What are some of the pros and cons of an SMSF? Mark Chapman, director of tax communications at H&R Block, looks at the benefits and disadvantages.
Benefits
1. Investment choice
SMSFs offer a wider range of investment options compared to other superannuation funds. With some limited exceptions, a SMSF can invest in virtually anything providing that this also meets the sole purpose test and adheres to the regulations. This includes investing in direct property.
An SMSF can also borrow to purchase an asset, however this is becoming increasingly difficult as many banks have removed their SMSF lending products from the market.
SMSFs are attractive to small business owners or the self-employed as a commercial property can be purchased by their SMSF. This property can then be rented to their business providing this is at the prevailing market rates.
Artwork and other collectables, physical gold and investments in some unlisted entities are all permitted within an SMSF. There are, however, stringent criteria that have to be met for these investments to ensure the SMSF remains compliant with the law.
2. Flexibility & control
As the members of the fund are also the trustees there is the flexibility to tailor the rules of the SMSF to suit their specific needs and circumstances. This is not available with other superannuation funds.
Managing your own super investments directly allows you to make quick adjustments regarding your portfolio following market changes or to take up sudden investment opportunities.
3. Effective tax management
SMSFs have the same tax rates as other superannuation funds, however through a SMSF you can more easily put in place tax strategies that best benefit you and your situation. Investment income is taxed at a flat rate of 15% and capital gains are taxed at 10%, both of which are substantially lower than individual (or company) tax rates. Key advantages include:
- Money going into your super is generally taxed at a lower rate than your regular income.
- Concessional contributions can be before-tax contributions and are generally taxed at 15%. This includes the super your employer pays for you, and any super you salary sacrifice.
- Non-concessional contributions are contributions you can make from your after-tax savings.
- Earnings on investments within your super fund are taxed at 15%.
- Consolidating your super is generally not taxed.
- If you are 60 or older, you will not be taxed on withdrawals.
- If you are under 60, the tax you will pay on any lump sum payments is 22%.
4. Accountability
Being both the trustee and member means you will be more aware of how your super monies are invested and the performance of those investments. This would not be the case with Industry or Retail Super Funds where, due to their size, investment performance is aggregated and not released until many months down the track.
A good SMSF administrator will utilise software that allows you to keep track of the value of your super regularly and give you the ability to obtain up-to-date information whenever you need so that you can track the outcome of your decisions and make the management of your fund easier.
5. Costs of running your fund
Traditionally, SMSFs were only used by the wealthy due to the high set up and ongoing compliance fees. These days, however, SMSFs are now a much more cost-effective option for all due to advances in technology and competition between service providers.
The level of professional support you engage will determine the costs associated with running your SMSF.
Most of the operational costs with running a SMSF are fixed. Therefore, as a fund grows in value its costs will generally reduce proportionally. This is different to Industry or Retails Super Funds where costs are usually taken as a percentage of your overall balance.
5. Pooling your super with others
SMSFs allow you to pool your superannuation with up to 3 other people. This opens up the opportunity to invest in things an individual may not be able to on their own such as direct property.
Protection from creditors
Creditors cannot generally access an individual’s superannuation. That is unless clawback laws apply where someone has deliberately transferred their assets into a SMSF to escape paying their creditors.
Disadvantages
Although SMSFs carry many benefits they are not suitable for everyone. The disadvantages of having a SMSF include:
1. Living overseas
The majority of a SMSF's members must permanently reside within Australia. If you intend to move overseas permanently or make contributions to you fund while living overseas this could make your fund non-compliant with the law.
2. Costs of running your fund
The cost of running an SMSF can be disadvantageous when the assets held within the SMSF are low in value. As outlined above, many SMSF management costs are fixed and can therefore erode low value SMSFs.
Costs to operate a SMSF do, however, reduce proportionately when the value of the fund’s assets are high. You must do the maths and see whether a SMSF is worthwhile for you based on your particular circumstances.
The general consensus is that you should have at least $250,000 of assets in your fund to make the costs of running a SMSF worthwhile.
What are the costs/time involved in running an SMSF?
In terms of costs, you need to think hard about the costs associated with starting and running a SMSF, which generally are fixed. Typical start-up costs are around $750 (if you have an individual as trustee) or $1,700 (with a corporate trustee, including the ASIC set-up fee)
You will also need to pay the annual supervisory levy to the ATO and arrange for an accountant to prepare the financial statements and tax return, and conduct an independent audit. Total annual accountants costs are around $2,500. You may also choose to pay for financial advice and insurance for members and you may need to pay for valuations of fund assets.
In terms of the time involved in running the SMSF, this depends on the extent of your personal involvement. If you engage professionals to undertake much of the administration and management, you won’t need to spend much of your own time on these tasks. Alternatively, if you choose to do much of the hard work yourself, your time commitment will be greater. It’s really a trade-off between time and fees, which each individual needs to consider according to their own circumstances.
General questions
Who are SMSF’s most suitable for? Who are they not suitable for?
Most commonly, those who decide to start an SMSF are motivated by the desire to choose and manage their own super investments. They are often dissatisfied by the performance of their super to date and believe they can do a better job, generating higher returns. Often a SMSF is created as part of a ‘whole of wealth’ plan by families that run their own business, since the SMSF itself can play a key role in the business, for instance owning the business premises from which the business is run.
SMSFs are not suitable for those with low super balances and for those who aren’t prepared to invest the time and resources to make a success of their own fund. If you’re happy with the performance of your existing fund, you may not want to change.
What are the risks and responsibilities of running an SMSF?
When you ‘self-manage’ your retirement savings you take on the responsibility of all investment decisions; compared to outsourcing this duty to an investment manager within an Industry or Retails Super Fund. Therefore, as a trustee, you should make sure you have a reasonable understanding of investment options and markets as poor investment decisions will have a direct impact on the assets of your fund and also the retirement savings of other members. Some people simply do not have this expertise.
Furthermore, trustees are responsible for ensuring that their fund complies with the legislation and rules which is a responsibility that should not be taken lightly. Trustees should become familiar with the tax laws governing superannuation. If the ATO considers there has been a breach of these obligations and responsibilities it can impose high penalties on trustees who will be personally liable. Serious breaches can result in an imposition of a tax rate of up to 47%.
Apart from the knowledge requirements, SMSFs also demand a lot of time from their trustees to ensure investments are managed properly. Fortunately there are SMSF administration managers, such as H&R Block SMSF Solutions, who can assist you in maintaining the accounting records of your fund and making sure your fund remains compliant.
On average, how do SMSF’s perform compared with retail or industry super funds?
Historically SMSFs have not performed any better than retail or industry super funds but obviously each fund is different. Ultimately, how well (or how badly) your fund performs is down to you, rather than the anonymous fund managers who typically look after the big funds.
If someone is serious about setting up an SMSF, what are the next steps they should take?
Take professional advice! Navigating the path to setting up and managing your own SMSF can be challenging, and it really helps to have knowledgeable advisors by your side to avoid making mistakes and running into trouble with the ATO. H&R Block SMSF Solutions can help you decide if setting up an SMSF is a good move for you and with the setup and ongoing management of the fund if you decide to proceed.