The majority of Australians entrust their super fund to a professional superannuation company which invests their contributions on their behalf. In addition, the company handles the administration, tax and compliance issues associated with doing so. You pay an annual fee – a percentage of your assets – for the convenience of this service.
However many Australians have opted to self-managed their superannuation. To the end of June 2021 there were nearly 600,000 SMSFs encompassing 1.1 million members. Many people are seeing some benefit, but is an SMSF right for you?
If you're interested, here are six steps to managing an SMSF, along with some considerations to make.
1. Assemble your team
Unless you’re an experienced investor, lawyer, financial planner and SMSF expert, then you’ll probably need some help - preferably ones who specialise in SMSFs. To begin with you’ll most likely need: a financial planner, a solicitor, an accountant and an investment strategist.
When choosing the right people to help you, ask the tough questions. Check their fee structures and their accreditation. Financial planners should have a CFP certification and some training in SMSF management.
Don’t be afraid to get a second opinion. And be wary of one-stop shops offering you huge savings on setting up your SMSF. While some may be good, others may not have the expertise in all areas that you need.
2. Appoint trustees
A self-managed super fund can have up to six trustees. This is a recent change - previously the maximum number allowable was four.
You may prefer to be the sole trustee or you may want to include family members or friends. According to the rules, no member can be an employee of another member (unless they are related) and no trustee can be paid for carrying out their trustee duties.
Anyone over 18 can be a trustee, so long as they are not disqualified under SMSF law (ie. Someone who has been convicted of an offence involving dishonesty or has been the subject of a civil penalty, is insolvent or bankrupt).
Trustees are responsible for ensuring the fund is properly managed and complies with SMSF rules, as well as tax and legal obligations. Duties of trustees include:
- Ensuring the SMSF complies with the ‘sole purpose’ and 'at arm's length' tests of providing retirement benefits to members
- Regularly reviewing and updating the SMSF investment strategy to sure it takes into account members’ retirement goals
- Ensuring that SMSF assets are not used for personal benefit until after retirement
Trustees may also need to appoint parties to carry out various functions on their behalf, including:
- Maintaining each member’s information and account balances
- Investing of the fund’s assets
- Preparing financial accounts, regulatory reports and audits of financial statements
- Budgeting and paying for costs and bills (ensuring SMSF money is kept separate from private funds)
- Accepting contributions and pay benefits (pension and lump sum) in accordance with super and tax laws
3. Obtain a trust deed
Once you’ve decided who will be the trustees in your SMSF, you need to sign a declaration and have a trust deed prepared. The deed evidences the existence of the trust and establishes the rules of operation for the fund.
The declaration must meet all legal requirements and be properly dated and signed by all trustees to ensure that they are aware of their duties and responsibilities under the super laws. The trust deed will need to set out many aspects, including:
- Details of who the trustees are
- How trustees may be appointed (or removed)
- The powers of trustees
- Eligibility for membership
- Conditions relating to acceptance of contributions
- Conditions for payment of benefits to members
- Procedures for winding up the fund and provisions relating to valuation of assets and so on
You must ensure your deed is tailored to meet the individual needs of your fund, so having an independent legal professional guide you through this process is highly advisable.
4. Register your SMSF with the Australian Tax Office
Once your fund is legally established and all trustees have signed a trustee declaration, you need to register your fund with the ATO so as to be recognised as a regulated fund (and made eligible for the concessional tax rate).
You will also need to obtain an Australian Business Number (ABN) and Tax File Number (TFN) for the fund. If the annual turnover of the fund is greater than $75,000 you will also need to register for GST. This must be done within 60 days of establishing the fund.
Once a trustee has elected to become regulated, the decision cannot be reversed without winding up the fund. You’ll be legally required to:
- Lodge an SMSF annual tax return
- Pay the supervisory levy of $259 per year
- Have an annual audit report prepared
ABN registration for superannuation entities (NAT 2944) forms can be obtained by visiting the Australian Taxation Office website.
5. Open a dedicated bank account
In order to keep it simple, it pays to keep it separate. It’s absolutely essential that you open a separate bank account dedicated to your SMSF as this will keep your super fund assets well away from your personal assets and simplify account-keeping and administration. This is part of that 'at arm's length' test requirement as mentioned earlier.
