THE TRUTH ABOUT SMSFs

Transcription

1 THE TRUTH Doing it yourself with a Self Managed Super Fund ABOUT SMSFs by Nick Bedding 1

2 Doing it yourself with a Self Managed Super Fund Table of contents Introduction Chapter One What s it all about? Chapter Two Thinking about the benefits Chapter Three Getting the foundations right Chapter Four Build your wealth and save tax Chapter Five Money in and money out Chapter Six Who s got you covered? Chapter Seven Growing your super nest egg Chapter Eight Borrowing within your SMSF Chapter Nine Reaching the end of the road Chapter Ten Where to from here? Chapter Eleven The final word About the author

3 Introduction Self Managed Superannuation Funds (SMSF) it seems everywhere you go people are espousing the benefits of do-it-yourself super. It is all made to look so easy that it is no wonder that an ever increasing number of individuals are jumping on the SMSF bandwagon. With experts springing up all over the place and a plethora of so called self help books making it appear straight forward there is a real danger that SMSFs ultimately prove to be a minefield for those deciding to manage their own retirement nest egg. Before you do ANYTHING, get professional advice from an adviser experienced in SMSFs and investments as a whole. By its very nature, Self Managed Superannuation Fund and Superannuation Legislation as a whole is complex. The aim of this ebook is to provide you with some guidelines and a general overview only. I have tried to simplify it as best I can, however the impact of simplification is that some of the necessary detail tends be omitted and, as with most things in life, the devil is in the detail. This means that it is really important you don t just take the information in this ebook and try to apply it without seeking professional financial advice. Every person s situation is different and there are many nuances regarding what you can and can t do with an SMSF. In addition, there are specific actions you must take and things you must not do to ensure your fund s compliance with the relevant tax and superannuation legislation. So, before you do ANYTHING, get professional advice from an adviser experienced in SMSFs and investments as a whole. 3

4 What makes this ebook different? With so much information available about SMSFs, you might ask yourself what makes this ebook different. What I ve attempted to do with this ebook is to step back and take a balanced view of the pros and cons of SMSFs and the questions you need to consider as you decide whether an SMSF really is the right structure for you. Over the following chapters we ll look at key questions you should be asking yourself, things to consider when establishing your SMSF and what goes into running your own fund. What you will discover as we cut through the hype, is that an SMSF is definitely not for everyone. As with all investments and investment structures it is important to consider the positives and negatives and then make an informed choice as to what is the best option to help you reach your financial goals and lifestyle aspirations. Nick Bedding Head of Shadforth As with all investments and investment structures it is important to consider the positives and negatives and then make an informed choice as to what is the best option to help you reach your financial goals. 4

5 CHAPTER WHAT S IT ALL ABOUT? 5

6 Chapter One: What s it all about? Self managed hype One of the hottest growth sectors in financial services in Australia over the past decade has been the growth in Self Managed Superannuation Funds (SMSFs). The total amount invested in SMSFs is now estimated to be over $500 billion dollars* out of a total estimated superannuation pool in Australia of $1.75 trillion dollars*. There are more than 500,000* funds in Australia with over 1 million* members. This makes SMSFs the largest type of superannuation vehicle in Australia and it s growing by about $30* billion a year! TOTAL AMOUNT INVESTED IN SMSFs IS NOW ESTIMATED TO BE OVER TOTAL ESTIMATED SUPERANNUATION POOL IN AUSTRALIA OF TOTAL AMOUNT INVESTED IN SMSFs IS NOW ESTIMATED TO BE OVER $500 $1.75 $30 * BILLION TRILLION BILLION A YEAR! Growth in SMSFs Financial Year Establishments *Total number of SMSF June , ,474 June , ,379 June , ,815 June , ,297 June , ,992 *Data extracted on 7 October Source: Australian Taxation Office Self-managed superfund statistical report September

7 So what is causing this tremendous growth in people s desire to run their own fund? There are a number of theories but fundamentally I believe it comes down to people wanting to regain control of their money. An SMSF helps people get far more involved with their future retirement nest egg and enables them to feel more in control of their future. For too long people have felt detached from what is usually their second largest asset after their family home. They have viewed their superannuation as something they will get when they retire and they generally haven t had much interest in or control over it until then. An SMSF helps people get far more involved with their future retirement nest egg and enables them to feel more in control of their future. I have a theory that one of the main reasons people want to regain control over their superannuation is that they just don t trust the system anymore. What do I mean by the system? I mean the legislators (the government), the regulators such as the Australian Securities and Investment Commission (ASIC), the Australian Taxation Office (ATO) and the Australian Prudential Regulatory Authority (APRA), as well as the superannuation and financial advisory industry as a whole. I have a theory that one of the main reasons people want to regain control over their superannuation is that they just don t trust the system anymore. What do I mean by the system? I mean the legislators (the government), the regulators such as the Australian Securities and Investment Commission (ASIC), the Australian Taxation Office (ATO) and the Australian Prudential Regulatory Authority (APRA), as well as the superannuation and financial advisory industry as a whole. People have lost trust in the legislators because of the volume of change imposed upon the superannuation system by successive governments. These continual changes to the rules have been made because of the substantial taxation benefits associated with superannuation, because of the sheer volume of money in the system and the potential long-term impacts of funding people in retirement. Unfortunately change creates uncertainty and, at the end of the day, uncertainty results in a loss of trust. Put simply, people have lost faith that the rules applying today will be the same rules which apply when they get to retirement age and need to live off their superannuation. People are wary of the regulators due to publicised instances where the regulators did not appear to have taken action quickly enough to deal with bad practices in the industry. Finally people have also lost faith in the superannuation and financial advisory industry as a whole due to the unscrupulous practices of some in the profession that have resulted in investors losing their hard earned money. 7

8 If you add to this lack of trust in the system an environment such as that which we experienced during the Global Financial Crisis (GFC) where returns from most public offer superannuation funds 1 were very poor, then many people have concluded that they would be better off looking after their own money and regaining some control over it. People have also lost faith in the superannuation and financial advisory industry as a whole due to the unscrupulous practices of some in the profession that have resulted in investors losing their hard earned money. The good news is that by establishing an SMSF you do regain some control over your money. In particular, you can control how your money is invested, you can get access to certain investments like residential property that are not generally available in public offer superannuation funds, you can use gearing to leverage up your investments (although there are very tight restrictions and additional risks associated with this) and you have more flexibility around transferring assets and some of the taxation timing decisions that can impact tax outcomes. We ll look at all these opportunities in more detail in the following chapters. The bad news is you are still in the superannuation system so you are still subject to many of the issues associated with the superannuation environment and in particular still subject to legislative uncertainty (that is the risk the government will change the rules). The Good Establishing an SMSF you regain some control over your money You can control how your money is invested You can get access to certain investments that are not generally available in public offer superannuation funds You can use gearing to leverage up your investments You have more flexibility around transferring assets and taxation timing decisions that can impact tax outcomes. The Bad You are still in the superannuation system so you are still subject to many of the issues associated with the superannuation environment You are still subject to legislative uncertainty 1 A public offer superannuation fund is one that can be joined by members of the public. 8

9 So what is an SMSF? The first thing to understand about an SMSF is what it is not. An SMSF is NOT an investment. An SMSF is a type of superannuation fund and the best way to think about a superannuation fund is that it is simply a vehicle or tax structure through which you invest. An SMSF is a type of superannuation fund and the best way to think about a superannuation fund is that it is simply a vehicle or tax structure through which you invest. An SMSF has the same underlying core objective as any other superannuation fund - that is to invest members funds for retirement. It is not an investment per se in its own right; it is just the vehicle through which you hold investments. The fund must have four members or less. Each member must generally be a trustee of the fund (if the trustees are individuals) or if the trustee is a company, each director of the company must generally be a member* The fund must have a trust deed that meets the requirements of the Superannuation Industry (Supervision) Act 1993 (SIS ACT) Members cannot be an employee of another member (unless they are related) It must be registered with and regulated by the Australian Tax Office (ATO) * If there is only one member then that member must be one of two trustees or the sole director of a company that is trustee or one of two directors of a company that is the trustee. Your fund will also require a well thought through investment strategy which will need to be regularly reviewed more on this in chapter seven. 9

10 Do you need one? The first question you should ask yourself BEFORE setting up an SMSF is Do I really need one? An SMSF is most definitely not for everyone. A guiding principle should be how much money you have or will have in the fund. Running a fund can be expensive and, for smaller amounts of money, the costs of running the fund can substantially exceed the costs associated with a public offer fund. A basic rule of thumb I use is that if the costs of running the fund exceed 1.5% of the assets you should seriously think twice about establishing your own fund. The costs of running a fund can vary considerably but generally the usual ongoing costs for running a fund are: Ongoing Accounting $ $3000 Audit Costs $300 - $1000 Other Costs $400 - $1500 Total Annual Cost $ $5500 Note: this is just the cost of running the fund and does not include investment costs or ongoing advice costs. 10

