian Securities and Investment Commission (ASIC), the Australian Taxation Office (ATO) and the Australian Prudential Regulatory Authority (APRA), as well as the superannuation and financial advisory industry as a whole.
“An SMSF helps
people get far more
involved with their
future retirement
nest egg and enables
them to feel more
in control of their
future.”
“I have a theory that one of the main reasons people want to regain
control over their superannuation is that they just don’t trust the
“system” anymore.
What do I mean by the “system”? I mean the legislators (the
government), the regulators such as the Australian Securities and
Investment Commission (ASIC), the Australian Taxation Office (ATO)
and the Australian Prudential Regulatory Authority (APRA), as well
as the superannuation and financial advisory industry as a whole.”
People have lost trust in the legislators because of the volume of change imposed upon the superannuation system by successive governments. These continual changes to the rules have been made because of the substantial taxation benefits associated with superannuation, because of the sheer volume of money in the system and the potential long-term impacts of funding people in retirement. Unfortunately change creates uncertainty and, at the end of the day, uncertainty results in a loss of trust. Put simply, people have lost faith that the rules applying today will be the same rules which apply when they get to retirement age and need to live off their superannuation.
If you add to this lack of trust in the “system” an environment such as that which we experienced during the Global Financial Crisis (GFC) where returns from most public offer superannuation funds1 were very poor, then many people have concluded that they would
be better off looking after their own money and regaining some control over it. The good news is that by establishing an SMSF you do regain some control over your
money. In particular, you can control how your money is invested, you can get access to certain investments like residential property that are not generally available in public offer superannuation funds, you can use gearing to “leverage” up your investments (although there are very tight restrictions and additional risks associated with this) and you have more flexibility around transferring assets and some of the taxation timing decisions that can impact tax outcomes. We’ll look at all these opportunities in more detail in the following chapters. The bad news is you are still in the superannuation “system” so you are still subject to
many of the issues associated with the superannuation environment and in particular still subject to legislative uncertainty (that is the risk the government will change the rules).
“People have also
lost faith in the
superannuation and
financial advisory industry
as a whole due to the
unscrupulous practices
of some in the profession
that have resulted in
investors losing their hard
earned money.”
The Good
The Bad
Establishing an SMSF you regainsome control over your money You can control how your money is invested You can get access to certain investments that are not generally available in public offer superannuation funds
You can use gearing to “leverage” up your investments You have more flexibility around transferring assets and taxation
timing decisions that can impact tax outcomes.
You are still in the superannuation “system” so you are still subject to many of the issues associated with the superannuation environment
Your fund will also require a well thought through investment strategy which
will need to be regularly reviewed – more on this in chapter seven.
The fund must have four members or less. Each member must generally be a trustee of the fund (if the trustees are individuals) or if the trustee is a company, each director of the company must generally be a member*
The fund must have a trust deed that meets the requirements of the Superannuation Industry (Supervision) Act 1993 (SIS ACT)
Members cannot be an employee of another member (unless they are related)
It must be registered with and regulated by the Australian Tax Office (ATO)
* If there is only one member then that member must be one of two trustees or the sole director of a company that is trustee or one of two directors of a company that is the trustee.
So what is an SMSF?
The first thing to understand about an SMSF is what it is not.
An SMSF is NOT an investment. An SMSF is a type of superannuation fund and the
best way to think about a superannuation fund is that it is simply a vehicle or tax structure through which you invest.
An SMSF has the same underlying core objective as any other superannuation fund - that is to invest members’ funds for retirement. It is not an investment per se in its own right; it is just the vehicle through which you hold investments.
Do you need one?
The first question you should ask yourself BEFORE setting up an SMSF is
“Do I really need one?”
An SMSF is most definitely not for everyone. A guiding principle should be how much money you have or will have in the fund. Running a fund can be expensive and, for smaller amounts of money, the costs of running the fund can substantially exceed the costs associated with a public offer fund.
The costs of running a fund can vary considerably but
generally the usual ongoing costs for running a fund are:
Ongoing Accounting
$2000 - $3000
Audit Costs
$300 - $1000
Other Costs
$400 - $1500
Total Annual Cost
$2700 - $5500
Note: this is just the cost of running the fund and does not include investment costs or ongoing advice costs.
“This is one of the great benefits of an SMSF, you can
effectively “pool” your assets with your partner in the
one fund and hence benefit by spreading the fixed costs
between you.”
Based on these numbers, if you assume the very most you should pay to run your fund is 1.5% of the assets then the minimum amount you should have to justify an SMSF from a fee perspective alone is $180,000 (ie, $2,700 / 1.5%) and this is assuming your costs are at the low end of the range.
If you don’t have at least $180,000 you should seriously consider whether an SMSF is the right structure for you. Personally I believe even that number is a little on the low side and suggest you don’t think about an SMSF if you have less than $200,000 and realistically closer to $400,000.
“Unless you have a certain
level of financial acumen
and experience in dealing
with money, or a strong
desire to learn, you should
really think twice about
setting up an SMSF.”
THE MAIN OTHER FACTORS ARE
EXPERIENCE AND KNOWLEDGE.
Unless you have a certain level of financial acumen and experience in dealing with money, or a strong desire to learn, you should really think twice about setting up an SMSF. While much of the burden can be assumed by professional advisers I believe it is really important that you understand what you are doing and the consequences of any advice provided. When running your own fund you do not have the protection of a professional trustee as with a public offer super fund, so you need to know what you are doing.
AGE.
Because of the above two points, your age is an important factor in deciding whether to run your own fund. Firstly, you should have some life experience before setting up an SMSF so I wouldn’t recommend someone just entering the work force set one up (besides, on their own, they wouldn’t typically meet the minimum suggested fund balance level anyway). Secondly, I find that as people get older in retirement they generally, although not always, want to play a less active role in their finances. It may, therefore, not be appropriate to establish an SMSF where you are at an age or close to an age where you don’t want the burden or responsibility.
