Self-managed super: Super choice?

By Nila Sweeney

 “The benefits of holding property in a super fund include asset diversification and its relatively low risk profile.” Richard Stacker, Macquarie Direct Property.

If you’re wondering how to best set yourself up for retirement and are interested in the popular avenue of property investment, don’t get caught up thinking that you need to keep a property portfolio separate from your super. In fact, property fits rather snugly into a balanced super fund.

Recent changes to the superannuation legislation, and the advent of Self-Managed Super Funds (SMSFs) have made it increasingly attractive to fashion your nest egg from property. The trouble is, with so many types of property investments to choose from, and a raft of complex rules to do with transferring assets into super funds, the process can appear daunting to the uninitiated.

While the process of actually setting up an SMSF can be arduous initially, and generally requires you to seek specialist advice, it can save you a good deal in fees that you would otherwise have to pay an institutional super fund. For example, a $200,000 super balance may attract up to $4,000 in fees annually, whereas you could actively manage an SMSF for as little as $2,500, according to Brett Lamond, of Lamond and Company Chartered Accountants.

Boasting both growth and income-producing qualities, incorporating property into a super fund brings numerous benefits, says Richard Stacker, general manager, Macquarie Direct Property. “The benefits of holding property in a super fund include asset diversification and its relatively low risk profile – it can protect the investor when equities aren’t performing so well.”

How does property fit in?

There are several ways in which you can incorporate property into your super fund. If you are a member of an employee or industry super fund, such as AMP or Cbus, your fund manager is probably doing it for you. The trouble with being a member of such a fund, is that you have no control over how your money is invested.

With SMSFs, as the Self-Managed name implies, you are in total control of your super destiny. Currently in Australia there are 330 SMSFs in operation, and present allocations toward property in these funds indicate its burgeoning popularity as a key component of super.

“Self-managed super funds have 30% of their assets allocated in property, which is quite high compared to allocations on a corporate super level. SMSFs have traditionally held higher allocations in property,” says Stacker.

Perhaps the most attractive reason for investing in property through your SMSF fund is this: assets are only taxed at 15% when held in super funds, whereas if you own the property outright, your personal tax rate will apply. And since budget time, when the marginal tax brackets were tweaked, it is now less attractive for those on higher incomes to negatively gear investment property.

Negative gearing occurs when your outgoings – interest on your mortgage, plus any repairs and maintenance – are larger than the rental income you receive. At the end of the year, you can deduct this loss from your other income sources, such as your salary.

In short, now that the top marginal tax rate has been reduced, it is less tax effective for those on high incomes to negatively gear, and now more attractive to hold assets in a super fund.

The aggregate amount held in property by SMSFs is now $54bn and growing, according to Macquarie Bank. Investors are holding a mixture of residential and commercial – residential property tends to be held directly, and commercial tends to be held via listed or unlisted property trusts.

Whilst holding property via an SMSF is a tax-effective strategy, the relative costs of acquiring and maintaining a direct property asset versus the average fund size has meant that SMSFs may not be adequately diversifying their investments.

Research indicates that at present, “12% of SMSFs have all their assets in one asset class; 30% have 90% of their assets from the same asset class. SMSFs don’t tend to diversify very well – some of them are rather lumpy,” says Ross Clare, principal researcher at Association of Superannuation Funds Australia (ASFA).

SMSFs: getting started

Firstly, you’ll need to contact your existing fund and find out how much super you have accrued to date. Experts advise that you would need a lump sum balance of at least $200,000 to build a meaningful super portfolio – this can be split between a married couple. You’ll need to arrange to have the outstanding balance of your super funds transferred into your new SMSF.

Before setting up your fund, it is essential that you seek advice from a lawyer, accountant or financial planner who understands both your financial affairs and the complex superannuation legislation. Do It Yourself super kits are available over the internet, but if you only have a reasonably novice grasp of personal finance, it’s not advisable to go down this road.

There are two ways you can set up an SMSF, as Lamond explains: “Basically a super fund is a trust with a specific set of rules. The trustees can either be the members of the fund, ie the mum and dad, or a trustee company. There is a limit of five members in an SMSF. It works better if it is a husband and wife, or defacto partnership.”

At the outset, you need to hold a meeting to approve the trustees of the fund or the trustee company, and apply for a tax file number (TFN) – it’s important to note that you must do this in writing as the tax office will not allow you to apply for it online.

The next step is to define the investment aspirations for your fund. “All SMSFs need an investment strategy. Implicit in this is having something written down – it’s not just open slather,” says Clare.

He adds: “Think about your fund’s risk tolerance, and how much diversification you would like it to have. As a general rule, an investment strategy that involves a large amount of trading activity is not always successful – and it’s certainly not a strategy that a novice investor should pursue.”

Going forward, there are a number of things you must do in order to comply with the Superannuation Act. Besides keeping the minutes of all your meetings on file for at least 10 years, you need to prepare a set of accounts at the conclusion of each financial year. In addition to this, you will need a company auditor to sign off on your accounts.

Which type of property?

Property as an asset class has numerous sub-groups – firstly there’s commercial and residential, then there’s direct and listed. Direct property includes any asset you physically own at least a share in, such as a house, shopfront or even a factory. You may own the property in your own name, or by purchasing units in a pooled commercial property investment such as an unlisted trust.

Listed property, on the other hand is a portfolio of direct property assets held in a trust and listed on the stock exchange. Effectively, this endows listed property with the gift of liquidity: there is an actively traded secondary market where units can be easily bought and sold. Furthermore, listed property trusts tend to be larger, and more diversified than their direct, unlisted counterparts.

The risk and return profile of direct property more precisely mirrors that of the actual asset, whether owned outright by the fund or purchased through a trust. The most significant risks in property ownership are the tenant moving out and the prospect of the asset losing value.

In listed property, it’s a whole different ball game. Being on the stock exchange opens you up to a wealth of added risk, but with it, the prospect of more impressive returns. “People go for listed property trusts (LPTs) because of liquidity, and a greater exposure to overseas assets. But LPTs have more price fluctuations, due to daily market movements and what’s happening in the underlying asset. Also, managers of LPTs are now taking on more risky income streams, such as property development activities,” says Stacker.

Whether your fund invests in property by purchasing a single property, or via a trust, will depend on the appetite for risk that you have specified in your investment strategy. As a general rule, super funds tend to have conservative risk levels, and favour stable income producing assets, rather than more volatile high growth properties.

Fund times

Imagine that you are already the proud holder of a successful investment property portfolio, which is generating solid stable returns. You’ve decided to set up an SMSF, and you’re keen as mustard to include the portfolio in your fund. But before you dive in, two potential impasses that may prevent you from doing so.

Firstly, it is quite difficult to transfer an asset you already hold title to into a fund of which you are the trustee. The Australian Tax Office (ATO) essentially classifies this as a related party transaction, and you could get into serious strife if you are caught in the act.

Secondly, the Superannuation Act precludes you from borrowing to invest in your super fund – this means that the fund must own 100% of the asset’s equity outright and have zero debt. This is easier to get around, because if you have a superannuation balance of say, $500,000, you would probably have enough to purchase a modest residential investment.

Another way to circumvent the “no borrowings” rule is to invest in through a trust – listed or unlisted. Trusts are permitted to borrow funds in order to buy assets, so you are in fact gaining exposure to debt, without actually taking out a mortgage in your own name.

SMSFs can be a great way to set up a nest egg for your retirement and allow you to retain control over your financial destiny. Once you learn the way to navigate through the ins and outs of the super legislation – with the guiding presence of your trusty accountant – you can make your super dollar work harder while saving yourself a packet in fees.