11 Based on these numbers, if you assume the very most you should pay to run your fund is 1.5% of the assets then the minimum amount you should have to justify an SMSF from a fee perspective alone is $180,000 (ie, $2,700 / 1.5%) and this is assuming your costs are at the low end of the range. If you don t have at least $180,000 you should seriously consider whether an SMSF is the right structure for you. Personally I believe even that number is a little on the low side and suggest you don t think about an SMSF if you have less than $200,000 and realistically closer to $400,000. Note however, this amount is the total fund size, so if you and your partner combined have over $400,000 between you then it is worth thinking about it. And this is one of the great benefits of an SMSF, you can effectively pool your assets with your partner in the one fund and hence benefit by spreading the fixed costs between you. This is one of the great benefits of an SMSF, you can effectively pool your assets with your partner in the one fund and hence benefit by spreading the fixed costs between you. 11

12 Unless you have a certain level of financial acumen and experience in dealing with money, or a strong desire to learn, you should really think twice about setting up an SMSF. THE MAIN OTHER FACTORS ARE 1 THE LEVEL OF INVOLVEMENT AND RESPONSIBILITY YOU WANT. Running your own fund places certain obligations on you as trustee. While you can use professional advisers to reduce this burden, ultimately as a trustee you are responsible and legally liable for your fund. So if you have no interest in finances and no desire to be actively involved in decisions around your superannuation you should not set up your own fund. 2 EXPERIENCE AND KNOWLEDGE. Unless you have a certain level of financial acumen and experience in dealing with money, or a strong desire to learn, you should really think twice about setting up an SMSF. While much of the burden can be assumed by professional advisers I believe it is really important that you understand what you are doing and the consequences of any advice provided. When running your own fund you do not have the protection of a professional trustee as with a public offer super fund, so you need to know what you are doing. 3 AGE. Because of the above two points, your age is an important factor in deciding whether to run your own fund. Firstly, you should have some life experience before setting up an SMSF so I wouldn t recommend someone just entering the work force set one up (besides, on their own, they wouldn t typically meet the minimum suggested fund balance level anyway). Secondly, I find that as people get older in retirement they generally, although not always, want to play a less active role in their finances. It may, therefore, not be appropriate to establish an SMSF where you are at an age or close to an age where you don t want the burden or responsibility. So if you meet all of these basic requirements then establishing an SMSF may be worth considering. If you don t, my strong advice is an SMSF is probably not for you! 12

13 In summary Before you do ANYTHING, get professional advice from an adviser experienced in SMSFs and investments as a whole. Establishing an SMSF does allow you to regain some control over your money. In particular, you can control how your money is invested. An SMSF has the same underlying core objective as any other superannuation fund - that is to invest members funds for retirement. One of the great benefits of an SMSF is you can effectively pool your assets with your partner in the one fund and hence benefit by spreading the fixed costs between you. When running your own fund you do not have the protection of a professional trustee as with a public offer super fund, so you need to know what you are doing. 13

14 CHAPTER 2 THINKING ABOUT THE BENEFITS 14

15 Chapter Two: Thinking about the benefits Why get an SMSF? The main benefits of an SMSF are: reduced costs (although note the previous comments in Chapter One about the minimum super balance required to benefit from this), flexibility and control: Reduced costs There is no doubt that once your superannuation assets exceed a certain amount there can be significant cost benefits from running your own fund. This is predominately because the costs associated with running your own fund are largely fixed, that is they don t depend on how much money you have. Compare this to the usual approach where superannuation funds charge a percentage of assets, so the higher your account balance the more you pay in fees. The other cost benefit is that you can pool your funds with other members allowing you to share the fixed costs. Let s look at an example. If you have $300,000 in an SMSF which has annual running costs of $3,000 the fixed costs represent 1% of your fund balance. If, however, your partner is also a member of the fund and also has $300,000 (ie, the total amount in the fund is $600,000) the fixed costs represent just 0.5% of the total fund balance. Reduced costs This is predominately because the costs associated with running your own fund are largely fixed, that is they don t depend on how much money you have. Compare this to the usual approach where superannuation funds charge a percentage of assets, so the higher your account balance the more you pay in fees. The other cost benefit is that you can pool your funds with other members allowing you to share the fixed costs. It is important to note that these costs just relate to the costs of running the fund. It does not include the costs associated with investments so, depending on the underlying investments in which you invest, there may be additional costs associated with these. In addition to the cost benefits, the other advantage of pooling your assets is that you can gain access to investments that might only be available to those with higher balances, for example residential or commercial property or a wholesale investment fund and you also have a better opportunity to diversify your investments. 15

16 An SMSF gives you greater flexibility around a range of important decisions. Flexibility An SMSF gives you greater flexibility around a range of important decisions such as how benefits can be paid to members when they retire, how death benefits are paid and the use of in-specie contributions and benefits. In-specie contributions and benefits are where you can contribute or pay out certain assets rather than just cash (there are limitations and possible taxation implications and this is explored in more detail under Taking fund assets instead of cash on page 40). Control Using an SMSF gives you power and control over your superannuation fund. It enables you to specifically tailor the investment strategy to meet your needs and to have a direct say in all investment decisions. This means you can target certain types of investments, such as residential property, acquire real business property and borrow to help leverage up your funds (see also Chapter Eight, Borrowing within your SMSF ). Control also extends to your ability to more effectively plan and structure for certain tax events. While an SMSF is not taxed any differently from other types of superannuation funds there are certain strategies you can adopt that are not available in a public offer fund (see Chapter Eight). REDUCED COSTS If you have $300,000 in an SMSF which has annual running costs of $3,000 the fixed costs represent 1% of your fund balance. If, however, your partner is also a member of the fund and also has $300,000 (ie, the total amount in the fund is $600,000) the fixed costs represent just 0.5% of the total fund balance. FLEXIBILITY Greater flexibility around a range of important decisions such as: How benefits can be paid to members when they retire How death benefits are paid and the use of in-specie contributions and benefits CONTROL Gives you power and control over your superannuation fund Enables you to specifically tailor the investment strategy to meet your needs You have a direct say in all investment decisions You can target certain types of investments, such as residential property, acquire real business property and borrow to help leverage up your funds Extends your ability to more effectively plan and structure for certain tax events 16

17 Not for everyone! An SMSF is definitely not for everyone and before establishing a fund for yourself you need to seriously consider whether it is right for you. There are a number of issues and risks associated with SMSFs and it is important you understand and appreciate these before you take the next steps. Remember that you can have investment choice within the safety of a public offer superannuation fund so it s worth investigating this option before setting up your own SMSF. With an SMSF, the risk with the most dramatic consequence is non-compliance. There are significant penalties where a trustee fails to meet their legal obligations and if the fund s compliance tax status is revoked the fund can be subject to tax at the highest marginal tax rate, which is currently 45%. If that isn t bad enough the tax office has the ability to take legal action which can result in significant penalties against the trustee(s). It s important to keep in mind that you can have investment choice within the safety of a public offer superannuation fund so it s worth investigating this option before setting up your own SMSF. 17

18 TIP: A word of caution for couples: The breakdown of a relationship can present real problems for couples running their own SMSF and adds a degree of complexity, potential costs and angst at a time when you are least likely to want or need any additional burdens. Should YOU have one? Below is a simple decision tree to help you decide if you should consider setting up your own SMSF: Do you have more than $200K in superannuation assets and/or are likely to reach this level in a relatively short period of time? YES Do you want to be actively involved in managing or overseeing your superannuation assets? NO Think twice about it YES Are you financially literate and able to understand financial matters? YES Are you over 25 and under 80? YES Seek professional advice 18

19 Illustrative case study $850,000 The Alexanders SMSF Mary and Jonathan $20,000 Edward $10,000 Peter The Alexanders are a family of four. Mary and Jonathan are both in their late 50s with a combined super balance of $850,000. Their two children, Edward and Peter, have both finished university and recently started new jobs. Edward has just under $20,000 in super while his brother has approximately $10,000. The Alexanders were keen to explore the cost savings from setting up their own family Self Managed Super Fund (SMSF). They saw this as a way of not only achieving savings in administrative costs from combining the family s four separate superannuation accounts into one, but also as a way of helping themselves and their children build their super balances through taking a more active role in their finances. As a family, the Alexanders have always taken a very keen interest in investing. Jonathan has worked in the banking industry his entire life, while Mary lectures in economics at a university and they are keen to pass some of their accumulated knowledge and interest to their sons. For the Alexanders an SMSF makes perfect sense. They achieved the level of control they wanted over all of their superannuation investment decisions and were able to put their knowledge and interest in investment markets to good use as well as help their children take a more active interest in the family finances a win, win situation all round. 19

20 In summary The main benefits of an SMSF are: reduced costs, flexibility and control. By pooling assets within your SMSF you can potentially gain access to investments that might not have been previously available to you. Remember that you can have investment choice within the safety of a public offer superannuation fund - it s worth investigating this option before setting up your own SMSF and comparing the benefits and disadvantages of each. 20