THE LEVEL OF INVOLVEMENT
AND RESPONSIBILITY YOU WANT.
Running your own fund places certain obligations on you as trustee. While you can use professional advisers to reduce this burden, ultimately as a trustee you are responsible and legally liable for your fund. So if you have no interest in finances and no desire to be actively involved in decisions around your superannuation you should not set up your own fund.
1
2
3
So if you meet all of these basic requirements then establishing an SMSF may be worth considering.
Before you do ANYTHING, get professional advice from an
adviser experienced in SMSFs and investments as a whole.
Establishing an SMSF does allow you to regain some control
over your money. In particular, you can control how your
money is invested.
An SMSF has the same underlying core objective as any
other superannuation fund - that is to invest members’
funds for retirement.
One of the great benefits of an SMSF is you can effectively
“pool” your assets with your partner in the one fund and
hence benefit by spreading the fixed costs between you.
When running your own fund you do not have the protection
of a professional trustee as with a public offer super fund, so
you need to know what you are doing.
Why get an SMSF?
The main benefits of an SMSF are: reduced costs (although note the previous comments in Chapter One about the minimum super balance required to benefit from this), flexibility and control:
Reduced costs
There is no doubt that once your superannuation assets exceed a certain amount there can be significant cost benefits from running your own fund. This is predominately because the costs associated with running your own fund are largely fixed, that is they don’t depend on how much money you have. Compare this to the usual approach where superannuation funds charge a percentage of assets, so the higher your account balance the more you pay in fees. The other cost benefit is that you can pool your funds with other members allowing you to share the fixed costs.
Let’s look at an example.
If you have $300,000 in an SMSF which has annual running costs of $3,000 the fixed costs represent 1% of your fund balance. If, however, your partner is also a member of the fund and also has $300,000 (ie, the total amount in the fund is $600,000) the fixed costs represent just 0.5% of the total fund balance.
It is important to note that these costs just relate to the costs of running the fund. It does not include the costs associated with investments so, depending on the underlying investments in which you invest, there may be additional costs associated with these. In addition to the cost benefits, the other advantage of pooling your assets is that you can gain access to investments that might only be available to those with higher balances, for example residential or commercial property or a wholesale investment fund and you also have a better opportunity to diversify your investments.
Chapter Two: Thinking about the benefits
“An SMSF gives you
greater flexibility
around a range of
important decisions.”
FLEXIBILITY
Greater flexibility around a range of important decisions such as: How benefits can be paid to members when they retire
How death benefits are paid and the use of “in-specie” contributions and benefits
CONTROL
Gives you power and control over your superannuation fund
Enables you to specifically tailor the investment strategy to meet your needs You have a direct say in all investment decisions
You can target certain types of investments, such as residential property, acquire real business property and borrow to help leverage up your funds Extends your ability to more effectively plan and structure for certain tax events
REDUCED COSTS
If you have $300,000 in an SMSF which has annual running costs of $3,000 the fixed costs represent 1% of your fund balance. If, however, your partner is also a member of the fund and also has $300,000 (ie, the total amount in the fund is $600,000) the fixed costs represent just 0.5% of the total fund balance.
Flexibility
An SMSF gives you greater flexibility around a range of important decisions such as how benefits can be paid to members when they retire, how death benefits are paid and the use of “in-specie” contributions and benefits. “In-specie” contributions and benefits are where you can contribute or pay out certain assets rather than just cash (there are limitations and possible taxation implications – and this is explored in more detail under ‘Taking fund assets instead of cash’ on page 40).
Control
Using an SMSF gives you power and control over your superannuation fund. It enables you to specifically tailor the investment strategy to meet your needs and to have a direct say in all investment decisions. This means you can target certain types of investments, such as residential property, acquire real business property and borrow to help leverage up your funds (see also Chapter Eight, ‘Borrowing within your SMSF’).
Not for everyone!
An SMSF is definitely not for everyone and before establishing a fund for yourself you need to seriously consider whether it is right for you. There are a number of issues and risks associated with SMSFs and it is important you understand and appreciate these before you take the next steps. Remember that you can have investment choice within the safety of a public offer superannuation fund so it’s worth investigating this option before setting up your own SMSF.
With an SMSF, the risk with the most dramatic consequence is non-compliance. There are significant penalties where a trustee fails to meet their legal obligations and if the fund’s compliance tax status is revoked the fund can be subject to tax at the highest marginal tax rate, which is currently 45%.
If that isn’t bad enough the tax office has the ability to take legal action which can result in significant penalties against the trustee(s).
TIP:
A word of caution for couples: The breakdown of a
relationship can present real problems for couples running
their own SMSF and adds a degree of complexity,
potential costs and angst at a time when you are least
likely to want or need any additional burdens.
Should YOU have one?
Below is a simple decision tree to help you decide if you should consider setting up your own SMSF:
YES Seek professional advice NO Think twice about it YES
Do you want to be actively involved in managing or overseeing your superannuation assets?
YES
Are you financially literate and able to understand financial matters?
YES
Are you over 25 and under 80?
Do you have more than $200K in superannuation assets and/or are likely to reach this level in a relatively short
$850,000
$20,000
$10,000
The Alexanders’ SMSF
Mary and Jonathan
Edward
Peter
Illustrative case study
For the Alexanders an SMSF makes perfect sense.
They achieved the level of control they wanted over all of their
superannuation investment decisions and were able to put
their knowledge and interest in investment markets to good
use as well as help their children take a more active interest
in the family finances – a win, win situation all round.
