Many Australians are now looking to take control and become more involved in their superannuation. SMSFs hold approximately one-third of the total superannuation funds, and are often the preferred choice for people who are highly engaged with their superannuation and retirement planning. Let’s start looking at some of the benefits of a SMSF.
Most of the rise in new SMSFs can be attributed to the baby boomers – those born between 1946 and 1964, to control their retirement assets. Contrary to popular opinion, it’s not necessary that these people believe that they can achieve superior performance by making their own investment decisions, however it’s more to do with the fact that they would prefer to have full control, flexibility and transparency over their own money.
There has also been a clear trend for the last few years that more and more Gen X’s, or those born between 1965 and 1980 are starting their own SMSF’s as they have managed to have superannuation for most of their working lives and have now managed to accumulate approximately $200,000 in their superannuation account.
There are other benefits that will make self-managed superannuation a very attractive option for many people.
1. Investment Choice
One of the key benefits of an SMSF’s is investment control, and the wider investment choices such as residential and commercial property, collectibles, term deposits, direct shares, etc. that trustees have compared to industry and retail super funds. You will also have access to derivatives and other complex strategies in order to implement downside protection or hedging your portfolio risk.
One of the main reasons that SMSF’s are recommended for small business owners is to be able to have business property owned by their SMSF’s and then leased back to the business. This gives a steady income for SMSF’s and frees up any capital in order to grow your business and provide secure tenancy.
2. An SMSF can borrow to invest
With the rules that now allow SMSF’s to borrow, SMSF members can now purchase large single assets such as residential property that would otherwise be outside of their reach. For example, a couple with a combined SMSF balance of $200,000 can borrow money via a limited recourse loan to purchase an investment property worth $400,000. Generally, a limited recourse loan can be secured for 60%-70% of the purchase price of a property. This excludes other costs associated with the purchase such as legal, stamp duty etc.
Important rules to note:
- Investment properties purchased through an SMSF cannot be lived in by you, any other trustee or anyone related to the trustees.
- Don’t buy a “renovator’s dream”. Borrowed funds can be used for property maintenance but cannot be used to improve a property. This also means that you cannot buy and empty block of land with the view to build a property on it at a later stage. This also means that you can’t purchase a development site including a knock-down rebuild.
SMSF property borrowing risks include:
- Higher costs than a normal home loan – SMSF property loans are more expensive than other property loans.
- Cash flow – Debt repayments must be made from your SMSF which means your fund must always have sufficient cash flow to meet the loan repayments.
- Hard to exit – Unwinding the arrangement or selling the property may cause substantial losses to the SMSF.
- Reduction in negative gearing benefits – Any tax and depreciation losses from the property cannot be offset against your taxable income outside of the SMSF.
- No alterations to the property – Until the SMSF property loan is 100% paid off, alterations or improvements to a property cannot be made if they change the ‘character of the property’.
3. Tax Minimisation
Apart from defined benefit super funds (like a government employee fund), most other superannuation funds will offer the ability to take a tax-free pension as an income stream upon retirement. Another benefit of an SMSF is that it gives you more flexibility than any other superannuation structure when it comes to contributions, the timing of contributions, allocating earnings to particular members and implementing ‘reserves’. This provides trustees and their professional advisers the ability to use the unique flexibility of an SMSF to minimize the amount of overall tax that the SMSF members pay within the fund, by taking their unique situation into consideration and making strategic decisions on contributions, reserves and distributions. In a public offer or ‘pooled’ superannuation fund, your unique circumstances cannot be considered because you are just one of thousands or even millions of members who all must be treated the same. This means that the trustee of the large superannuation fund may make a decision that negatively affects your tax position, and you have no way to prevent this.
4. Tax Control
Through timing pensions and structuring as well as tilting investment strategies to utilise the concessional tax treatment for the funds, like targeting franking credits, tax can be reduced and for most retirement phase client’s refunds can be claimed from ATO for any excess credits. There is also the flexibility when it comes to dealing with taxable liabilities for your fund, as this fund only has one single tax return although there may be up to four different members for the fund and each can have numerous pension accounts.
Where the fund has one or more members who have retired and are therefore paying 0% tax, tax advantages can be achieved by allocating earnings from members who are not retired and are therefore sitting in a 15% tax environment.