21 CHAPTER 3 GETTING THE FOUNDATIONS RIGHT 21

22 Chapter Three: Getting the foundations right The basic structure of an SMSF One of the first concepts to understand when it comes to the structure of an SMSF is that an SMSF is a trust. A trust is simply an arrangement where a party, that is a person or company, holds assets for the benefit of another party - referred to as a beneficiary or in the case of an SMSF, a member. The rules for establishing and operating a trust are detailed in a trust deed. All SMSFs need to have a trust deed which sets out the fund s objectives, who the trustees are, who can be members of the fund and various other details. All SMSFs need to have a trust deed which sets out the fund s objectives, who the trustees are, who can be members of the fund and various other details. There are essentially three main parties to an SMSF: 1. Trustee (s) The person, people or company appointed under a trust deed to hold and invest the fund s assets for the benefit of its members. The trustee is responsible for running the fund and making all the appropriate decisions with respect to the fund. The trustee must at all times act in the best interests of the members of the fund. Choosing the type of trustee is an important decision in establishing a trust. You can either elect to have individual trustees (in which case all members must generally be trustees) or a corporate trustee ie, a company, in which case all members must generally be directors of the trustee company. A corporate trustee tends to be a more expensive option but has certain benefits particularly in the event of the death or departure of a trustee. 1. The Fund An SMSF is a special type of trust established under a trust deed that is for the sole purpose of providing retirement benefits to its members. An SMSF is a special type of trust established under a trust deed that is for the sole purpose of providing retirement benefits to its members. 1. The Member(s) The members are the beneficiaries of the trust arrangement for whom the trustees are holding the fund assets. An SMSF must have a maximum of four members and no member can be an employee of another member unless they are related. 22

23 Typical structure of an SMSF with individual trustees Trustee One Mr Smith Trustee Two Mrs Smith MR & MRS SMITH SUPERFUND Member One Mr Smith Member Two Mrs Smith Typical Structure of an SMSF with a Corporate Trustee Director One Mr Smith Director Two Mrs Smith MR & MRS SMITH COMPANY PTY LTD Choosing the type of trustee is an important decision in establishing a trust. MR & MRS SMITH SUPERFUND Member One Mr Smith Member Two Mrs Smith 23

24 Can anyone be a trustee? An SMSF must have a maximum of four members and no member can be an employee of another member unless they are related. Certain individuals are banned from acting as trustee of a superannuation fund. If an individual is insolvent, under administration, been convicted of an offence involving dishonest conduct or has had an order against them in relation to breaching the Superannuation Industry (Supervision) Act 1993, then they are not able to act as a trustee. Responsibilities of a trustee The trustee is responsible for running the SMSF and making decisions in respect to the fund. Trustee duties and obligations include: 1. To act at all times in the best interests of all fund members 1. To keep the assets of the SMSF separate from personal assets 1. To ensure that the fund is operated for the sole purpose of providing retirement benefits for members or members dependants 1. To develop an investment strategy 1. To invest the assets of the fund in compliance with the investment strategy 1. To comply with record keeping and reporting requirements Setting up a fund The actual setting up of an SMSF is NOT a Do It Yourself Process and so it is important you seek professional advice. The Australian Taxation Office (ATO) has an excellent booklet titled Setting up a self-managed super fund and this is available from The actual setting up of an SMSF is NOT a Do It Yourself Process and so it is important you seek professional advice. 24

25 All SMSFs are required to have a trust deed, which is a legal document detailing the rules for establishing and running your fund. Your SMSF trust deed All SMSFs are required to have a trust deed, which is a legal document detailing the rules for establishing and running your fund. The trust deed needs to contain information such as: 1. The objectives of your SMSF 1. Who can be a member and/or trustee 1. What types of benefits can be paid and how benefits are to be paid 1. What contributions can be accepted 1. What investments you can make 1. How your benefits are to be treated on death As a legal document your trust deed needs to be regularly reviewed and kept up-to-date to ensure it continues to meet the needs of your fund s members. I would strongly recommend that you have this document prepared by a qualified professional. SMSFs allow for some great wealth building strategies but you may find that you re not able to take advantage of these if your trust deed does not provide you with the flexibility you need, so it really is critical to get the foundations for your fund correct. 25

26 Costs There are two types of costs associated with running your own fund: Establishment Costs the costs to set your fund up. Ongoing Costs the costs of running and maintaining your fund (see chapter one). Establishment Costs can vary depending on fees charged by professional service providers and whether you have a corporate trustee or individual trustees. The main costs involved in establishing a fund are: Trust Deed Preparation $500 - $1,000 Corporate Trustee Establishment $1,000 - $1,500 Other $1,000 - $1,500 Total $2,500 - $4,000 As a legal document your trust deed needs to be regularly reviewed and kept up-to-date to ensure it continues to meet the needs of your fund s members. In addition to these costs there are likely to be fees for professional advice, ATO registration and advice or establishment costs associated with investing. 26

27 In summary A trustee is responsible for running an SMSF and for making all the appropriate decisions with respect to the fund. All SMSFs must have a trust deed, which is a legal document detailing the rules for establishing and running your fund. Your trust deed needs to be regularly reviewed and kept up-to-date to ensure it continues to meet the needs of your fund s members Have your trust deed prepared by a qualified professional to ensure you have the flexibility to take advantage of different wealth building strategies. 27

28 CHAPTER 4 BUILD YOUR WEALTH AND SAVE TAX 28

29 Chapter Four: Build your wealth and save tax The tax benefits One of the most misleading perceptions about SMSFs is that they have significant taxation benefits. Unfortunately this is because some people promoting SMSFs often use the tax benefits associated with superannuation as a whole, such as the low tax rate on earnings, as a reason to establish an SMSF. This is misleading at best. The tax benefits associated with an SMSF are the same as the tax benefits associated with any other Australian complying superannuation fund. The tax benefits associated with an SMSF are the same as the tax benefits associated with any other Australian complying superannuation fund. While an SMSF does give you greater flexibility and hence potential tax benefits over other types of complying funds, the core tax benefits of superannuation should not be used to promote or encourage the use of an SMSF. TIP: Without doubt, superannuation as a whole remains one of the most tax effective vehicles available to investors in Australia today. It is a very powerful structure to accumulate wealth in an environment that has considerable tax benefits, although because of the benefits there are limits on the amount you can put into your fund. 29

30 The main taxation benefits of superannuation - whether or not it is an SMSF - are: 1. Tax on income - the maximum tax rate in a complying superannuation fund is 15%. This compares to a top marginal tax rate in Australia of 45% (plus the medicare levy), and is less than even the lowest marginal tax rate of 19% plus the medicare levy. In addition, from 1 July 2014 earnings over $180,000 will attract an additional 2% tax known as the Temporary Budget Repair Levy. This temporary levy on high income earners will be in place for a three year period. If you re over 60 years of age and in the pension phase, the tax rate generally falls to nil - yes that s right there is generally NO income tax once you re over 60 on income associated with paying a pension from a complying superannuation fund. Tax rate: Complying superannuation fund Top marginal tax rate in Australia Earnings over $180,000 Over 60 years of age 15% 45% + medicare levy + 2% Temporary Budget Repair Levy 0% On pension payments from a complying fund People often underestimate just how powerful this tax concession is when building their wealth. As an example, the graph below compares saving $10,000 per annum for 20 years earning 7% paying the highest marginal tax rate to saving the same amount in superannuation paying 15%. $ 35,000 Long-term investment Superannuation Personal Investment 30,000 25,000 20,000 15,000 10,000 5, Years The compounding effect of this saving is quite remarkable when looked at over a long time and remember, superannuation is a long-term investment. 30

31 1. Tax on capital gains - there is a 33.3% discount that applies to capital gains from assets that have been held for longer than 12 months. This means that the maximum tax rate on capital gains (for assets held longer than 12 months) is 10%. Compare this to capital gains from assets held outside of superannuation which typically attract a 50% discount, meaning if you are on the top marginal tax rate a capital gain will have an effective tax rate of 22.5% plus the medicare levy. The benefits: 10% tax 22.5% tax + medicare levy Superannuation Assets held for longer than 12 months Assets held outside superannuation 1. Tax deductions for contributions - in certain circumstances it is possible to claim a taxation deduction for contributions to a superannuation fund or for you to enter into a salary sacrifice arrangement with your employer so that your contributions are made from before tax income. This means you save income tax on the contribution made. Note however, that the contribution is taxed at 15%. As an example if your employer pays you $10,000 in normal income and you are on the top marginal tax rate plus the medicare and temporary deficit levies, you will only receive $10,000 49% = $5,100. If, however, your employer contributes $10,000 to a superannuation fund then this payment generally attracts only 15% tax meaning the net amount available to you within your superannuation fund is $8,500 a tax saving of $3,400. The benefits: Normal income from employer: Super contribution from employer: Up to 49% tax 15% tax Depending on your income level Up to a set dollar value TIP: I want to stress these advantages apply to ALL complying superannuation funds, they are not unique to SMSFs. So if someone is trying to persuade you to set up an SMSF based on these benefits look very closely at the advice and, if in doubt, get a second opinion. 31

32 What s different about an SMSF? Despite the previous comments about the main tax benefits being the same for an SMSF as any other complying fund, there are some unique features about an SMSF that means there are certain benefits over and above most other complying funds. The main tax benefits associated with SMSFs that can be different from other types of complying superannuation funds are: 1. The ability to segregate assets. The trustee of an SMSF can chose to use the segregated assets method or the unsegregated asset method for determining how to treat taxable income when a fund runs both a pension and accumulation phase. Basically this means you can specify particular assets that apply to the pension component of the fund. This can have a substantial benefit because the income and capital gains from assets associated with the payment of a superannuation income stream are exempt from income tax. This means you can have the more tax inefficient assets, or those assets with high levels of accumulated capital gain (which you may want to realise), in the pension phase where no tax is payable. 1. The ability to time the realisation of capital gains. The ability to choose when to realise a capital gain and, in particular, to defer it until commencement of a pension is a very powerful strategy. Let s say you have an asset that has grown from $100,000 to $200,000 - during the accumulation phase if you sell the asset you would realise a $100,000 capital gain and, assuming it had been held for twelve months, this would be subject to tax at 10% or $10,000. If, however, you wait until you commence a superannuation income stream, or pension, and then sell the asset, the gain may be exempt and if so NO tax should be payable. TIP: So in summary - yes there are fantastic taxation benefits associated with an SMSF but many of these benefits also apply to other forms of complying superannuation funds. The main additional tax benefits associated with an SMSF revolve around flexibility and the ability to time and control tax events so you maximise the benefits to members. 32