The Alexanders are a family of four. Mary and Jonathan are both in their late 50s with a combined super balance of $850,000. Their two children, Edward and Peter, have both finished university and recently started new jobs. Edward has just under $20,000 in super while his brother has approximately $10,000.The Alexanders were keen to explore the cost savings from setting up their own family Self Managed Super Fund (SMSF). They saw this as a way of not only achieving savings in administrative costs from combining the family’s four separate superannuation accounts into one, but also as a way of helping themselves and their children build their super balances through taking a more active role in their finances.
The main benefits of an SMSF are:
reduced costs, flexibility and control.
By pooling assets within your SMSF you can potentially
gain access to investments that might not have been
previously available to you.
CHAPTER
GETTING THE
FOUNDATIONS RIGHT
The basic structure of an SMSF
One of the first concepts to understand when it comes to the structure of an SMSF is that an SMSF is a trust. A trust is simply an arrangement where a party, that is a person or company, holds assets for the benefit of another party - referred to as a beneficiary or in the case of an SMSF, a member. The rules for establishing and operating a trust are detailed in a trust deed. All SMSFs need to have a trust deed which sets out the fund’s objectives, who the trustees are, who can be members of the fund and various other details.
Chapter Three: Getting the foundations right
“All SMSFs need to have a trust deed which sets out the fund’s
objectives, who the trustees are, who can be members of the
fund and various other details.”
There are essentially three main
parties to an SMSF:
1. Trustee (s) – The person, people or company appointed under a trust deed to hold and invest the fund’s assets for the benefit of its members. The trustee is responsible for running the fund and making all the appropriate decisions with respect to the fund. The trustee must at all times act in the best interests of the members of the fund.
Choosing the type of trustee is an important decision in establishing a trust. You can either elect to have individual trustees (in which case all members must generally be trustees) or a corporate trustee ie, a company, in which case all members must generally be directors of the trustee company. A corporate trustee tends to be a more expensive option but has certain benefits particularly in the event of the death or departure of a trustee.
1. The Fund – An SMSF is a special type of trust established under a trust deed that is for the sole purpose of providing retirement benefits to its members.
1. The Member(s) – The members are the beneficiaries of the trust arrangement for whom the trustees are holding the fund assets. An SMSF must have a maximum of four members and no member can be an employee of another member unless they are related.
“Choosing the type
of trustee is an
important decision in
establishing a trust.”
Typical structure of an SMSF with individual trustees
Typical Structure of an SMSF with a Corporate Trustee
Responsibilities of a trustee
The trustee is responsible for running the SMSF and making decisions in respect to the fund. Trustee duties and obligations include:
Setting up a fund
The actual setting up of an SMSF is NOT a “Do It Yourself Process” and so it is important you seek professional advice. The Australian Taxation Office (ATO) has an excellent booklet titled “Setting up a self-managed super fund” and this is available from
www.ato.gov.au/Print-publications/Setting-up-a-self-managed-super-fund/
“The actual setting up of an SMSF is NOT a “Do It Yourself
Process” and so it is important you seek professional advice.”
1. To act at all times in the best interests of all fund members1. To keep the assets of the SMSF separate from personal assets
1. To ensure that the fund is operated for the sole purpose of providing retirement benefits for members or members’ dependants
1. To develop an investment strategy
1. To invest the assets of the fund in compliance with the investment strategy 1. To comply with record keeping and reporting requirements
Can anyone be a trustee?
Certain individuals are banned from acting as trustee of a superannuation fund. If an individual is insolvent, under administration, been convicted of an offence involving dishonest conduct or has had an order against them in relation to breaching the
Superannuation Industry (Supervision) Act 1993, then they are not able to act as a trustee.
Your SMSF trust deed
All SMSFs are required to have a trust deed, which is a legal document detailing the rules for establishing and running your fund. The trust deed needs to contain information such as:
“All SMSFs are
required to have a
trust deed, which
is a legal document
detailing the rules
for establishing and
running your fund.”
1. The objectives of your SMSF
1. Who can be a member and/or trustee
1. What types of benefits can be paid and how benefits are to be paid
1. What contributions can be accepted
1. What investments you can make
1. How your benefits are to be treated on death
Costs
There are two types of costs associated with running your own fund: Establishment Costs – the costs to set your fund up.
Ongoing Costs – the costs of running and maintaining your fund (see chapter one). Establishment Costs – can vary depending on fees charged by professional service providers and whether you have a corporate trustee or individual trustees.
The main costs involved in establishing a fund are:
In addition to these costs there are likely to be fees for professional advice, ATO registration and advice or establishment costs associated with investing.
$2,500 - $4,000 Total Trust Deed Preparation Corporate Trustee Establishment Other $500 - $1,000 $1,000 - $1,500 $1,000 - $1,500
A trustee is responsible for running an SMSF and for making
all the appropriate decisions with respect to the fund.
All SMSFs must have a trust deed, which is a legal
document detailing the rules for establishing and running
your fund.
Your trust deed needs to be regularly reviewed and kept
up-to-date to ensure it continues to meet the needs of your
fund’s members
Have your trust deed prepared by a qualified professional
to ensure you have the flexibility to take advantage of
different wealth building strategies.
CHAPTER
BUILD YOUR WEALTH
AND SAVE TAX
The tax benefits
One of the most misleading perceptions about SMSFs is that they have significant taxation benefits. Unfortunately this is because some people promoting SMSFs often use the tax benefits associated with superannuation as a whole, such as the low tax rate on earnings, as a reason to establish an SMSF. This is misleading at best. The tax benefits associated with an SMSF are the same as the tax benefits associated with any other Australian complying superannuation fund. While an SMSF does give you greater flexibility and hence potential tax benefits over other types of complying funds, the core tax benefits of superannuation should not be used to promote or encourage the use of an SMSF.
Chapter Four: Build your wealth and save tax
TIP:
Without doubt, superannuation as a whole remains one
of the most tax effective vehicles available to investors in
Australia today. It is a very powerful structure to accumulate
wealth in an environment that has considerable tax benefits,
although because of the benefits there are limits on the
amount you can put into your fund.