5. Passing on Tax Benefits
Using certain strategies like Future Service Benefit Deductions, SMSF family members may be able to benefit from a large tax deduction that may in fact make the fund tax-free for many years after the death of a member.
6. Minimise transaction costs: brokerage, buy/sell, and CGT spread costs:
Whenever it comes time to move to the pension/retirement phase an SMSF will allow you to have an almost seamless transition from the accumulation phase to the pension phase without the need to sell down assets, therefore not triggering capital gains tax (CGT) and other transaction costs. You do not need to sell your assets such as shares which would incur various taxes and fees in the process. You just retain your investments and begin to draw down on your SMSF balance as an income.
7. Transferring your wealth to the next generation
There are plenty of useful estate planning benefits that are built into Australia’s superannuation system. However, an SMSF offers even more benefits, control and flexibility over a member’s estate plan that can ensure that the funds from the SMSF go to the right people, at the right time, in the most tax effective way possible.
Firstly, you will need to be clear that your Will doesn’t control your superannuation benefits unless you nominate for your superannuation balance to form part of your estate. Keeping superannuation assets outside of the Will may be a smart move, especially considering if you have a blended family, plus the high rate of success when people formally challenge a Will who feel that they have been unfairly treated. With a SMSF, you are able to create a strategy that will execute your wishes for distributing your wealth, with superior tax outcomes. This includes being able to leave your taxable pensions to dependents who are able to receive them tax free, or substantially tax free for non-dependents.
You are also able to structure tax-effective income streams to your dependents like disabled children, or a sick spouse with control around when they receive the pension income and any the lump sum. A simple example of this is that you may nominate to pay a dependent child an income of $60,000 a year for 10 years, rather than a lump sum of $600,000 immediately upon your death. Another option would be to pay $120,000 upfront to fund large upfront expenses, then pay the remaining balance evenly over the next 10 years. This strategy is very powerful when the dependents are young children who are not in a position to manage their own money, or where there are spendthrift beneficiaries – e.g problem gamblers.
8. Protect your assets
Asset protection can be a key consideration for many people, especially business owners and superannuation can be a structure that protects the members from litigation and bankruptcy. In either of these events, your superannuation benefits are likely to be protected from creditors. In the event of a failing business venture, a business owner may be left with their superannuation balance as their only remaining asset. However, as superannuation is intended for retirement, your superannuation balance cannot be used to prop up a struggling business.
9. Cost Savings
For some people, the cost of having SMSF can be lower than alternative public offer super funds, especially when the fund balance is high – greater than $200,000. The average cost of annual administration is around $2,000 to $3,000 p.a which includes audit and accounting fees. The average retail super funds charge approximately 1.5%, which is $3,000 p.a on an account balance of $200,000.
Establishment Costs: Average SMSF Annual Administration & Compliance Fees
Ongoing Costs: Average SMSF Annual Administration & Compliance Fees
Look to team up with professionals that have experience in the strategies that will suit your needs. An SMSF will allow you to have ultimate control over selecting your team of professionals, and how you will pay for their advice. There may be the opportunity to pay for their fees via your SMSF funds.
Only a qualified Financial Planner can recommend that you establish a SMSF. In the past Accountants could make such a recommendation, however this exemption has now ceased. Accountants still play a critical role in generating the tax return for the SMSF, however they cannot make any recommendations relating to the set-up, or investments of the SMSF. Therefore, the first professional that you should seek to engage if you are considering starting your own SMSF is a Financial Planner. However, be careful as not all Financial Planners are accredited to provide advice on SMSFs due to their complexity and specialist nature.
In conclusion, Self-Managed Super Funds are popular today and have become the most powerful retirement savings structure available. You must be willing to take on the responsibilities of an SMSF trustee, and a good Financial Planner will help guide you and educate you along the way. You will be able to ‘pass the sleep test’ knowing that you have control of your superannuation, that you control your investment decisions, have maximised your tax effectiveness, and have implemented effective estate planning and asset protection strategies.
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At Assure Wealth, we specialise in helping busy, successful families get their financial house in order, bring structure to their finances and achieve financial peace of mind. We have a particular focus on helping people to establish a self-managed superannuation fund (SMSF), plus self-managed superannuation property investment.
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Author: Pat Casey – Managing Director, Assure Wealth