33 What tax deductions are available in your fund? As with individuals, your SMSF can claim a tax deduction for costs incurred in the course of gaining or producing assessable income. So your fund may be able to claim deductions for things like: Ongoing management fees Accountancy and legal costs Interest costs on limited recourse borrowing (see Chapter Eight for more details) In any wealth strategy, tax and tax alone should never be the sole driver for any investment decision. Deductions are also available for some types of insurance premiums. Remember the tax rate in a superannuation fund is a maximum of 15% so as a general rule you are better off to have deductions in your own name at your marginal tax rate (which will probably be higher) rather than in the name of your superannuation fund in order to reduce your personal income tax liability. TIP: MY PERSONAL WARNING ON TAX While legally reducing tax is important in any wealth strategy, tax and tax alone should never be the sole driver for any investment decision. Over many years I have seen people lose significant amounts where they invest solely on the basis of tax. Unfortunately, I have also seen many unscrupulous promoters make money by selling tax effective investments where the tax benefits are great BUT the investment is lousy, over priced or the fees are uneconomically high. The only people that tend to benefit from these schemes are the promoters and the managers. The investors and the Australian government are the ultimate losers. So my advice is never make an investment decision based solely on the tax benefits - always make sure the investment stacks up in its own right. 33

34 Do all superannuation funds get these tax concessions? In a simple word, NO! In order to receive the concessional tax treatment the fund must be a Complying Superannuation Fund. For an SMSF to be complying it must be what is known as a resident regulated fund and it must comply with various regulatory provisions (the main one being the SIS Act). In order to receive the concessional tax treatment the fund must be a Complying Superannuation Fund. The cost of non-compliance The cost of your fund not complying is dramatic. A tax rate of 45% is applied to the entire taxable income of a non-complying fund! This is the same as the top marginal tax rate in Australia. The consequences of non-compliance are actually far worse, not only is the income subject to tax at the top marginal tax rate but the whole value of the fund, less any tax-free component, is also subject to tax at the top marginal rate. This means that if your fund becomes non-complying for any reason you could potentially lose almost half of the funds in tax! Non-complying funds Taxable income from a non-complying fund = $35,000 Minus tax rate of 45% = $15,750 $19,250 Remaining The most common causes for SMSFs becoming non-compliant are: 1. Members moving overseas 1. The fund not being managed and controlled in Australia 1. The fund having no active members So you need to be very careful if you are a trustee or member of an SMSF and you plan to move overseas. 34

35 In summary In any wealth strategy, tax and tax alone should never be the sole driver for your investment decisions. You can claim a tax deduction for the costs incurred in producing assessable income within your SMSF. In order to receive concessional tax treatment your SMSF must be a Complying Superannuation Fund. 35

36 CHAPTER 5 MONEY IN AND MONEY OUT 36

37 Chapter Five: Money in and money out Types of contributions to superannuation Whenever you make a contribution to your SMSF it will either be a deductible contribution (also referred to as a concessional contribution) or an after-tax contribution (also referred to as a non-concessional contribution). A deductible contribution is a contribution from your employer or a contribution for which you intend to claim a tax deduction. Because deductible contributions are made from pretax earnings, or you have claimed a tax deduction on them they are taxed at a maximum rate of 15%. An after-tax contribution is typically a contribution you make with after-tax funds on which you do not claim a tax deduction. Because you have typically already paid tax on money used to make non-concessional contributions these types of contributions are not taxed when contributed to the fund. Who can contribute to superannuation? To be able to contribute to a superannuation fund you must be under 65 years of age or if aged between 65 and 75 years, you must satisfy certain work test criteria. You are generally unable to contribute to superannuation over age 75 with the exception of mandated employer contributions. Who can contribute to superannuation? > Under 65 years of age > Between 65 years and 75 years and satisfy certain work criteria 37

38 Limits on contributions Because of the substantial tax benefits associated with superannuation there are contribution caps on the amount you can contribute. There are two types of caps: A concessional contribution cap (the maximum amount that can be contributed for which a tax deduction is claimed) and a non-concessional cap (the maximum amount you can contribute). For the financial year the maximum concessional cap is $30,000 if you are less than 49 years of age, or $35,000 if you are aged 49 years or over, on 30 June The non-concessional cap is $180,000 in any one year. A non-concessional cap of up to $540,000 may be available over a three year period depending on your age and contributions history. Limits on contributions Maximum concessional cap: Age: Under 49 years Age: 49 years or over $30,000 $35,000 Non-concessional cap: $180,000-1 year $540,000-3 yrs TIP: NOTE: There are significant penalties for exceeding contribution caps so always seek professional financial advice before making any changes to your contribution level. 38

39 In order for your fund to pay out either a lump sum or a pension you must satisfy a condition of release. When can you get your money? In order for your fund to pay out either a lump sum or a pension you must satisfy a condition of release. There are a range of conditions of release but the most common are: 1. Retirement 1. Age Commencing a transition to retirement income stream after reaching preservation age 1. Termination of employment, however there are restrictions on payments if you are under preservation age 1. Permanent incapacity or terminal illness Preservation age is the minimum age at which you may access your superannuation benefits once you meet the retirement conditions. The preservation age has been progressively increased and depends upon your date of birth as shown in the table below. Date of Birth Preservation Age Prior to 1 July July 1960 to 30 June July 1961 to 30 June July 1962 to 30 June July 1963 to 30 June On or after 1 July

40 Taking fund assets instead of cash One advantage of an SMSF over other types of superannuation funds is that it is possible for your fund to pay out a benefit in-specie. This means that instead of cash your fund could transfer an asset to you. For example, if your fund owned a portfolio of shares, on retirement, instead of paying out a cash benefit, the fund could transfer the portfolio of shares into your name in lieu. There are tax and other implications in doing this as the transfer may trigger a capital gains tax liability and/or stamp duty so it is worth getting professional advice to explore the different options available. How are your benefits taxed on withdrawal from your SMSF? Benefits paid from a superannuation fund can be taxable, whether they are or not and the tax rate applicable depends upon your age, the type of payment and the component of the payment. In the case of lump sum withdrawals, the tax depends on your individual circumstances and the components in your fund. The non-concessional, or after tax, contributions you have made are tax-free and not subject to tax on withdrawal. The deductible, or before tax, contribution plus the fund s earnings are taxed at different rates depending on your age as shown in the table below: Age Taxable rate 60 years and above nil Preservation age to 59 years First $185,000 nil Balance 15%* Under Preservation Age 20%* *Plus the medicare and temporary deficit levies 40

41 Drawing an income from your SMSF One of the most effective ways to benefit from your superannuation in retirement is to commence a pension. The main type of pension payable from an SMSF is a called an Account-Based Pension. An Account-Based Pension is simply an income stream paid from a superannuation fund that satisfies certain requirements. There are minimum pension payment levels that must be paid each year and this minimum amount will depend upon your age and the value of your fund. The percentage of the assets that must be drawn as the minimum pension increases each year and in effect forces you to draw down your capital over your lifetime. Minimum pension payments Age % of assets that must be drawn down each year Under 65 4% % % % % % One of the most effective ways to benefit from your superannuation in retirement is to commence a pension % While you must draw a minimum amount of pension each year (as shown in the above table), the amount and frequency of the pension payment is up to you. You are also able to make lump sum withdrawals. 41

42 You need to ensure there is sufficient cash in your fund to make the minimum pension payment each year. Tax on pensions Account-Based Pensions are very tax effective because: 1. Earnings and capital gains associated with the pension assets in your SMSF are generally tax-free 1. If you are over 60 all withdrawals and pension payments are generally tax-free. If you are under 60 the income drawn is subject to tax at your marginal tax rate but there can be a tax-free component (depending on the components of your fund) and you are generally entitled to a 15% tax rebate on the part of your pension that is subject to tax. TIP: WARNING ON PENSIONS The big issue for SMSFs in paying a pension is ensuring there is sufficient cash to make the minimum pension payment each year. This can be a problem where the SMSF has invested in one or a limited number of illiquid investments (ie, investments that can t be easily converted to cash) such as property and where the income from the investments are not sufficient to meet the pension payments. This problem increases as you get older as the minimum pension amount increases each year. 42