Years
$
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 35,000
5,000
Long-term investment Superannuation Personal Investment
The main taxation benefits of superannuation
- whether or not it is an SMSF - are:
1. Tax on income - the maximum tax rate in a complying superannuation fund is 15%. This compares to a top marginal tax rate in Australia of 45% (plus the medicare levy), and is less than even the lowest marginal tax rate of 19% plus the medicare levy. In addition, from 1 July 2014 earnings over $180,000 will attract an additional 2% tax known as the ‘Temporary Budget Repair Levy’. This temporary levy on high income earners will be in place for a three year period.
If you’re over 60 years of age and in the pension phase, the tax rate generally falls to nil - yes that’s right there is generally NO income tax once you’re over 60 on income associated with paying a pension from a complying superannuation fund.
Tax rate:
People often underestimate just how powerful this tax concession is when building their wealth.
As an example, the graph below compares saving $10,000 per annum for 20 years earning 7% paying the highest marginal tax rate to saving the same amount in superannuation paying 15%.
The compounding effect of this saving is quite remarkable when looked at over a long time and remember, superannuation is a long-term investment.
1. Tax on capital gains - there is a 33.3% discount that applies to capital gains from assets that have been held for longer than 12 months. This means that the maximum tax rate on capital gains (for assets held longer than 12 months) is 10%. Compare this to capital gains from assets held outside of superannuation which typically attract a 50% discount, meaning if you are on the top marginal tax rate a capital gain will have an effective tax rate of 22.5% plus the medicare levy.
1. Tax deductions for contributions - in certain circumstances it is possible to claim a taxation deduction for contributions to a superannuation fund or for you to enter into a salary sacrifice arrangement with your employer so that your contributions are made from before tax income. This means you save income tax on the contribution made. Note however, that the contribution is taxed at 15%.
As an example – if your employer pays you $10,000 in normal income and you are on the top marginal tax rate plus the medicare and temporary deficit levies, you will only receive $10,000 – 49% = $5,100. If, however, your employer contributes $10,000 to a superannuation fund then this payment generally attracts only 15% tax meaning the net amount available to you within your superannuation fund is $8,500 – a tax saving of $3,400.
The benefits:
The benefits:
TIP:
I want to stress – these advantages apply to ALL
complying superannuation funds, they are not unique to
SMSFs. So if someone is trying to persuade you to set up
an SMSF based on these benefits look very closely at the
Superannuation Assets
held for longer than 12 months
Depending on your
income level dollar valueUp to a set
Assets
held outside superannuation
10% tax
Up to
49% tax 15% tax
Normal income
from employer: Super contribution from employer:
What’s different about an SMSF?
Despite the previous comments about the main tax benefits being the same for an SMSF as any other complying fund, there are some unique features about an SMSF that means there are certain benefits over and above most other complying funds.
The main tax benefits associated with SMSFs that can be different from other types of complying superannuation funds are:
1. The ability to segregate assets. The trustee of an SMSF can chose to use the segregated assets method or the unsegregated asset method for determining how to treat taxable income when a fund runs both a pension and accumulation phase. Basically this means you can specify particular assets that apply to the pension component of the fund. This can have a substantial benefit because the income and capital gains from assets associated with the payment of a superannuation income stream are exempt from income tax. This means you can have the more tax inefficient assets, or those assets with high levels of accumulated capital gain (which you may want to realise), in the pension phase where no tax is payable.
1. The ability to time the realisation of capital gains. The ability to choose when to realise a capital gain and, in particular, to defer it until commencement of a pension is a very powerful strategy. Let’s say you have an asset that has grown from $100,000 to $200,000 - during the accumulation phase if you sell the asset you would realise a $100,000 capital gain and, assuming it had been held for twelve months, this would be subject to tax at 10% or $10,000. If, however, you wait until you commence a superannuation income stream, or pension, and then sell the asset, the gain may be exempt and if so NO tax should be payable.
TIP:
So in summary - yes there are fantastic taxation benefits
What tax deductions
are available in your fund?
As with individuals, your SMSF can claim a tax deduction for costs incurred in the course of gaining or producing assessable income. So your fund may be able to claim deductions for things like:
• Ongoing management fees
• Accountancy and legal costs
• Interest costs on limited recourse borrowing (see Chapter Eight for more details)
“In any wealth
strategy, tax and
tax alone should
never be the
sole driver for
any investment
decision.”
Deductions are also available for some types of insurance premiums.
Remember the tax rate in a superannuation fund is a maximum of 15% so as a general rule you are better off to have deductions in your own name at your marginal tax rate (which will probably be higher) rather than in the name of your superannuation fund in order to reduce your personal income tax liability.
TIP: MY PERSONAL WARNING ON TAX
While legally reducing tax is important in any wealth strategy, tax and tax alone should never be the sole driver for any investment decision.
Do all superannuation funds
get these tax concessions?
In a simple word, NO!
In order to receive the concessional tax treatment the fund must be a Complying Superannuation Fund. For an SMSF to be complying it must be what is known as a resident regulated fund and it must comply with various regulatory provisions (the main one being the SIS Act).
The cost of non-compliance
The cost of your fund not complying is dramatic. A tax rate of 45% is applied to the entire taxable income of a non-complying fund! This is the same as the top marginal tax rate in Australia. The consequences of non-compliance are actually far worse, not only is the income subject to tax at the top marginal tax rate but the whole value of the fund, less any tax-free component, is also subject to tax at the top marginal rate. This means that if your fund becomes non-complying for any reason you could potentially lose almost half of the funds in tax!
“In order to receive
the concessional tax
treatment the fund
must be a Complying
Superannuation Fund.”
