Is an SMSF right for you?

As anyone who has joined the weekend crowd at Bunnings knows, Australians love DIY. And that same can-do spirit helps explain why 1.1 million Aussies choose to take control of their retirement savings with a self-managed superannuation fund (SMSF).

As well as control, investment choice is a key reason for having an SMSF. As an example, these are the only type of super fund that allow you to invest in direct property, including your small business premises.

Other reasons people give are dissatisfaction with their existing fund, more flexibility to manage tax and greater flexibility in estate planning.

What type of person has an SMSF?

If you think SMSFs are only for wealthy older folk, think again.

The average age of people establishing an SMSF is currently between 35 and 44. They’re also dedicated. The majority of SMSF trustees say they spend 1 to 5 hours a month monitoring their fund.i,ii

But an SMSF is not for everyone. There has been ongoing debate about how much you need in your fund to make it cost-effective and whether the returns are competitive with mainstream super funds.

So is an SMSF right for you? Here are some things to consider.

The cost of control

Running an SMSF comes with the responsibility to comply with superannuation regulations, which costs time and money.

There are set-up costs and ongoing administration and investment costs. These vary enormously depending on whether you do a lot of the administration and investment yourself or outsource to professionals.

A recent survey by Rice Warner of more than 100,000 SMSFs found that annual compliance costs ranged from $1,189 to $2,738. These are underlying costs that can’t be avoided, such as the annual ASIC fee, ATO supervisory levy, audit fee, financial statement and tax return.iii

If trustees decide they don’t want any involvement in the administration of their fund, the cost of full administration ranges from $1,514 to $3,359.

There is an even wider range of ongoing investment fees, depending on the type of investments you hold. Fees tend to be highest for funds with investment property because of the higher management, accounting and auditing costs.

By comparison, the same report estimated annual fees for industry funds range from $445 to $6,861 for one member and $505 to $7,055 for two members. Fees for retail funds were similar. Fees for SMSFs are the same whether the fund has one or two members.

Size matters

As a general principle, the higher your SMSF account balance, the more cost-effective it is to run.

According to the Rice Warner survey:

  • Funds with $200,000 or more in assets are cost-competitive with both industry and retail super funds, even if they fully outsource their administration.
  • Funds with a balance of $100,000 to $200,000 may be competitive if they use one of the cheaper service providers or do some of the administration themselves.
  • Funds with $500,000 or more are generally the cheapest alternative.

Returns also tend to be better for funds with more than $500,000 in assets.

Even though SMSFs with a balance of under $100,000 are more expensive than industry or retail funds, they may be appropriate if you expect your balance to grow to a competitive size fairly soon.

Increased responsibility

While SMSFs offer more control, that doesn’t mean you can do as you like. Every member of your fund has legal responsibility for ensuring it complies with all the relevant rules and regulations, even if you outsource some functions.

SMSFs are regulated by the ATO which monitors the sector with an eagle eye and hands out penalties for rule breakers. And there are lots of rules.

The most important rule is the sole purpose test, which dictates that you must run your fund with the sole purpose of providing retirement benefits for members. Fund assets must be kept separate from your personal assets and you can’t just dip into your retirement savings early when you’re short of cash.

Don’t overlook insurance

If you considering rolling the balance of an existing super fund into an SMSF, it could mean losing your life insurance cover. To ensure you are not left with inadequate insurance you may need to arrange new policies.

If you would like to discuss your superannuation options and whether an SMSF may be suitable for you, don’t hesitate to call on 03 5120 1400 and speak to a Financial Adviser.

https://www.smsfassociation.com/media-release/survey-sheds-new-insights-on-why-individuals-set-up-smsfs?at_context=50383

ii https://www.smsfassociation.com/media-release/survey-sheds-new-insights-on-why-individuals-set-up-smsfs?at_context=50383

iii https://www.ricewarner.com/wp-content/uploads/2020/11/Cost-of-Operating-SMSFs-2020_23.11.20.pdf

Material contained in this publication is a summary only and is based on information believed to be reliable and received from sources within the market. It is not the intention of RGM Financial Planners Pty Ltd ABN 36 419 582 Australian Financial Services Licence Number 229471, RGM Accountants & Advisors Pty Ltd ABN 69 528 723 510 or RGM Finance Brokers Pty Ltd ABN 81 330 778 236 (RGM) that this publication be used as the primary source of readers’ information but as an adjunct to their own resources and training. No representation is given, warranty made or responsibility taken as to the accuracy, timeliness or completeness of any information or recommendation contained in this publication and RGM and its related bodies corporate will not be liable to the reader in contract or tort (including for negligence) or otherwise for any loss or damage arising as a result of the reader relying on any such information or recommendation (except in so far as any statutory liability cannot be excluded).

