THE TRUTH ABOUT SMSFs

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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

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