A Guide to Investing in Property Using a Self Managed Super Fund Why would I consider a SMSF? I already have a super fund. Self Managed Superannuation Funds (SMSF s) are the fastest growing sector of the Australian superannuation (super) industry. They are currently one of the most popular super investment vehicles in Australia. This document provides you with a general guide about SMSF s. The harsh reality is that a significant number of Australians who aim to retire in the next decade will wake up to the grim reality that their superannuation nest egg will not provide them with a comfortable retirement. Why? The average life expectancy in Australia is now 82 years, an increase of 5 years from 2000. For the average Australian retiring at 65, this is 17 years or 884 weeks of retirement. In 2011, The National Centre for Social and Economic Modelling (NATSEM), found the average Australian woman aged 55 to 64 years was estimated to have an average superannuation balance of about $54,500. The average Australian male superannuation balance is estimated to be $113,200. This would realistically translate into 2 to 3 years of income in retirement before the funds are completely exhausted. This is the shocking reality being faced by thousand of retiree s. After just 3 years of retirement, they are facing 728 weeks (14 years) of struggling to survive on the pension. This predicament has been compounded by the fact that thousands of investors would have been better off putting their super in a cash account or term deposit as many reputable super funds have consistently under performed over the past decade. SuperRatings found the average fund has returned just 2.5% a year since 2006, while annual inflation has been 2.9% over the same period of time. This means a $100,000 investment in an average balanced superannuation fund in 2006 would, in real terms, be worth only $98,000 today. You can understand why more Australians want to take control of their super funds to better utilise favourable government tax incentives with the belief that they can generate better returns than highly paid fund managers they have never met. This document outlines the benefits of SMSF s and asks whether it might be the right retirement investment strategy for you. Additionally, this document is a brief introduction to superannuation funds for those who are not aware of how SMSF s can be established in Australia. The information provided in this report should only be used as a general guide and you should always seek professional advice from a qualified Blackburne Finance & Investment adviser before making any decision in relation to your financial position. 1
What is Superannuation? Superannuation (super) in Australia is money accumulated and set aside for your retirement over your lifetime of employment. For most people, accumulation of super begins when you start working and your employer commences paying the mandatory Superannuation Guarantee (SG). The SG requires employers to pay 9 % (indexed to increase to 12 % by 2020) of your salary or wage into a approved super fund. The intention is to create a significant sum of money to fund your retirement. You have the choice of which superannuation fund to use and how to invest these funds until your retirement. However, over 70% of Australians trust their retirement to strangers (fund managers) they have never met. You can also increase your superannuation balance with your own additional cash contributions to take advantage of super s favourable tax incentives. The Australian Federal Government taxes superannuation monies at significantly lower rates than normal savings if the super fund complies with certain conditions. Superannuation funds pay income tax at a flat rate of 15% and capital gains tax of 10% if an asset is held for longer than 12 months while the fund is in accumulation phase. The favourable tax benefits experienced when accumulating investments in super combine to produce a larger benefit for retirement. Additionally, you have the potential to completely eliminate capital gains tax. When your super fund changes from the accumulation phase to the pension phase and the beneficiary is over 60 years old, capital gains tax is not payable whenever assets within the super fund are sold. Australian s have over $1.3 trillion dollars invested in Australian super funds. Incredibly, SMSF s now exceeds $442 billion of the total amount invested in super funds. With new SMSF s being established daily, this sum continues to grow. It is important to know where to invest your money in order to maximise your retirement earnings. The key to this is firstly knowing, which most hardworking Australian s, due to lack of clear information, don t really understand. Through no fault of their own, for most people, the selection of the correct investment strategy for such an important asset is given very little consideration due to a lack of time and understanding of how critical superannuation is. What is a Self Managed Super Fund? SMSF s allow you to take on the responsibility and control of your superannuation investments for your retirement. SMSF s perform the same role as other super funds by investing your mandatory employer paid SG contributions and other contributions which then become available at retirement as a nest egg. Generally, a Self Managed Super Fund is defined as a super fund where: 1. There are up to four members, 2. All the members are trustees, and 3. Trustees do not receive any remuneration for their trustee services. 2