43 Dealing with your SMSF There are a range of restrictions around members dealing directly with their SMSF and in particular selling or purchasing assets from it. There is a specific prohibition on a trustee of an SMSF acquiring an asset from a related party (for example a member) but there are certain assets which are exempt. The main ones include: 1. Business Real Property - that is a property that is used in carrying out a business - for example a doctor who owned the property from which their practice is run could transfer this into their SMSF 1. Listed Securities - for example shares listed on the Australian Securities Exchange 1. Units in a widely held unit trust - for example units in a public unit trust The most important guideline in any transaction with your SMSF is to ensure it is on an arms length basis. In other words you cannot transact with your SMSF unless it is at fair market value. Some good examples of what you should generally avoid include: 1. Buying an asset off your fund for more or less than its market value 1. Selling an asset to your fund (except as noted above and then at market value) 1. Hiring, renting or using an asset of the fund other than on a strictly commercial basis 1. Lending money to or providing financial assistance to members of the fund or their relatives As noted above, this however does not prevent you from transferring certain assets into your fund - if they are bought at fair market value then it is just like any other transaction, but if you transfer them in at below market value then the shortfall in the value may be treated as a member s contribution. This means that you can transfer assets like shares or business real property to your fund as a superannuation contribution although you should note that the normal superannuation contribution limits still apply. TIP: A Word of Warning: The transfer of an asset into your SMSF is a sale and as such capital gains tax may apply. 43

44 There are many issues and regulations around trustees dealing with related parties of an SMSF. These can be complex and the consequences of breaching the regulations can be severe so it is very important that before transferring any assets in or out of your fund or entering into any arrangement with your fund, you seek professional financial advice. Illustrative case study Neal and Julia $500,000 SMSF With the ever-increasing popularity of Self Managed Super Funds (SMSF) retired couple, Neal and Julia Parker, were keen to join the growing number of Australians taking greater control of their retirement savings. With a combined super balance of $500,000, Neal and Julia were confident they had sufficient funds to make having an SMSF financially viable, while also having the spare time needed to run their fund. Neal and Julia did their homework and sought expert advice before making any decisions about their retirement savings. Based on this advice, Neal and Julia decided that as they got older running their own SMSF was probably going to be more of a burden at a time when they were likely to need increasing assistance with their financial affairs. Neal and Julia eventually decided that an SMSF wasn t for them at this time in their lives and instead chose another investment option which gave them the flexibility as well as the ongoing professional support they wanted as they got older. 44

45 In summary To contribute to a superannuation fund, you must be under 65 years of age or, if aged between 65 and 75 years, you must satisfy certain work test criteria. For your fund to pay out either a lump sum or a pension, you must satisfy a condition of release. To really benefit from your superannuation in retirement make sure you start a pension. 45

46 CHAPTER 6 WHO S GOT YOU COVERED? 46

47 Chapter Six: Who s got you covered? Insurance in your SMSF One of the real dangers in setting up an SMSF is that you forget one of the key benefits often associated with industry or employer sponsored superannuation funds, insurance. Many industry and employer sponsored funds have automatic term and total disability cover. If you transfer out of one of these funds before you have an alternative policy in place you may find you have a period where you are uninsured or worse still, because a number of these policies provide automatic cover, if you have health issues you may find it is not possible to get the same insurance cover elsewhere. It is crucial that before you transfer money out of your existing superannuation funds, you check what insurance cover you have, confirm whether you need the cover or not and if you do, make sure that BEFORE you withdraw from the fund you put in place alternate insurance cover. 47

48 The main types of insurance to consider are: Term Life Insurance Term Life Insurance pays a lump sum in the event of death. Total and Permanent Disability Insurance Total and Permanent Disability Insurance pays a lump sum in the event of permanent disability. Salary Continuance or Income Protection Insurance Salary Continuance and Income Protection Insurance pays an income in the event of disability that results in you being unable to work. Trauma Insurance Trauma Insurance pays a lump sum where you suffer a defined traumatic event such as a heart attack, cancer or a range of other debilitating events. 48

49 Insurance may be taken out directly ie, in your own name, or via your SMSF. There are benefits and disadvantages in holding insurance within superannuation. The main benefits are: 1. It can be tax effective because you are effectively paying premiums from your contributions, which may come from your pre-tax income (hence you effectively get a tax deduction for your premiums). 1. By using the fund s money to pay premiums there is no impact on your personal cash flow. The big disadvantage is that the taxation of any payouts to non-dependants is a lot more. For example, a benefit from a life insurance lump sum outside of super doesn t attract tax no matter who it is paid to. If, however, a payout goes to a non-dependent as part of a superannuation death benefit it can attract tax of up to 30% plus the medicare and temporary deficit levies. Trustees Note: It is a requirement that, as Trustee of an SMSF you consider whether to hold insurance for members of the fund when formulating and reviewing your fund s investment strategy. This doesn t mean you have to have insurance in your SMSF, it just means that the trustees need to show that it was considered. 49

50 In summary Before you transfer money out of your existing superannuation fund(s), check what insurance cover you have in place. Decide what insurance you need and make sure BEFORE you withdraw from your existing super fund you put in place alternate insurance cover. 50

51 CHAPTER 7 GROWING YOUR SUPER NEST EGG 51

52 Chapter Seven: Growing your super nest egg Investing So you ve made it this far and decided to set up your own fund. Not only have you set your fund up but you have transferred in your future wellbeing. You have transferred your accumulated life time superannuation savings for most people that means your superannuation fund now contains the majority of what will become your retirement income and hence the key to a secure and enjoyable retirement. TIP: Establishing a fund and transferring assets into it is really just a very minor step and will not determine your success or otherwise. What you do with the money will determine just how successful you will be. How will you invest and what steps will you take to protect and grow your superannuation funds? What is crucial is that you ensure that you invest the funds to secure your desired outcomes without exposing it to risks you can t afford to take. Your fund s investment strategy Trustees of a superannuation fund are required to formulate and implement an investment strategy and also to regularly review it. The strategy needs to take into account the likely risk and return having regard to the fund s objectives and the types of investments the fund can invest in. In addition, it should provide guidelines on how investments will be chosen, appropriate levels of diversification, liquidity and the risk and return associated with investments. There is no legal requirement to have this strategy documented, however this is a sensible practice to ensure there is evidence of compliance. Risk versus return Trustees of a superannuation fund are required to formulate and implement an investment strategy and also to regularly review it. All investments have a certain amount of risk associated with them. One of the most important concepts to understand when investing is the tradeoff between risk and return. Generally speaking, the higher the potential return, the higher the risk. All investments carry some risk due to factors such as inflation, taxation, an economic downturn or a fall in a particular market. There are obvious risks, like the risk associated with shares or property and their potential to fall in value but there are also hidden risks or risks that aren t so obvious. 52

53 The level of risk you ought to take should also factor in the stage of life you are in. For example, when you are in your 30 s and 40 s, a certain amount of manageable and diversified risk is appropriate because at this point you are in what is called the accumulation phase. This means, you are starting to reach high or maximum earning potential, and should be putting your salary to work by accumulating wealth via savings and increased super contributions. You are not living off your superannuation and you have time to sit through cycles of ups and downs. So, all things being equal, you should be able to accept a higher level of risk in your investment portfolio. Once you have built up your assets and the value of your superannuation and you are nearing retirement, you should start to transition to a protection phase, as your level of risk tolerance naturally shifts down a gear. Once you begin drawing down on your super you are in what is called pension phase. At this point your investment approach should be focused on preserving your funds so they can provide an income throughout your retirement. It is however, important that you factor in inflation and so some exposure to growth asset classes like shares and property might still be appropriate. ACCUMULATION PHASE You are starting to reach high or maximum earning potential PROTECTION PHASE Your level of risk tolerance naturally shifts down a gear PENSION PHASE Your investment approach should be focused on preserving your funds Examples of less obvious risks are: Fixed interest investments that have a fixed capital value and a guaranteed interest payment but the security behind them is poor. While the interest rate for these types of investments might appear attractive, you are risking the capital you have invested for only a modest increase in income. Even an investment that looks low risk, for example a term deposit with a large bank, carries with it the risk that the value is eroded over time by inflation. Liquidity, or the ability to convert your investments to cash, is also an investment risk you need to factor in. This is particularly the case where your SMSF is paying a pension, the amount of which is designed to increase each year as you get older. In particular, if your SMSF has a large single property holding it might create liquidity issues because you can t sell part of a property like you can with some other investments. Time is a crucial element of managing risk in a portfolio. If you have a short investment time frame you cannot afford the risk of investing in volatile assets where the value can fluctuate (like shares and property). When you have invested for long periods of time your money generally has more time to recover from the ups and downs of investment markets so you can afford to accept the volatility for a potentially higher return. 53

54 Diversification - the key to managing risk A very important consideration in developing your investment portfolio is diversification and one of the most common issues you see with SMSFs is the failure to adequately diversify the portfolio. Diversification simply means investing your money across a range of different investments to reduce risk. The exact mix of investments you choose depends upon: 1. Your financial objectives and current circumstances 1. Your investment timeframe 1. Your personal tolerance for risk. Diversification is important because every type of investment has different characteristics and can experience different periods of ups and downs. Owning a diverse range of investments should help you achieve smoother, more consistent investment returns over time. It also reduces the impact should one particular investment not perform as expected. The more ways you diversify, the more you can reduce your risk. For example, you can invest: 1. Across different investment types or asset classes such as cash, fixed interest, property and shares 1. In more than one investment within each type of asset class for example, invest in several different industries and companies when investing in shares A key to successful investing is diversification of your savings 1. In more than one type of fund, and more than one fund manager, when using actively managed funds. 54

