Some of the most significant positives:
1. Increased Investment choice and flexibility
This is probably the most common reason people give to set up a SMSF. A SMSF can offer you ‘almost’ the same flexibility you have to invest as an individual. Some of the most common investment choices are direct property and share trading, but it can open options to invest in any number of things including art, coins or even wine. There are strict rules that surround how the investments must be managed, with the overarching ‘sole purpose test’. This in essence refers to the fact an investment must be made with the ‘sole purpose’ of providing benefits at retirement. There are several rules that you must be aware of, that impact the investment decision.
2. Potential Cost Savings
Once all costs associated to running the fund are considered, it is possible you will have a lower cost base, by setting up a SMSF. Fee differentials will depend on the investment strategy you adopt in the fund, however as a general rule the fee benefits only become relevant once your balance exceeds $200,000 - $400,000. The reason for the significant difference noted here, is influenced by the investment strategies you choose to adopt.
3. Increased Tax Planning opportunities
One of the most appealing things about a SMSF is that it provides you greater tax planning opportunities and flexibility. It is actually possible to run your fund so that you receive a tax refund at the end of the year, adding to your ultimate after tax investment return, which can work fantastically well for share traders for example.
Three of the best tax planning opportunities which exist include:
a. Control over Capital Gains Tax. You can choose to sell assets considerate of Capital gains. Public offer funds will sell down when they deem appropriate, without consideration of your individual tax position.
b. Investing into shares with Franked Dividends – Shares that pay franked dividends give up to a 30% tax credit, for tax the underlying company has already paid. Considering super funds are only taxed at up to 15%, it is actually possible to run your fund, tax free or even to be eligible for a tax credit, if your strategy is to favour high paying franked dividends.
c. Insurance – you can own some of your personal insurances within your SMSF and claim a tax refund on premiums paid. If you need to claim on your insurance, there is a degree of additional control you have as trustees of your fund that can be tax advantageous.
4. Opportunity to borrow from the bank to invest in real estate
Since 2007, it has been possible to borrow in your SMSF, using what is commonly referred to as an instalment warrant lending arrangement. In theory, this is no different to borrowing personally, as you can leverage up your investment and therefore compound any positive return you might make. With this said, there are several things to consider with this strategy before jumping in.
5. Opportunity to pool funds to purchase a larger asset than you otherwise could
SMSF’s can have up to 4 member’s maximum. Typically it is a structure which is shared amongst family members and while account balances are managed individually for tax purposes, it is possible to pool balances to make combined asset purchases. This can make it more affordable to purchase assets such as property for example.
6. Opportunity for business owners to purchase the premises they work from
This is a strategy that can work fantastically well for self employed people who own or aspire to own the commercial premises they work from. Some of the advantages of this strategy include:
a. You are the tenant – unlike other commercial property purchases, you are not relying on demand from the market, to ensure your property remains rented. Considering commercial tenancy demand is fueled by the strength of the prevailing economy, there is a greater risk of low occupancy than residential property.
b. You can get more into your super fund – In this scenario you can theoretically make maximum pre-tax contributions to super annually, as well as paying in the rent you pay yourself
c. You have some control over the rent you pay – within reasonable market limits you set the rent you pay.
d. You have control over when you sell your asset – if you sell your premises, once your super has been converted to a pension, it is possible to sell with 0% capital gains tax implications. This could naturally lend itself to when you are no longer in need of the premises for your business when you retire.
Some of the most significant risks:
1. You do nothing
It is incredible how many people have a super fund set up and the money just sits in cash. This is invariably driven by lack of understanding of the options or what is suitable and/or paralysis by analysis. If a SMSF is suitable and you assume control of your own funds, you need to have a strategy and a plan for how you use the funds.
2. Poor assessment of costs
Costs within the fund can quickly spiral when considering, set up, investment costs and ongoing Accounting and legal advice. Before you set up a SMSF, you need to draft out your known costs, including:
a. Set up of the fund itself
b. If you elect to have a corporate trustee (something you must do if you are a sole investor or if you are borrowing in the fund) you will have the additional cost of a trustee company structure
c. If you intend to borrow in the fund, you will need to set up a bare trust
d. If you intend to borrow in the fund, there will normally be a loan application fee with the bank
e. Ongoing Accounting Costs
f. Ongoing Auditing Costs
g. Know what you are going to invest into and what costs are associated with the investment. Many people intend to buy property for example and its essential to calculate all of the purchase costs of property, including stamp duty and legal’s amongst others. If your intention is to trade shares, consider the buy and sell costs, including brokerage.
h. Know what the ongoing costs are of the underlying investments you put your money into
i. Ongoing advice costs, if applicable
Only once all costs are known and understood, can you make an informed choice that a SMSF is the most cost effective option.
3. Underestimate the time a SMSF takes to run
This is probably the least understood or considered aspect of what it means to start your own SMSF.
In order to manage your super fund effectively you need to have a clear investment strategy. Whether it is property or shares or even buying art that motivates you to set up a fund, you are doing it because you believe you can achieve a rate of return in excess of the Fund Managers that would be investing your money otherwise, were you to leave it invested in a public offer fund.
In order to do this effectively of course, you need to commit a certain amount of time to ensure your investments are managed effectively and your time commitment does not rest at that.
In reality, if you are to manage your SMSF effectively the time output includes:
a. Research and education – this is an ongoing commitment
b. Investment management – Physically managing the investment. This could be trading shares or co-ordinating maintenance on an investment property, for example.
c. Tax returns – You are now responsible for your own tax work, which means collating your years information in the same manner you do currently for your personal tax returns
You could outsource any one or all of these time outputs (with the exception of preparing your tax work) however you would need to weigh up the costs of this against how this might impact your overall fund return.
Time is a precious commodity that is finite and it also has a value attached to it.
It is therefore vital that you understand and weigh up what your time is worth, before committing it to running your fund.
4. Increased Risk through having legal responsibility
If you choose to start a SMSF, you are taking on the legal responsibility of a Trustee. In short, your legal responsibility is to operate under the rules of the SIS Act and to work within the rules of your Trust Deed.
While SMSF’s offer considerable flexibility compared to other super fund structures, the rules they operate within are regularly changing. You as Trustee are responsible and liable, if you breach these.
Your Financial Planner and Accountant can provide a lot of guidance in this regard, however the ultimate responsibility still rests with you as Trustee.
5. Do not effectively benchmark return
One of the problems with super generally is that you are not given a reasonable point of comparison to see how you are going, compared to the underlying investment markets that you are invested in. The information is out there, but as it stands it is up to you to seek out the answer and the reality is that most of us would not know where to start.
As a consequence we can all be guilty of making ‘apple for oranges’ judgements on performance.
The same is true for SMSF investors too. Fed up with relying on someone else to manage their funds, they take control back and invest it for themselves, but what do your returns really mean if you are not benchmarking them? You may achieve a 15% return and feel pretty good about it, but if that is 10% less than market for that year, it’s actually a really poor result.
If you do decide to set up a SMSF, it is essential that you identify how you can effectively benchmark performance if you are really going to achieve what you’ve set out to do and that is outperform the alternative you’re thinking of moving away from.
"GOOD FORTUNE NEEDS GREAT PLANNING"
The content of this presentation is intended to be general information only and has been prepared without taking into account any person’s objectives, financial situation or needs. Each person should consider its appropriateness having regard to these matters or obtain relevant professional financial advice before making any financial decisions. Examples are illustrative only. Each person should obtain any relevant professional financial, taxation and social security advice before making any financial decisions.