The most common causes for SMSFs becoming non-compliant are:
1. Members moving overseas
1. The fund not being managed and controlled in Australia
1. The fund having no active members
So you need to be very careful if you are a trustee or member of an SMSF and you plan to move overseas.
Taxable income from a non-complying
fund = $35,000
$19,250 Remaining Minus tax rate of 45%
In any wealth strategy, tax and tax alone should never be
the sole driver for your investment decisions.
You can claim a tax deduction for the costs incurred in
producing assessable income within your SMSF.
In order to receive concessional tax treatment your SMSF
must be a Complying Superannuation Fund.
CHAPTER
MONEY IN
AND MONEY OUT
Types of contributions
to superannuation
Whenever you make a contribution to your SMSF it will either be a deductible contribution (also referred to as a concessional contribution) or an after-tax contribution (also referred to as a non-concessional contribution).
A deductible contribution is a contribution from your employer or a contribution for which you intend to claim a tax deduction. Because deductible contributions are made from pre-tax earnings, or you have claimed a pre-tax deduction on them they are pre-taxed at a maximum rate of 15%.
An after-tax contribution is typically a contribution you make with after-tax funds on which you do not claim a tax deduction. Because you have typically already paid tax on money used to make non-concessional contributions these types of contributions are not taxed when contributed to the fund.
Who can contribute
to superannuation?
To be able to contribute to a superannuation fund you must be under 65 years of age or if aged between 65 and 75 years, you must satisfy certain work test criteria. You are generally unable to contribute to superannuation over age 75 with the exception of mandated employer contributions.
Chapter Five: Money in and money out
Who can contribute to superannuation?
> Under 65 years of age
Limits on contributions
Because of the substantial tax benefits associated with superannuation there are contribution caps on the amount you can contribute. There are two types of caps: A concessional contribution cap (the maximum amount that can be contributed for which a tax deduction is claimed) and a non-concessional cap (the maximum amount you can contribute).
For the 2014 – 2015 financial year the maximum concessional cap is $30,000 if you are less than 49 years of age, or $35,000 if you are aged 49 years or over, on 30 June 2014. The non-concessional cap is $180,000 in any one year. A non-concessional cap of up to $540,000 may be available over a three year period depending on your age and contributions history.
TIP:
NOTE: There are significant penalties for exceeding contribution
caps so always seek professional financial advice before making
any changes to your contribution level.
$30,000
$180,000 - 1 year $540,000 - 3 yrs
Maximum concessional cap:
When can you get your money?
In order for your fund to pay out either a lump sum or a pension you must satisfy a
“condition of release”. There are a range of “conditions of release” but the most common are:
“In order for your fund
to pay out either a
lump sum or a pension
you must satisfy a
“condition of release.”
1. Retirement
1. Age 65
1. Commencing a transition to retirement income stream after reaching “preservation age”
1. Termination of employment, however there are restrictions on payments if you are under “preservation age”
1. Permanent incapacity or terminal illness
Prior to 1 July 1960 1 July 1960 to 30 June 1961 1 July 1961 to 30 June 1962 1 July 1962 to 30 June 1963 1 July 1963 to 30 June 1964 On or after 1 July 1964 55 56 57 58 59 60
“Preservation age” is the minimum age at which you may access your superannuation benefits once you meet the retirement conditions. The preservation age has been progressively increased and depends upon your date of birth as shown in the table below.
Taking fund assets instead of cash
One advantage of an SMSF over other types of superannuation funds is that it is possible for your fund to pay out a benefit “in-specie”. This means that instead of cash your fund could transfer an asset to you. For example, if your fund owned a portfolio of shares, on retirement, instead of paying out a cash benefit, the fund could transfer the portfolio of shares into your name in lieu.
There are tax and other implications in doing this as the transfer may trigger a capital gains tax liability and/or stamp duty so it is worth getting professional advice to explore the different options available.
How are your benefits taxed on
withdrawal from your SMSF?
Benefits paid from a superannuation fund can be taxable, whether they are or not and the tax rate applicable depends upon your age, the type of payment and the component of the payment.
In the case of lump sum withdrawals, the tax depends on your individual circumstances and the components in your fund. The non-concessional, or after tax, contributions you have made are tax-free and not subject to tax on withdrawal. The deductible, or before tax, contribution plus the fund’s earnings are taxed at different rates depending on your age as shown in the table below:
Preservation age to 59 years First $185,000
Balance Under Preservation Age
nil
nil 15%* 20%*
*Plus the medicare and temporary deficit levies
Age
Taxable rate
Drawing an income from your SMSF
One of the most effective ways to benefit from your superannuation in retirement is to commence a pension. The main type of pension payable from an SMSF is a called an Account-Based Pension.
An Account-Based Pension is simply an income stream paid from a superannuation fund that satisfies certain requirements. There are minimum pension payment levels that must be paid each year and this minimum amount will depend upon your age and the value of your fund.
The percentage of the assets that must be drawn as the minimum pension increases each year and in effect forces you to draw down your capital over your lifetime.
“One of the most
effective ways to
benefit from your
superannuation in
retirement is
to commence
a pension.”
Under 65 65-74 75-79 80-84 85-89 90-94 95+Age % of assets that must be drawn down each year
4% 5% 11% 14% 6% 7% 9%
While you must draw a minimum amount of pension each year (as shown in the above table), the amount and frequency of the pension payment is up to you. You are also able to make lump sum withdrawals.
Tax on pensions
Account-Based Pensions are very tax effective because:
1. Earnings and capital gains associated with the pension assets in your SMSF are generally tax-free
1. If you are over 60 all withdrawals and pension payments are generally tax-free. If you are under 60 the income drawn is subject to tax at your marginal tax rate but there can be a tax-free component (depending on the components of your fund) and you are generally entitled to a 15% tax rebate on the part of your pension that is subject to tax.
“You need to ensure
there is sufficient cash
in your fund to make
the minimum pension
payment each year.”