You can then use this account to receive any new contributions and/or rollovers from other super funds, pay all fund-related bills and loan payments, and keep track of benefits paid to members. You won’t need to open a separate bank account for each member, but you will need to keep a separate record of their entitlement, called a ‘member account’. Each member account will record member contributions, fund earnings and benefit payments made.
One of main appeals with an SMSF is that members get to control their investments with some tax benefits to boot. Within certain guidelines you can borrow to invest in shares, property and other assets, leverage off their existing capital to multiply their growth, and pay a great deal less away to the tax man when you come to realise those gains.
When you come to develop and document your SMSF investment strategy it is important to consider the whole circumstances of the fund and the respective needs of the members. An SMSF strategy document is like a mini-business plan for the fund and should account for the:
- Relative risk and rewards of your chosen investments
- Degree of diversification across different asset types and markets
- Liquidity of the fund with regards to the demands on its cash resources
- Ability of the fund to discharge its existing and prospective liabilities and debt
Each SMSF has an investment strategy
Each fund must have what's called an investment strategy. This is more than just notes on a page; it is essentially a breakdown of where your money is going and a justification as to how each investment will benefit members for retirement.
It's usually a requirement this is updated annually, or if any significant events happen, such as a market downturn, a member leaves (or dies), a housing correction or some other event.
It is also essential that you keep records of your decisions or ‘minutes’ so that an independent party can assess whether your investment adhered to your funds investment strategy.
According to ATO data to March 2022, here are some statistics for popular asset classes:
Listed shares are the single biggest asset class on SMSF trusts' books. It comprises more than $245 billion of the approximate $800 billion in total assets held. Unlisted shares also make up about $9.4 billion, while overseas shares made up nearly $13 billion.
Since 2007, SMSFs have been able to borrow to invest in property, although lending limitations do apply. Borrowings for property are called LRBAs - limited recourse borrowing arrangements. They are also called 'SMSF loans'.
The most members can borrow (LVR) is 80% of the property value. Usually properties must be geared in such a way that they provide a positive cash-flow.
The benefits are a maximum of 10% capital gains tax (CGT) payable on the sale of the property as long as the fund has held it for at least 12 months, and potentially no CGT bill if the property is sold after you retire and the SMSF has moved into ‘pension phase’.
LRBAs made up nearly $68 billion of SMSF assets, more than double the value from five years ago. Non-residential real estate (not under a LRBA) made up more than $94 billion, while residential real estate made up approximately $50 billion.
3. Cash and term deposits
Many investors sit on cash for a rainy day, and also enjoy the relative security of a term deposit.
Term deposits lock-in interest rates, with all bank deposits in Australia guaranteed by the Government's Financial Claims Scheme up to $250,000.
Cash and term deposits made up nearly $147 billion in SMSF assets held.
Benefits of SMSFs
You can invest the money as you fit – in particular companies, an ultra-safe fixed interest term deposit, or even a property to live in when you retire. You probably don't get this level of granular control with regular regulated super funds.
For example, there's nothing stopping you from investing solely in one singular asset - for example, a house. While probably ill-advised, the floor is yours.
You have a wide variety of investment options – bank deposits, direct mortgages, shares, managed funds and direct property. You can even put in fine art or other valuable items if you see fit.
Property is able to be purchased with LRBAs or SMSF loans, allowing you to leverage and potentially realise further capital gains than if you just used your cash on-hand.
3. Potentially lower fees
Depending on how much you 'self manage' your super, compared to a regular fund, you could come out ahead. In 2020 actuaries and research company Rice Warner looked at where SMSFs become cost-competitive.
It found $200,000 was where it becomes competitive, and $500,000 in assets is where it became cheaper. The median value of assets held within each individual fund surpasses $700,000, implying many are getting a better deal than if they sought out a regular fund.
There can also be up to six members per fund, allowing the costs to be split further.
4. Tax savings
Contributions to your SMSF are tax deductible and SMSFs allow you to buy other assets and pay a maximum of 15% tax. You can save more tax by targeting franked dividend income and timing the realisation of your capital gains carefully.
5. Estate planning
SMSFs can continue indefinitely and surviving family members may enjoy tax-advantaged income after your death.
Downsides of SMSFs
As a trustee you’ll have to meet super and taxation law requirements – penalties can be very harsh, including hefty fines and imprisonment. Penalties handed down by the ATO are usually delivered in units. The current penalty unit is $180 with up to $10,800 enforcable per breach.
