More and more property investors are turning to self-managed super funds to realise their property investment goals, but the myths and misconception surrounding these complex financial arrangements continue to catch people out.
Blogger: Dominique Bergel-Grant, founder, Leapfrog Financial
The dream of putting your feet up, retiring and living with financial security is one that we all aspire to. For many people, a crucial step in this process is taking control of what will one day be your biggest asset – superannuation. But is taking control of your super and setting up a self-managed super fund (SMSF) the same thing? Or are you just falling for the marketing and allure?
As a financial adviser, I spend just as much time unwinding self-managed super funds as I do establishing them. This leads me to think: why do so many people choose to set up a self-managed super fund and where are people going wrong?
Gone are the days where, as a trustee of your own self-managed super fund, you could invest in questionable assets, take little or no responsibility for your investment decisions, or benefit from tax breaks not available to those in normal super funds.
However, these myths and many more still exist when it comes to SMSFs.
It is time to bust these myths so you can be confident you are making an independent decision that is right for you, rather than just following the crowd and joining the one million Australians who have an SMSF.
1. Cash is king
I hear many trustees speak of stories about how they saved their super during the global financial crisis by having it invested in cash. In many cases, when I drill down it turns out to be it was more luck than technical ability.
The biggest concern, however, is that with nearly 50 per cent of assets in SMSFs still invested in cash, people are continuing to believe their own stories, or simply do not have the time or technical expertise to know where to start investing.
In reality, if they had just left their money in a balanced portfolio of investments, they would have more money in their account today than they currently do. Cash may provide stability, but it will not deliver you the growth you need to be financially secure in the long term.
2. Structure and responsibilities
Many of the super funds that need to be closed down have reached this point because they were not set up correctly in the first place. I have even come across funds that do not have a trust deed. This trust deed is required by law as it governs the rules of the SMSF. I have also seen attempts by trustees to change these rules to make it more flexible than the superannuation legislation itself!
Remember, no matter what you put into your trust deed, you still have to comply with the legislation that the Australian Taxation Office (ATO) enforces – and they will always be looking over your shoulder.
If the ATO finds that you have breached the super legislation, there are very high penalties – sometimes including hundreds of thousands of dollars in fines, or even imprisonment.
The ATO won’t accept any excuses. If you decide to set up a self-managed super fund, you take on not only the role of being a member, but also a trustee. Your sole responsibility is to act in the member’s best interest. In theory, you are the same person, but not legally. What you may want as a member may not be legal for you to do as a trustee and vice versa.
3. Access your super
One of the most common mistakes made by trustees is to access superannuation money for personal reasons before they are allowed to. You cannot take money from your fund to pay off your mortgage or invest into your own business venture, and you can’t put artwork you have purchased in the fund on your wall for your enjoyment.
Until you reach your preservation age you are unable to access or benefit from the investments that you have created. The preservation age for anyone born after 30 June 1964 is 60. If you were born before this you will have an earlier preservation age.
4. When can you borrow?
Gearing, or borrowing, in superannuation was introduced in September 2007 and opened the floodgates to people borrowing to buy property and other investments.
A loan in an SMSF is not a normal loan and it must meet certain rules. For example, the action the lender can take in the event of your SMSF defaulting must be limited to only the asset you borrowed for.
With the maximum tax rate in super at just 15 per cent, there is little point having a negative gearing strategy in place since the tax benefits are extremely limited.
You also need to ensure that your fund’s assets are diversified and that you do not have all your eggs in one basket. This is called your ‘SMSF investment strategy’. This has to be recorded, regularly reviewed, and will be checked by your auditor. You also need to make sure your trust deed allows you to borrow in the first place.
The legislation may say you can do something, but if your trust deed has more strict rules, you must comply with your trust deed.
Importantly, if you borrow, you must also consider the insurance cover your SMSF needs as part of your investment strategy. Otherwise, as trustee, you could personally face penalties from the ATO. You may also need to make amendments to your trust deed to protect the fund’s assets should one of your members die or become totally and permanently disabled.
If this occurred, the fund would need to pay out the member’s benefit, which without insurance and correct wording in the trust deed would result in the geared investment (such as property) needing to be sold because the SMSF must meet its obligations to the member and their beneficiaries.
5. DIY super
Just because you run a self-managed super fund does not mean it is DIY super. Building a team around you will without a doubt leave you better off financially in the long run, even after you pay the necessary fees. So who do you need?
A financial adviser will be able to assess whether or not you should be considering setting up an SMSF. I would confidently say that six out of 10 people I meet who want an SMSF can achieve their investment requirements through a normal super fund. In the process, they will save themselves thousands in fees, as well as the compliance headache of being a fund trustee.
If they do recommend an SMSF, the financial adviser will also help to ensure your fund is established in a way that meets the legislative requirements. In addition, they will be able to establish your fund’s investment stratey and consider any insurance you and your SMSF will require. They will also be able to keep you up to date with legislative changes and continue to work with you on your fund’s investment strategy.
An accountant is key. They will ensure your tax returns are compliant, that a good independent auditor is sourced, and they will keep you on the straight and narrow. The key here, however, is to ensure you are dealing with an accountant who is a specialist in SMSFs.
A specialist SMSF solicitor is also vital. They are few and far between, but will ensure you end up with a strong and compliant trust deed, and will also be able to assist you with any amendments you need to make to tailor it to your specific needs.
6. Winding up
As you get older, or as your investment needs change, do not be afraid to shut down your SMSF and convert back to a public super fund. Typically, the key reasons people should be holding an SMSF these days are for direct property investment, borrowing to invest in shares through installment warrants, or if they have complex estate planning affairs and want certainty on whom their super money will go to.
If you are just investing in a combination of shares, managed funds and term deposits, then a good quality public offer fund may be lower in cost, provide consolidated reporting, take over the trustee responsibility and importantly, give you your time back.
You should of course seek financial advice about which fund will suit you, since every fund has its pros and cons. It is also important to know that there are many wholesale platforms and funds that are only available through financial advisers, so you can actually save money with the right set up and enjoy the benefit of full advice.