TIP: WARNING ON PENSIONS
Dealing with your SMSF
There are a range of restrictions around members dealing directly with their SMSF and in particular selling or purchasing assets from it. There is a specific prohibition on a trustee of an SMSF acquiring an asset from a related party (for example a member) but there are certain assets which are exempt. The main ones include:
1. Business Real Property - that is a property that is used in carrying out a business - for example a doctor who owned the property from which their practice is run could transfer this into their SMSF
1. Listed Securities - for example shares listed on the Australian Securities Exchange 1. Units in a widely held unit trust - for example units in a public unit trust
The most important guideline in any transaction with your SMSF is to ensure it is on an “arms length” basis. In other words you cannot transact with your SMSF unless it is at fair market value.
Some good examples of what you should generally
avoid include:
1. Buying an asset off your fund for more or less than its market value
1. Selling an asset to your fund (except as noted above and then at market value) 1. Hiring, renting or using an asset of the fund other than on a strictly commercial basis 1. Lending money to or providing financial assistance to members of the fund or
their relatives
As noted above, this however does not prevent you from transferring certain assets into your fund - if they are bought at fair market value then it is just like any other transaction, but if you transfer them in at below market value then the shortfall in the value may be treated as a member’s contribution.
This means that you can transfer assets like shares or business real property to your fund as a superannuation contribution although you should note that the normal superannuation contribution limits still apply.
TIP:
Illustrative case study
With the ever-increasing popularity of Self Managed Super Funds (SMSF) retired couple, Neal and Julia Parker, were keen to join the growing number of Australians taking greater control of their retirement savings. With a combined super balance of $500,000, Neal and Julia were confident they had sufficient funds to make having an SMSF financially viable, while also having the spare time needed to run their fund.
Neal and Julia did their homework and sought expert advice before making any decisions about their retirement savings. Based on this advice, Neal and Julia decided that as they got older running their own SMSF was probably going to be more of a burden at a time when they were likely to need increasing assistance with their financial affairs.
Neal and Julia eventually decided that an SMSF wasn’t for them at this time in their lives and instead chose another investment option which gave them the flexibility as well as the ongoing professional support they wanted as they got older.
There are many issues and regulations around trustees dealing
with related parties of an SMSF. These can be complex and the
consequences of breaching the regulations can be severe so it
is very important that before transferring any assets in or out of
your fund or entering into any arrangement with your fund, you
seek professional financial advice.
$500,000
To contribute to a superannuation fund, you must be under
65 years of age or, if aged between 65 and 75 years, you
must satisfy certain work test criteria.
For your fund to pay out either a lump sum or a pension,
you must satisfy a “condition of release”.
To really benefit from your superannuation in retirement
make sure you start a pension.
CHAPTER
WHO’S GOT
YOU COVERED?
Insurance in your SMSF
One of the real dangers in setting up an SMSF is that you forget one of the key benefits often associated with industry or employer sponsored superannuation funds, insurance. Many industry and employer sponsored funds have automatic term and total disability cover. If you transfer out of one of these funds before you have an alternative policy in place you may find you have a period where you are uninsured or worse still, because a number of these policies provide automatic cover, if you have health issues you may find it is not possible to get the same insurance cover elsewhere.
Chapter Six: Who’s got you covered?
The main types of insurance
to consider are:
Total and Permanent Disability Insurance
Total and Permanent Disability Insurance pays a lump sum in
the event of permanent disability.
Salary Continuance or Income Protection Insurance
Salary Continuance and Income Protection Insurance pays an
income in the event of disability that results in you being unable
to work.
Trauma Insurance
Trauma Insurance pays a lump sum where you suffer a defined
traumatic event such as a heart attack, cancer or a range of
other debilitating events.
Term Life Insurance
Trustees Note:
It is a requirement that, as Trustee of an SMSF you consider whether
to hold insurance for members of the fund when formulating and
reviewing your fund’s investment strategy. This doesn’t mean you
have to have insurance in your SMSF, it just means that the trustees
need to show that it was considered.
Insurance may be taken out directly ie, in your own name, or via your SMSF. There are benefits and disadvantages in holding insurance within superannuation. The main benefits are:
1. It can be tax effective because you are effectively paying premiums from your contributions, which may come from your pre-tax income (hence you effectively get a tax deduction for your premiums).
1. By using the fund’s money to pay premiums there is no impact on your personal cash flow.
Before you transfer money out of your existing
superannuation fund(s), check what insurance cover you
have in place.
Decide what insurance you need and make sure BEFORE
you withdraw from your existing super fund you put in place
alternate insurance cover.
CHAPTER
GROWING YOUR
SUPER NEST EGG
Investing
So you’ve made it this far and decided to set up your own fund. Not only have you set your fund up but you have transferred in your future wellbeing. You have transferred your accumulated life time superannuation savings – for most people that means your superannuation fund now contains the majority of what will become your retirement income and hence the key to a secure and enjoyable retirement.
Chapter Seven: Growing your super nest egg
TIP:
Establishing a fund and transferring assets into it is really just a
very minor step and will not determine your success or otherwise.
What you do with the money will determine just how successful
you will be. How will you invest and what steps will you take to
protect and grow your superannuation funds? What is crucial is
that you ensure that you invest the funds to secure your desired
outcomes without exposing it to risks you can’t afford to take.
“Trustees of a
superannuation
fund are required
to formulate
and implement
an investment
strategy and also to
regularly review it.”
Your fund’s investment strategy
Trustees of a superannuation fund are required to formulate and implement an investment strategy and also to regularly review it. The strategy needs to take into account the likely risk and return having regard to the fund’s objectives and the types of investments the fund can invest in. In addition, it should provide guidelines on how investments will be chosen, appropriate levels of diversification, liquidity and the risk and return associated with investments. There is no legal requirement to have this strategy documented, however this is a sensible practice to ensure there is evidence of compliance.