55 Asset classes All investments belong to what is known as an asset class. An asset class is simply a category of assets with similar characteristics. The main asset classes referred to in the investment world are: Cash and short-term deposits (usually just referred to as cash) Cash includes at call bank accounts, cash management trusts and accounts, on-call deposits and other short-term interest bearing deposits. The general definition of a cash investment is that it has a maturity or term of less than 12 months. Funds required for short-term expenses or to meet pension payments or capital withdrawals should be maintained in a cash based account. Fixed interest Fixed interest is a debt instrument that pays a return in the form of interest where the maturity or term is greater than 12 months. There are various forms of fixed interest investments but the most common are bonds, term deposits, debentures and mortgages. TIP: A word of warning about fixed interest: A common mistake you see inexperienced investors and trustees make is being attracted to higher rates of interest paid by less secure borrowers. Investment history in Australia is full of many shocking examples where investors have placed money on deposit at high interest rates without realising the potential risk to their capital. When the inevitable crash occurs the unfortunate investors lose some or all of their funds. My advice is, for the fixed interest part of your portfolio, that the increase in return achieved by risking your capital is simply not worth it. Let s consider why. What it boils down to is that you are risking capital for a relatively small increase in return. The most you can ever get is the extra interest, unlike shares or property where you can get substantial capital gains, so for an extra 2% or even 5% you need to seriously question Is it worth the risk? Always remember that there is a reason for the higher interest rate being offered - that reason is usually a higher risk to your capital. 55

56 Shares/equities A share is simply a part ownership in a company. Shares can be listed on the Australian Securities Exchange (ASX). When you buy shares you are essentially buying an interest in that company, and along with the other shareholders, you then become a part owner of the business. The rationale for buying shares is that when the company profits, so do you. The return from shares is in the form of income from any dividends paid and capital from any growth in the share price. As shares can go up and down in value, you need to ensure you have a long-term investment horizon when considering whether to invest in them. Typically you should only invest in shares if you have a minimum three to five year investment time frame. Property This asset class includes residential, commercial, retail, hotel and industrial property. You can invest in property directly such as when you buy a house or commercial premises such as a shop, or indirectly, such as by purchasing units in a property trust that is listed on a stock exchange. Property is usually considered a medium-term investment, with a minimum time frame of three to five years. 5 International investments Investing internationally enables you to gain exposure to a wider range of investment options and increases your portfolio s diversification. It is possible to invest either directly or via managed funds in overseas markets. Be aware that investing internationally does have its own specific risks because you are taking a risk on the relative value of the Australian dollar against the value of the currency you are investing in. Many managers offset or mitigate this risk by hedging their international investments. It is important that you understand the hedging strategy and the impact it can have on any international investments you hold. A common mistake by trustees of SMSFs is to ignore international investments and hence not adequately diversify the portfolio. Australia makes up a very small part of world markets and by not considering international exposure you are limiting your opportunities and also concentrating the risk of your portfolio to only the Australian economy. 56

57 TIP: A word of warning on international investments: Investing internationally can be complex and also exposes your portfolio to currency risk ie, that the value of the currency you are investing in falls against the Australian dollar. A well diversified portfolio should have exposure to all of the asset classes. The percentage you put in each asset class should depend upon factors such as your age, your investment time frame and objectives and your risk profile or your level of comfort with risk. You need to ensure that you consider the risk profile, appropriate investment strategy and the different investment time horizons for each member of the fund. An experienced professional financial adviser should be able to assist you in determining your risk profile and designing an appropriate portfolio structure to ensure adequate diversification. Alternatively why not try the Risk Profile calculator at risk-profiler.sfg.com.au Average 20 yearly returns by asset class 6% Emerging Markets International Shares 5% 4% 3% Australian Shares Australian Real Estate Investment Trusts Australian Fixed Interest Cash 2% 1% 0% Source: Morningstar YEAR 57

58 Investment structures You can gain access to the different asset classes either by investing directly in them, for example buying shares on the ASX or buying an investment property, or by using a managed structure such as a managed fund, exchange traded fund or real estate investment trust. Managed funds Managed funds pool the money of many individual investors. This money is then invested by a professional fund manager in one of the asset classes eg, shares, property and fixed interest, or across a range of the asset classes in line with the fund s stated investment objectives. Exchange traded funds Exchange Traded Funds (ETFs) are funds that hold a portfolio of securities managed to match the performance of an underlying index. Because they are index based, they are generally an efficient, liquid and cost effective way to gain index exposure to various equity markets. Instead of issuing units like a managed fund, ETFs issue shares which trade throughout the day at prevailing market prices, like other securities on the ASX. Real estate investment trusts For most SMSFs, buying commercial office buildings, shopping centres, or industrial real estate is simply out of reach financially. A Real Estate Investment Trust (REIT) is a corporate structure whereby a number of smaller investors can pool funds and acquire large property assets or a portfolio of properties, with a professional property manager managing the day to day activities of the trust. The investor owns a proportional share of the REIT. Putting all your eggs in one basket There is no restriction on investing all of the fund s assets in one investment such as a property or one investment class like shares. However, trustees should ensure they can justify doing this and document the approach in the formal investment strategy. It is important that the trustees are aware of and accept the risk associated with investing in just one asset and also address the potential issues such as liquidity and managing cash flow for expenses and pension payments (see my comments on owning direct property on page 59). 58

59 Owning direct property in your SMSF A very common strategy for SMSFs has been to borrow funds in order to buy an investment property. While investing in property and gearing into property can be highly effective strategies, there are a number of things to be very careful about if using your superannuation fund to do this: Diversification - usually you would be limited to one or maybe two properties - this means that you are putting all of your retirement savings in just one investment. Not only that, most peoples only other major asset is the family home (which is also a residential property) and hence you have put nearly all of your assets in one type of investment, residential property. If you re approaching retirement, make sure you have sufficient liquid assets within your fund. Liquidity - the purpose of your superannuation is to provide you with a lump sum or income stream in retirement. As highlighted above, one of the most effective things to do with your superannuation on retirement is to commence an income based pension. If you hold all of your superannuation in one or two investment properties, unless they are paying an income (after all costs) in excess of the minimum pension required to be drawn down (which increases each year) you might find you do not have sufficient cash to pay the pension. See also Chapter Eight - Borrowing within your SMSF. 59

60 Illustrative case study Shane $100,000 Geraldine $80,000 Shane Bertrand is 55 years old and his wife, Geraldine, is in her early 40s. The Bertrand s saw having an SMSF as a great opportunity to grow their wealth for their retirement. Shane and Geraldine believed having an SMSF gave them a chance to reduce the administration charges they were currently paying from having two separate superannuation accounts. They were also keen to use their SMSF as a way of purchasing an investment property something which up until now had only been a pipe dream for the couple and not something they believed they could afford to do outside of the superannuation environment. Shane had $100,000 in his super while his wife had $80,000 in super savings. When they spoke with an expert in Self Managed Super Funds, they were surprised to discover that an SMSF was probably not the best investment vehicle to help them achieve their long-term financial goals and objectives. After taking into consideration the ongoing running expenses of the fund and associated investment costs, given the amount of super they had to invest, it was going to be more cost effective for them to continue investing separately in their current superannuation funds. While one of the Bertrand s objectives had been to use their proposed SMSF to purchase an investment property, they found this would have severely limited the diversification they could achieve within their SMSF. This would have caused greater problems for the couple as Shane approached retirement and needed to draw down on funds from their SMSF. Ultimately, this may have resulted in the need to sell their investment property sooner than they would have hoped, potentially missing out on the investment growth they were hoping the property would achieve. Based on the advice received, and given the increasing investment flexibility available within public offer super funds, Shane and Geraldine decided that an SMSF was not the right choice for them and found there were more suitable options available to help them achieve their desired investment outcomes over time. Thanks to seeking professional advice, Shane and Geraldine were also pleasantly surprised to discover they could afford an investment property outside their super savings. They used a negative gearing strategy and were able to maximise the tax benefits from this type of investment. 60

61 In summary Remember that all investments carry a degree of risk due to factors such as inflation, taxation, an economic downturn or a drop in a particular market. If you re a trustee of a superannuation fund you will be required to formulate and implement an investment strategy and also to regularly review it. A key to successful investing is diversification of your savings this helps to spread risk and smooth out your investment journey. 61

62 CHAPTER 8 BORROWING WITHIN YOUR SMSF 62

63 Chapter Eight: Borrowing within your SMSF Neither borrower nor lender be One of the main attractions for many people in establishing an SMSF is the ability to leverage up your investment through borrowing. While there are specific prohibitions on SMSFs borrowing, they are able to do so on what is referred to as a limited recourse basis. There are quite tight restrictions and requirements around borrowing but the essence is that the other assets in the SMSF must be protected and not used as security. In other words the lender must only be able to claim against the asset acquired with the loan and no other assets of the fund. The method of achieving this is by holding the asset against which the funds are borrowed in a separate trust so the SMSF acquires what is known as a beneficial interest only. A typical example of how a Limited Recourse Loan Works Loan to SMSF SMSF Loan repayments LENDER Income from asset Right to acquire Asset Loan plus any additional SMSF capital Lender Lender s recourse is limited to asset only HOLDING TRUST (Asset Owner) Asset Owner ASSET 63