Liability limited by a scheme approved under Professional Standards Legislation.


Is your SMSF balanced?

The recent sell-off on global sharemarkets due to the economic impact of COVID-19 has highlighted the risks of depending too heavily on a single asset class. Even before the current crisis, the ATO was concerned about a minority of self-managed superannuation funds (SMSFs) with up to 90 per cent of their money in a single asset class.

Invariably that single asset is an investment property for which the SMSF has borrowed money through a limited recourse borrowing arrangement (LRBA). While property has historically provided good returns over the long run, this is not always a good recipe for providing income in retirement. 

The ATO is so concerned about this trend, that last year it wrote to 17,700 SMSFs warning them about the dangers of concentration of risk and suggesting they should perhaps consider greater diversification. 

One of the foundations of prudent investing is diversification. By putting your money in a range of investments and asset classes you effectively spread your risks. 

Have a written strategy

Diversification is important for all investors, but especially so for those with an SMSF who are ultimately responsible for their own investment strategy. That’s why SMSFs are required to put their investment strategy in writing. 

This is your plan for making, holding and realising assets consistent with your investment objectives and retirement goals. It should explain how your chosen investments will help you meet your goal. 

If you have 90 per cent of your fund’s money in a property, you need to document that you have considered the risks associated with this lack of diversification. You need to state why you think the investment will meet your fund’s investment objectives and cash flow requirements. 

This document can be attached to your strategy as a signed and dated addendum. If you cannot justify your heavy weighting in property, then you need to change the fund’s portfolio mix otherwise each individual trustee may face a fine of $4200. 

Understanding gearing

Of those SMSFs that have focused heavily on property, a disturbing fact is that many of those funds have lower balances of between $200,000 and $500,000. This makes them even more vulnerable to a market fall. In 2017 the average borrowing under a LRBA was $380,000 and the average value of assets was $768,600.i

With an LRBA, the asset is held in a separate trust. Any investment returns earned from the asset go to the SMSF trustee. If the loan defaults, the lender’s rights are limited to the assets in the separate trust so there is no recourse on any other assets held in the SMSF. 

That’s all very well, but if those other assets represent less than 10 per cent of a fund where the balance is $300,000, then having around $30,000 left in your super should you come a cropper clearly will not provide adequately for your retirement. 

The banks require a personal guarantee from the members when setting up an LRBA so if you default on the loan then any shortfall must be met personally which could further undermine your retirement planning. 

How to diversify

How you achieve diversity in your SMSF will depend on the risk profile of the fund’s members. For example, there’s no harm in being skewed towards more conservative investments if the members have a low tolerance for risk, but the trade-off is lower returns in the long run. 

The type of investments in the fund may also depend on the age of members. If retired, then you probably need two years’ cash readily available. However, the remainder should be in a balanced portfolio of growth investments, bonds and fixed interest. That way the capital can still grow even in retirement, which will help ensure you don’t outlive your fund. 

In contrast, younger fund members might skew their portfolio more towards growth assets such as domestic and international shares. This is because there is plenty of time to recover from market falls such as the one we are currently experiencing. Alongside these growth assets you should also have some fixed interest and bond exposure. 

If you would like to discuss your SMSF’s investment strategy and make sure that you are not exposing yourself to unnecessary risk, then give us a call on 03 5120 1400.

i https://www.cfr.gov.au/publications/policy-statements-and-other-reports/2019/leverage-and-risk-in-the-superannuation-system/

Material contained in this publication is a summary only and is based on information believed to be reliable and received from sources within the market. It is not the intention of RGM Financial Planners Pty Ltd ABN 36 419 582 Australian Financial Services Licence Number 229471, RGM Accountants & Advisors Pty Ltd ABN 69 528 723 510 or RGM Finance Brokers Pty Ltd ABN 81 330 778 236 (RGM) that this publication be used as the primary source of readers’ information but as an adjunct to their own resources and training. No representation is given, warranty made or responsibility taken as to the accuracy, timeliness or completeness of any information or recommendation contained in this publication and RGM and its related bodies corporate will not be liable to the reader in contract or tort (including for negligence) or otherwise for any loss or damage arising as a result of the reader relying on any such information or recommendation (except in so far as any statutory liability cannot be excluded).

Liability limited by a scheme approved under Professional Standards Legislation.