You’ll need to be savvy about investing to ensure your SMSF is outperforming gains it could have made with a traditional superannuation company. You can appoint advisers or brokers to help you, but that will cost you money.
You will be required to meet all your record-keeping and reporting obligations, including annual tax returns, records of transactions and contributions, outlining your investment strategy and trustee deed, and so on. Relying on experts to handle this aspect will cost you money (but could be worth it).
4. Investment risk
Your SMSF will likely be less diversified than one chosen by a super fund company. These funds have the teams and size to invest in an incredibly wide array of assets. Some even invest in infrastructure projects, which are largely unobtainable to the average investor.
While regular super funds sometimes come with insurance coverage, you’ll need to independently source the life, total permanent disability and income protection insurance that you’ll need.
Borrowing to fund an SMSF property purchase? Here's what you should know
As mentioned earlier, borrowing to fund a property purchase is called an LRBA - limited recourse borrowing arrangement. They are limited in recourse because if you default on the mortgage, the lender can only go after that asset in the SMSF, not the whole fund. Here are some considerations when applying for an LRBA.
1. Investment Performance
When you invest in a property, you cannot be 100% sure that this investment will create a large amount of profit for you. However, there are measures you can take to help improve the investment’s performance.
Properties aren't cheap, and it likely takes up a significant portion of your fund's overall asset value. This enhances risk for the fund - think of it like putting all your eggs in one basket. Consider future influences on the property’s value such as population growth, housing development, local transport and more. This is something you'll have to make note of in your investment strategy.
Like regular property investment, you'll probably want to keep up-to-date with your investment, such as if the property manager is providing a good service, or if the tenants are looking after the property.
It's advised you speak with a financial advisor before you purchase a property to ensure you are financially prepared. It is also a good idea to sit down regularly and have a progress review to ensure you are still on track with your finances.
2. Management minefield
It is important that as the trustee you know what you are doing. Managing a self-managed super fund requires work and knowledge and if you don’t understand the processes, you may end up losing money. If you are a trustee, you should:
- Get training: Training programmes will help you learn the basics about self-managed super funds and you will also be able to have all of your questions answered by professionals.
- Get advice: Your accountant will be your best friend when it comes to your SMSF. They will show you how to operate the accounts, file receipts and make entries into the accounts.
- Use checklists: If you are planning to meet with your accountant, make sure you are prepared. Write a checklist of what you need to bring and you need to do before you meet with your accountant. Things can easily be forgotten if you don’t write them down.
3. Legal & Contractual Issues
There are continuous changes in the area of self-managed super funds investing in property, so it is important to keep up to date with all of the documentation. For example, the purchase contracts need to suit the type of purchase you are making and the titles need to be correct. This area should not be left to chance; you need to find a good lawyer or conveyancer with the right qualifications to act on your behalf. It shouldn’t be left to someone who is not 100% sure on what they are doing.
4. Lender Review
Depending on your lender, there may be a list of possible scenarios that result in a review. Some examples include:
- The SMSF applying for another loan
- A valuation review showing that the maximum LVR has been breached
- The SMSF entering pension phase or a member entering retirement
- The death or permanent disability of a member
- Members being added or removed from the fund
If any of these events occur, the lender will need to make sure it is still appropriate for the SMSF to have the loan. If it isn’t appropriate, you may be required to repay the rest of the loan or sell your property. So, to avoid this situation, it is best to discuss any possible changes with your lender before they happen to ensure you are not breaking any rules.
5. Depreciation and Tax Advantages
Even though land usually goes up in value, plant and buildings depreciate. Although investors are given a depreciation allowance as a tax deduction, some see it as free money and spend it all. Then, when it comes time to make repairs to the building, investors may not have enough money saved. This depreciation allowance is there for a reason, and you can manage this risk by maintaining a cash account with adequate funds kept in it for emergency repairs.
Although tenants do provide you with income, they can also cause a great amount of stress. It is important that you find a good property manager. Do not just look for the cheapest option, do your research and speak with other landlords. Property managers typically take 5-8% of the weekly rental income as a fee.
It is also important that you consider landlord’s insurance. This will cover you for things such as loss of rent when repairs for a claim are being completed. Regular inspections with your rental agent will allow you to keep an eye on the state of the property to ensure your tenants are maintaining the property.
Article first published by Nila Sweeney, 4 April 2011. Last updated by Harrison Astbury, 20 June 2022.
Collections: Property Investment