64 There are a range of restrictions on limited recourse borrowing, which are largely designed to mitigate some of the risks associated with gearing a fund that is designed as a vehicle to provide benefits to members in retirement. The main issues to be aware of include: 1. The borrowed funds must be used to purchase a single acquirable asset. This means the asset must be either one single asset or a collection of identical assets. So you can buy a property on a single title, or a parcel of shares in the one company that are purchased as a whole, or units in a unit trust BUT you can t buy assets that are made up of a range of different assets such as a number of strata title units ie, units on different titles or a portfolio of different shares. 1. The lender s rights must be limited to the asset acquired. In other words in the event that the SMSF trustee defaults the proceeds from the sale of the asset is the only amount that can be used to repay the lender and there must be no recourse to the other assets in the SMSF. This ensures the other assets in the fund are protected. 1. The asset acquired must be held on a separate trust arrangement. 1. The acquired asset cannot have any other charge against it. 1. Once you have purchased an asset using limited recourse borrowing you cannot simply replace that asset with another one except in very limited circumstances. So as a general rule if you sell the asset you will need to unwind the structure and enter into a new arrangement to buy a different asset. The effect of this requirement is that you also can t make substantial changes to the asset that would result in it being regarded as a substantially different asset. You need to be careful here as actions such as subdividing a block, building on a block, reinvesting dividends etc can all result in a breach of the limited recourse borrowing arrangement (LRBA) requirements. Make sure your trust deed and investment strategy allows it In order for you to use limited recourse funding both the trust deed and the investment strategy must allow the fund to borrow for investment purposes so, before undertaking any of these arrangements, check that your deed and investment strategy specifically allows for it. If they don t you will need to update them and you should get professional help to do this. If you want to use limited recourse funding make sure your trust deed and investment strategy allows for it. Can I lend money to my SMSF? There is no specific prohibition on you lending money to your SMSF however, any such arrangement should be on an arm s length basis (see Dealing with your SMSF on page 43). This means that the terms and conditions of the loan (as an example the interest rate charged) should be no better or worse than those that would apply should you have entered into the arrangement with a non-related party (such as a financial institution). 64

65 The benefits of borrowing So why would you want to borrow in your superannuation fund? The answer is leverage. By borrowing you can increase your exposure to an asset that can potentially grow in value and hence you can increase the return on your invested capital. The following is a very simple example of how leveraging works, ignoring taxes and costs. Not Borrowing vs Borrowing $100,000 $100,000 PLUS BORROWING $100,000 INVEST INVEST 10% RETURN ON INVESTMENT 10% RETURN ON INVESTMENT = $110,000 = $220,000 Be careful if borrowing to invest - while it can increase your returns it can also increase your risk and magnify your losses Assume you have $100,000 in your superannuation fund and you invest it and achieve a return of $10,000, you have made a 10% return on your capital. If however you take your $100,000 and borrow a further $100,000 so that you invest $200,000 in the same asset and it achieves the same return of 10% you have made $20,000, or a 20% return on your original capital. That is the power of using O.P.M. (other people s money)! Unfortunately, in practice, it is not quite that simple. 65

66 Firstly if the asset falls in value by 10% you have lost $20,000 or 20% of the value of your fund and secondly there are costs such as interest and fees which offset the profit you may make or increase the loss. So borrowing significantly magnifies the outcome - positively if the asset grows in value at a rate greater than the costs and negatively if the asset falls in value. Hence the term leverage, you are leveraging your money. So the bottom line is that borrowing to invest, whether in superannuation or outside of superannuation, can increase the return on your capital but it also significantly increases the risk and magnifies any capital losses. There is no right or wrong answer as to whether you should borrow using your SMSF. Like so many investment strategies, it all depends on you and your overall objectives. Things to consider: 1. Your age - younger people can typically benefit more from leveraging because of the longer time frame before they need access to their capital. People approaching retirement should be very cautious because they will need access to capital and/ or income and hence risk needs to be minimised and there needs to be adequate liquidity to fund retirement. 1. Your risk profile (see chapter seven) you need to be comfortable with the additional volatility associated with leveraging. 1. Your other assets if you have assets outside of superannuation you might be prepared to take a more aggressive stance with your superannuation. If your superannuation is the only asset you have to fund your retirement you should be cautious about taking higher risks using gearing (unless you have a long time until you will need the money). 1. Your level of other debts your superannuation should never be thought about in isolation. You need to take into account your other assets and liabilities. If you have high levels of debt relative to assets outside of superannuation it may be wise to take a more cautious approach with your superannuation. Negative gearing Negative gearing is when you borrow to invest and the costs, such as interest payments, associated with the investment are greater than the income. This is a common strategy used to build wealth because the income loss you make is tax deductible and hence the real loss is less. If the asset grows by more than the after tax loss, you benefit. TIP: A note on negative gearing Negative gearing is far less effective in an SMSF because the tax rate (in the accumulation phase) is only 15% and so the benefit of the tax deduction is much less than if it was in your own name at your marginal tax rate (which could be as high as 45% plus the medicare and temporary deficit levies). For this reason negative gearing strategies are usually best applied outside of the superannuation environment. 66

67 In summary Understand how and where you want to invest. If you want to use limited recourse funding to purchase assets within your SMSF, both the trust deed and investment strategy must allow your fund to borrow for investment purposes. Be careful if you re borrowing to invest. While this approach can increase the return on your capital, it can also significantly increase your risk and magnify your losses. If you re approaching retirement make sure you have sufficient liquid assets within your fund to pay the minimum pension requirements. 67

68 CHAPTER 9 THE END OF THE ROAD 68

69 Chapter Nine: The end of the road What happens when you die? On a member s death your SMSF is required to pay out a death benefit from the accumulated funds belonging to that member. The benefit can be paid to a spouse, former spouse, child, financial dependent, the executor or trustee of your Will or some other person if the trustee is unable to find a dependant or legal representative. Typically the benefit would be paid out as cash, although it is possible to pay the benefit as a pension to a dependant. It is also possible to make an in specie payment of the fund s assets. TIP: It s worthwhile making sure you have an up-to-date Will and Death Benefit nomination when it comes to your superannuation. Many people are surprised to discover that their superannuation is not automatically covered by their Will. In the event of your death, if you don t have a binding death nomination in place, the trustees of your SMSF can ultimately decide to whom your super assets are paid. Tax on death Where a lump sum death benefit is paid from a superannuation fund it is tax-free if paid to what is referred to as a tax dependant. A tax dependant includes a spouse, former spouse, child under 18 or a financial dependent. Where the benefit is paid to a non-tax dependant it is subject to tax. The rate applied depends upon the tax components of the fund. The tax-free component is tax-free and the taxable component is taxed at 15% or 30% (plus the medicare and temporary deficit levies) depending on whether it is the taxed or untaxed element of your fund. Make sure you have an up-to-date Will and a current Death Benefit nomination in place. There are a number of different strategies which you can use to help reduce the amount of tax paid, for example a re-contribution strategy or a multiple pension strategy. The tax applicable to superannuation benefits can be complex so you should seek professional advice before withdrawing or paying out funds from an SMSF but note the high tax if paying a benefit to a non-tax dependant. 69

70 Chapter Nine: The end of the road What happens when a trustee dies? On the death of a trustee, the member s executor or administrator of the estate may replace them as trustee subject to the remaining trustees agreeing to their appointment. What determines who gets the money? There are a range of methods of determining who gets to decide who your superannuation fund assets are paid to on death. The fund s trust deed should contain the rules in relation to the payment of death benefits. The main options when it comes to deciding who your super fund assets are paid to are: Trustee Discretion - Under this option the trustee has discretion as to who to pay the benefit to. This option provides a level of flexibility to the trustees and in particular enables the benefit to be paid in the most tax effective manner, but you need to be very confident the remaining trustees will act in accordance with your wishes. In some cases, trustee discretion can lead to disputes between potential beneficiaries. Binding Death Benefit Nomination - This is where a member provides specific written directions as to how benefits are to be paid. The trustees are bound to follow these instructions provided the nominated beneficiaries are dependants under superannuation law. Reversionary Pension Nomination - If the fund is in pension phase, it is possible for a member to nominate an individual as a reversionary beneficiary so that they can continue to receive a pension from the fund in the event of the member s death. An important point - running your own SMSF can add a degree of complexity to your estate planning so, as a general rule, it is wise to review your overall estate plan (such as your Will) when thinking about setting up your own fund. 70

71 Illustrative case study SMSF ACCOUNT-BASED PENSION Greg and Martha Professional Adviser Greg and Martha Greg and Martha Shaw are both in their late 60s and have been running their SMSF for more than 10 years. Greg in particular has always had an interest in investing and saw that when he retired he could take more active control of his and his wife s super savings. Greg saw this as an opportunity to develop a skill he never really had time for whilst working full-time. As Greg and Martha have progressed through their retirement, Greg s health started to deteriorate and he became increasingly concerned that, should something happen to him, Martha would be left to look after the running of their SMSF. While his wife has a passing interest in their SMSF the real interest and running of their fund had always been with Greg. During their yearly SMSF compliance review, Greg raised his concerns with his financial adviser. After this discussion, both Greg and Martha decided that as they were getting older, now would probably be the best time to discontinue their SMSF and instead opt for the flexibility and ease of having an Account-Based or Allocated Pension via a public offer fund. This approach freed up Greg s time so he could concentrate on his health and spending quality time with his family, while at the same time taking away some of the worry about the additional stress on his wife from managing their SMSF should something happen to him. 71