Risk versus return
Examples of less obvious
risks are:
• Fixed interest investments that have a fixed capital value and a “guaranteed” interest payment but the security behind them is poor. While the interest rate for these types of investments might appear attractive, you are risking the capital you have invested for only a modest increase in income.
Even an investment that looks low risk, for example a term deposit with a large bank, carries with it the risk that the value is eroded over time by inflation.
• Liquidity, or the ability to convert your investments to cash, is also an investment risk you need to factor in. This is particularly the case where your SMSF is paying a pension, the amount of which is designed to increase each year as you get older. In particular, if your SMSF has a large single property holding it might create liquidity issues because you can’t sell part of a property like you can with some other investments.
• Time is a crucial element of managing risk in a portfolio. If you have a short
investment time frame you cannot afford the risk of investing in volatile assets where the value can fluctuate (like shares and property). When you have invested for
‘ACCUMULATION’
PHASE
You are starting to reach high or maximum
earning potential
‘PROTECTION’
PHASE
Your level of risk tolerance naturally shifts
down a gear
‘PENSION’
PHASE
Your investment approach should be focused on preserving your funds
The level of risk you ought to take should also factor in the stage of life you are in. For example, when you are in your 30’s and 40’s, a certain amount of manageable and diversified risk is appropriate because at this point you are in what is called the ‘accumulation’ phase. This means, you are starting to reach high or maximum earning potential, and should be putting your salary to work by accumulating wealth via savings and increased super contributions. You are not living off your superannuation and you have time to sit through cycles of ups and downs. So, all things being equal, you should be able to accept a higher level of risk in your investment portfolio.
Diversification - the key
to managing risk
A very important consideration in developing your investment portfolio is diversification and one of the most common issues you see with SMSFs is the failure to adequately diversify the portfolio.
Diversification simply means investing your money across a range of different investments to reduce risk.
The exact mix of investments you choose depends upon:
1. Your financial objectives and current circumstances
1. Your investment timeframe
1. Your personal tolerance for risk.
Diversification is important because every type of investment has different characteristics and can experience different periods of “ups and downs”. Owning a diverse range of investments should help you achieve smoother, more consistent investment returns over time. It also reduces the impact should one particular investment not perform as expected. The more ways you diversify, the more you can reduce your risk. For example, you can invest:
1. Across different investment types or asset classes such as cash, fixed interest, property and shares
1. In more than one investment within each type of asset class for example, invest in several different industries and companies when investing in shares
1. In more than one type of fund, and more than one fund manager, when using actively managed funds.
Asset classes
All investments belong to what is known as an “asset class”. An asset class is simply a category of assets with similar characteristics.
The main asset classes referred to
in the investment world are:
Cash includes at call bank accounts, cash management trusts and accounts, on-call deposits and other short-term interest bearing deposits. The general definition of a “cash investment” is that it has a maturity or term of less than 12 months. Funds required for short-term expenses or to meet pension payments or capital withdrawals should be maintained in a cash based account.
Fixed interest is a debt instrument that pays a return in the form of interest where the maturity or term is greater than 12 months.
There are various forms of fixed interest investments but the most common are bonds, term deposits, debentures and mortgages.
Cash and short-term deposits
(usually just referred to as cash)Fixed interest
TIP:
A word of warning about fixed interest: A common mistake you see inexperienced investors and trustees make is being attracted to higher rates of interest paid by less secure borrowers. Investment history in Australia is full of many shocking examples where investors have placed money on deposit at high interest rates without realising the potential risk to their capital. When the inevitable crash occurs the unfortunate investors lose some or all of their funds. My advice is, for the fixed interest part of your portfolio, that the increase in return achieved by risking your capital is simply not worth it.
A share is simply a part ownership in a company. Shares can be listed on the Australian Securities Exchange (ASX). When you buy shares you are essentially buying an interest in that company, and along with the other shareholders, you then become a part owner of the business. The rationale for buying shares is that when the company profits, so do you. The return from shares is in the form of income from any dividends paid and capital from any growth in the share price. As shares can go up and down in value, you need to ensure you have a long-term investment horizon when considering whether to invest in them. Typically you should only invest in shares if you have a minimum three to five year investment time frame.
This asset class includes residential, commercial, retail, hotel and industrial property. You can invest in property directly such as when you buy a house or commercial premises such as a shop, or indirectly, such as by purchasing units in a property trust that is listed on a stock exchange. Property is usually considered a medium-term investment, with a minimum time frame of three to five years.
Investing internationally enables you to gain exposure to a wider range of investment options and increases your portfolio’s diversification. It is possible to invest either directly or via managed funds in overseas markets.
Be aware that investing internationally does have its own specific risks because you are taking a risk on the relative value of the Australian dollar against the value of the currency you are investing in. Many managers offset or mitigate this risk by hedging their international investments. It is important that you understand the hedging strategy and the impact it can have on any international investments you hold.
A common mistake by trustees of SMSFs is to ignore international investments and hence not adequately diversify the portfolio. Australia makes up a very small part of world markets and by not considering international exposure you are limiting your opportunities and also concentrating the risk of your portfolio to only the Australian economy.
Shares/equities
Property
International investments
Emerging Markets International Shares Australian Shares
Australian Real Estate Investment Trusts Australian Fixed Interest Cash 1993 1994 1995 1995 1996 1997 1997 1998 1999 1999 2000 2001 2001 2002 2003 2003 2004 2005 2005 2006 2007 2007 2008 2009 2009 2010 2011 2011 2012 2013 2013 2014 6% 5% 4% 3% 2% 1% 0%
A well diversified portfolio should have exposure to all of the asset classes. The percentage you put in each asset class should depend upon factors such as your age, your investment time frame and objectives and your risk profile or your level of comfort with risk. You need to ensure that you consider the risk profile, appropriate investment strategy and the different investment time horizons for each member of the fund. An experienced professional financial adviser should be able to assist you in determining your risk profile and designing an appropriate portfolio structure to ensure adequate diversification. Alternatively why not try the Risk Profile calculator at risk-profiler.sfg.com.au
Average 20 yearly returns by asset class
TIP:
A word of warning on international investments: Investing
internationally can be complex and also exposes your portfolio
to currency risk ie, that the value of the currency you are
investing in falls against the Australian dollar.
Investment structures
You can gain access to the different asset classes either by investing directly in them, for example buying shares on the ASX or buying an investment property, or by using a managed structure such as a managed fund, exchange traded fund or real estate investment trust.
Managed funds pool the money of many individual investors. This money is then invested by a professional fund manager in one of the asset classes eg, shares, property and fixed interest, or across a range of the asset classes in line with the fund’s stated investment objectives.
Exchange Traded Funds (ETFs) are funds that hold a portfolio of securities managed to match the performance of an underlying index. Because they are index based, they are generally an efficient, liquid and cost effective way to gain index exposure to various equity markets. Instead of issuing units like a managed fund, ETFs issue shares which trade throughout the day at prevailing market prices, like other securities on the ASX.
For most SMSFs, buying commercial office buildings, shopping centres, or industrial real estate is simply out of reach financially. A Real Estate Investment Trust (REIT) is a corporate structure whereby a number of smaller investors can pool funds and acquire large property assets or a portfolio of properties, with a professional property manager managing the day to day activities of the trust. The investor owns a proportional share of the REIT.
Putting all your eggs in one basket
There is no restriction on investing all of the fund’s assets in one investment such as a property or one investment class like shares. However, trustees should ensure they can justify doing this and document the approach in the formal investment strategy. It is important that the trustees are aware of and accept the risk associated with investing in just one asset and also address the potential issues such as liquidity and managing cash flow for expenses and pension payments (see my comments on owning direct property on page 59).
Managed funds
Exchange traded funds
Owning direct property
in your SMSF
A very common strategy for SMSFs has been to borrow funds in order to buy an investment property. While investing in property and gearing into property can be highly effective strategies, there are a number of things to be very careful about if using your superannuation fund to do this:
Diversification - usually you would be limited to one or maybe two properties - this means that you are putting all of your retirement savings in just one investment. Not only that, most peoples’ only other major asset is the family home (which is also a residential property) and hence you have put nearly all of your assets in one type of investment, residential property.
Liquidity - the purpose of your superannuation is to provide you with a lump sum or income stream in retirement. As highlighted above, one of the most effective things to do with your superannuation on retirement is to commence an income based pension. If you hold all of your superannuation in one or two investment properties, unless they are paying an income (after all costs) in excess of the minimum pension required to be drawn down (which increases each year) you might find you do not have sufficient cash to pay the pension.
See also Chapter Eight - Borrowing within your SMSF.
Illustrative case study
Shane Bertrand is 55 years old and his wife, Geraldine, is in her early 40s. The Bertrand’s saw having an SMSF as a great opportunity to grow their wealth for their retirement. Shane and Geraldine believed having an SMSF gave them a chance to reduce the administration charges they were currently paying from having two separate superannuation accounts. They were also keen to use their SMSF as a way of purchasing an investment property – something which up until now had only been a pipe dream for the couple and not something they believed they could afford to do outside of the superannuation environment.
Shane had $100,000 in his super while his wife had $80,000 in super savings. When they spoke with an expert in Self Managed Super Funds, they were surprised to discover that an SMSF was probably not the best investment vehicle to help them achieve their long-term financial goals and objectives. After taking into consideration the ongoing running expenses of the fund and associated investment costs, given the amount of super they had to invest, it was going to be more cost effective for them to continue investing separately in their current superannuation funds.
While one of the Bertrand’s objectives had been to use their proposed SMSF to purchase an investment property, they found this would have severely limited the diversification they could achieve within their SMSF. This would have caused greater problems for the couple as Shane approached retirement and needed to draw down on funds from their SMSF. Ultimately, this may have resulted in the need to sell their investment property sooner than they would have hoped, potentially missing out on the investment growth they were hoping the property would achieve.
Based on the advice received, and given the increasing investment flexibility available within public offer super funds, Shane and Geraldine decided that an SMSF was not the right choice for them and found there were more suitable options available to help them achieve their desired investment outcomes over time.
Thanks to seeking professional advice, Shane and Geraldine were also pleasantly surprised to discover they could afford an investment property outside their super savings. They used a negative gearing strategy and were able to maximise the tax benefits from this type of investment.
$100,000
Shane
$80,000
Remember that all investments carry a degree of risk –
due to factors such as inflation, taxation, an economic
downturn or a drop in a particular market.
If you’re a trustee of a superannuation fund you will be
required to formulate and implement an investment strategy
and also to regularly review it.
A key to successful investing is diversification of your
savings – this helps to spread risk and smooth out your
investment journey.
CHAPTER
BORROWING
WITHIN YOUR SMSF
Neither borrower nor lender be
One of the main attractions for many people in establishing an SMSF is the ability to leverage up your investment through borrowing. While there are specific prohibitions on SMSFs borrowing, they are able to do so on what is referred to as a “limited recourse” basis.
There are quite tight restrictions and requirements around borrowing but the essence is that the other assets in the SMSF must be protected and not used as security. In other words the lender must only be able to claim against the asset acquired with the loan and no other assets of the fund.
The method of achieving this is by holding the asset against which the funds are borrowed in a separate trust so the SMSF acquires what is known as a beneficial interest only.
Chapter Eight: Borrowing within your SMSF
Lender’s recourse is limited to asset only
Asset Owner
Lender Loan plus any
additional SMSF capital