72 In summary A lump sum death benefit paid from a superannuation fund is tax-free if paid to a tax dependant such as a spouse, former spouse, child under 18 or a financial dependent. Don t pay more tax than you need to. The tax which applies to superannuation benefits can be complex so it s important you seek professional advice before withdrawing or paying out funds from your SMSF. Reviewing or putting in place an estate plan is an instrumental part of your financial strategy. Make sure you have an up-todate Will and current Death Benefit Nomination in place so your assets go to the intended recipients. 72

73 CHAPTER WHERE TO FROM HERE? 73

74 Chapter Ten: Where to from here? Making an informed choice Hopefully over the course of this ebook you will have discovered there are many factors you need to consider before deciding whether or not an SMSF is right for you and the different levels of assistance you may need if you do decide to journey down the SMSF path. When it comes to managing money that needs to last throughout your retirement, I can t stress enough the importance of seeking professional financial planning advice. This will help you decide whether an SMSF is the best investment vehicle to help you reach your financial and lifestyle goals or whether there are other options which may be more appropriate for you. Your lifetime savings Using the services of a professional financial adviser and accountant will help ensure your SMSF is established and remains compliant with the myriad of legal and regulatory legislation. They will also be able to assist you in taking advantage of strategic tax and wealth creation opportunities such as: 1. Getting the structure of your trust deed correct 1. Formulating your investment strategy 1. Wealth accumulation and investment considerations 1. Managing tax Again, make sure that you do your homework. There are many companies offering SMSF services who will readily help you set up an SMSF. Make sure you look at the range of services available to help you set up and run your fund. Also look for a company that allows you to tailor services to suit your needs and investment experience whether it s help in setting up your trust deed and strategy advice, yearly administrative and accounting requirements through to more comprehensive advice and assistance. Using the services of a professional financial adviser and accountant will help ensure your SMSF is established and remains compliant with the myriad of legal and regulatory legislations. Ultimately you need to be confident that whoever you re getting advice from is taking the time to take a holistic view of your financial situation and provide you with a honest appraisal of what really is right for you given your unique needs and circumstances. 74

75 Selecting your financial coach At the end of the day your financial adviser is there to provide you with the security and comfort of knowing you have the right financial strategy in place to get you where you want to be. The benefits of financial advice are about meeting your lifestyle goals in an efficient and timely manner and providing you with the confidence that you are making the most of your financial opportunities. Choosing a financial adviser who is right for you is an important personal matter. The financial adviser must be authorised to represent a licensed advisory business and ideally should be a member of the Financial Planning Association of Australia (FPA) and a CFP (Certified Financial Planner) practitioner. The value of advice in times of uncertainty is something that must not be overlooked. Often the comfort with the relationship can be put down to that feeling of trust and the chemistry working as much as anything else. It is a given that a good financial adviser must have the prerequisite technical expertise and be professionally competent. A good financial adviser is one who listens to your circumstances and understands the need behind the need. You should feel that they focus on you and the benefits of the advice to your situation rather than just the technical aspects of what is delivered. The Shadforth difference Not owned by a bank or insurance company 90 years heritage Offers breadth of services tailored to suit your needs Experienced, qualified financial advisers Awarded the prestigious Money Management Independent* Dealer Group for 2013 National network of financial advisers and accountants So what makes Shadforth so different? Well, for a start Shadforth isn t owned by a bank or insurance company, so straight away you can be confident that the advice you receive really will be in your best interest. Shadforth s financial advisers are also among the best qualified and highly awarded in the country. So when you partner with us you can be confident you will meet with the most experienced, qualified financial advisers. *The award recognises that Shadforth is not owned by a financial institution such as a bank or life insurance company. Shadforth is a wholly owned subsidiary of SFG Australia Limited (SFGA). SFGA is a leading non-aligned client focused financial advice and end-to-end wealth management firm. 75

76 TIP: For many people the greatest comfort comes from our client centric approach to wealth management. As an end-to-end wealth management firm, Shadforth offers a full range of financial planning solutions and services. This means we can look at your entire financial situation before making a recommendation to help you get to where you want to be. For some that may well be setting up an SMSF, for others, we may suggest an alternate investment pathway. Either way, our job is to help you make informed investment choices which you re comfortable with and to make sure you feel in control every step of the way. SMSF Services tailored for you Shadforth s specialised SMSF Service has been designed to take away some of the stress associated with meeting the administrative and compliance requirements which come from having an SMSF. With a range of services which can be tailored to suit your needs you ll enjoy seamless integration of your SMSF with your overall financial plan allowing you to: 1. Spend less time coordinating your finances 1. Reduce your risk of non-compliance 1. Receive timely and accurate information If you are looking for a complete service solution then Shadforth has the proven expertise and capabilities to provide the assistance you need including: 1. Existing fund transfers 1. Deed services 1. Pension establishments, commutations and conversions 1. Limited recourse borrowing 1. Technical advice and consulting 76

77 Proven expertise and advice you can trust From 1924 to today, Shadforth s priority has always been the financial well-being of our clients. Our time-honoured aim is to provide the best financial advice, solutions and services to meet our clients needs, whilst our 90 year heritage of building real wealth stories means we have a proud record of helping generations of Australians. Awarded the prestigious Money Management Independent* Dealer Group for 2013, Shadforth continues to be one of Australia s leading financial advisory groups. With Shadforth you access a network of advisers and accountants across Australia providing financial planning, investment consulting, superannuation, SMSF, personal insurance and lending advice and much more. If you are looking for high quality financial advice and an honest appraisal of the best way for you to reach your lifestyle aspirations or business goals, then make sure you speak to your team at Shadforth. Take advantage of our obligation-free appointment or telephone call by contacting us today on or [email protected] *The award recognises that Shadforth is not owned by a financial institution such as a bank or life insurance company. Shadforth is a wholly owned subsidiary of SFG Australia Limited (SFGA). SFGA is a leading non-aligned client focused financial advice and end-to-end wealth management firm. 77 The Truth about SMSFs

78 In summary Using the services of a professional financial adviser and accountant will help ensure your SMSF is established and remains compliant with the myriad of legal and regulatory legislations. Look at the range of services available to help you set up and run your fund. Find a company that allows you to tailor services to suit your needs and investment experience. Do your homework and decide if an SMSF is the best way for you to achieve your overall financial and lifestyle goals. Make sure you have a sound financial plan in place and review it regularly so you continue to take advantage of tax and wealth building strategies within your SMSF. 78

79 CHAPTER THE FINAL WORD 79

80 Chapter Eleven: The final word Putting it all together Hopefully you have enjoyed this ebook on SMSFs and had your questions answered or perhaps it has given you food for thought about items you hadn t previously considered. The important thing is to do your homework, focus on what s important to you and have a clear understanding of your goals and objectives. My advice when it comes to making a decision about what is usually your largest asset outside of the family home, and with money that needs to last you a lifetime, is to take the time to get professional financial planning advice before making any decisions. I hope it has become clear that an SMSF is definitely not for everyone. It is a great tool for individuals who want to be actively engaged in their superannuation and are prepared to commit the time and learning to operating their own fund. While they certainly have a number of benefits that can enhance your overall financial position, there may be other more suitable investment structures to help you get to where you ultimately want to be. At the end of the day, whether an SMSF is right for you will depend upon you, your needs, your circumstances and your objectives. 80

81 About the author Nick Bedding is the Head of Shadforth Financial Group Limited, with broad-ranging responsibility for all financial planning, stockbroking, insurance and corporate superannuation services at SFG Australia Ltd. Nick has extensive experience in the financial planning and stockbroking industries working in a range of financial advising and management roles. Nick has been in the financial services industry for over 20 years commencing his career as a financial adviser. He was the CEO of Shadforths Limited and Financial Acuity Limited prior to being appointed as the CEO of Shadforth Financial Group Limited in Nick holds a Masters Degree in Business Administration from the University of Tasmania and was awarded the McCarthy Medal as the top graduate. He was also awarded the ANZ Prize as the top graduate in Australia for the Diploma of Financial Planning from Deakin University. He has a Certificate in Financial Markets from the Securities Institute of Australia, is a Certified Financial Planner, a Senior Associate of the Financial Services Institute of Australasia, a Master of Stockbroking, a member of the Australian Institute of Company Directors and a Fellow of the Australian Institute of Management. Nick is passionate about leading a financial services company that exemplifies the very highest standards of service and professionalism. Our main aim in life is to help clients achieve their financial goals. Both as an adviser dealing directly with clients and as a manager of financial services companies, I have seen over many years the benefits that come to people who receive good financial planning advice and I know what a difference it makes to peoples lives., Nick says. We are a company that is highly focused on delivering the very best standards of advice and ensuring everything we do and everything we recommend is based on meeting our clients needs and objectives. Nick /pub/nick-bedding/26/447/659 81

82 Shadforth Financial Group Limited, Shadforth Financial Group Limited ABN AFSL No , is a wholly owned subsidiary of SFG Australia Limited ABN (SFGA). This brochure has been prepared as general information only and does not take into account individual investment objectives, financial situation or personal needs. Before making any financial decision based on this information, you should consider speaking to a financial adviser and assess whether the information is appropriate to your specific needs, objectives and circumstances. The information contained in this publication has been given in good faith and is believed to be accurate and reliable. Neither Shadforth Financial Group, nor its affiliated entities, employees, officers or directors gives any warranty of accuracy or reliability nor accepts any responsibility or liability for any errors or omissions or for loss or damage suffered by any person as a result of any inaccuracies or omissions. SFG