The difference is that the members of SMSF s are also the trustees. Trustee s control the investment strategy in relation to the contributions and investment returns. With all members being trustees, they are in a position to ensure their funds are invested appropriately. They have complete security, control and flexibility over their super. The members, being the trustees, develop the investment strategy. This is usually in conjunction with appropriately licensed advisors who assists the trustee s to make investment decisions accordingly and appropriately. Through their SMSF s, trustee s can invest in almost any asset type (subject to certain restrictions). This includes - Cash, term deposits or fixed interest securities Listed or unlisted shares Managed funds and units trusts Foreign exchange and derivatives Collectables such as artwork and rare coins Property, residential and commercial. Being able to invest directly in residential property is a significant point of difference to industry super funds. Generally industry super funds only invest in property through Listed and Unlisted Property Trust s that are again managed by other people. A SMSF can combine the super balances of up to four people. For example, four friends or family members can take individual super balances of $50,000 each to create a single SMSF with combined assets of $200,000. Collectively, this SMSF can now invest in assets such as direct residential property whereas individually, each person would not be able to do so due to insufficient funds. When structured correctly, the costs of having a SMSF can be and are often lower than the fees charged by retail superannuation funds. The cost of running a SMSF can also produce savings where a fixed rate fee for service is lower than commissions traditionally paid to fund managers. Establishment fees are a once off and the accounts are lodged with the Australian Tax Office after being prepared by an accountant and assessed by an approved SMSF auditor. In Australia, there are now more than 450,000 SMSF s in existence. The value of assets residing in these vehicles currently stands at $442 billion and continues to rise fast with direct property investment activity increasing significantly following regulation changes in 2007 that permitted borrowing of funds. Self Managed Super Funds and Property In 2007, new Australian Tax Office (ATO) rules were introduced which allowed self managed super funds to borrow money under limited recourse borrowing arrangements with banks. Subsequently, these new rules have made it significantly easier for SMSF s to acquire direct investment property. Previously, a SMSF required the available funds to purchase the property in full including purchase costs. However, SMSF s can now acquire direct property with a deposit plus stamp duty and purchase costs with the balance being paid by a bank loan. This is the same as buying your own home, paying a cash deposit of 20% and borrowing the remaining 80% plus costs from the bank to buy the property. The loan is a limited recourse loan which means in the event of default, the bank cannot personally pursue the trustee s assets outside of the SMSF. The liability is limited to the asset which has entered into the limited recourse borrowing arrangement. The Super Industry Supervision Act (SISA) of 1993 is a set of strict guidelines in relation to how you can legally use your SMSF to borrow funds and purchase a property. Placing your super in property may seem complex. However with the right advice, it is possible to comfortably access this type of investment and substantial reduce tax. 3
Source: Australian Bureau of Statistics It is easy to see why buying property with a SMSF has been the preferred super investment strategy for so many Australians. The housing market has traditionally been a popular investment in Australia as it is broadly considered as a relatively stable and conservative investment (as can be seen in the chart above). If you use a SMSF to purchase a property, you will not only receive the rental income but also enjoy considerable tax savings compared to investing in property outside of a SMSF. Outside of a SMSF, individuals can pay up to 47% capital gains tax. In a SMSF, when you decide to sell the property you will only pay 10% capital gains tax if you are under 60 years of age and still in the accumulation phase. If you are over 60 years of age and in the pension phase, you will pay zero capital gains tax. The tax saving in relation to one property alone can be in the tens, if not hundreds of thousands of dollars. That may be the difference between a restricted retirement and a comfortable retirement. What are some of the criteria to buy property in a SMSF? There are a number of criteria which you need to meet in order to purchase a property using your SMSF. Some of these criteria are: The bank loan for the purchase of the property must be a limited recourse borrowing arrangement. The property cannot have major renovations or upgrades made whilst in the SMSF. When purchased, the property must not be a residential property owned by one of the trustees or their dependents. It must also not be a property in which any of the trustees or their trustees live. There are no redraw facilities allowed on such a property however an offset account can be used. Most importantly the fund must also prove that the sole purpose of the investment is for the retirement benefits of the trustees or their dependents. The type of property you intend to purchase must also be in line with the ATO rules. To achieve a compliant SMSF borrowing arrangement, you must satisfy your lender that the property complies with the legislation and guidance rules set by the ATO and that you will not use your loan for restoration or renovation of your property. Without the above being met, it will be difficult to purchase property in your SMSF using a limited recourse loan and meet the ATO and SISA requirements. 4
Why use your SMSF to invest in property? The key benefits of a SMSF is choice of asset class, tax control with substantial tax incentives, estate planning, limited recourse borrowing arrangements and the competitive costs of running a SMSF. SMSF s can be an extremely effective investment opportunity that provides attractive tax relief and other benefits whilst maintaining a flat annual fee. You can expect a 15% flat tax rate on income into the SMSF. With the deductible components of a rental property you can further potentially reduce the taxable amount of income to zero. You can expect a maximum capital gains rate of 10% (having held the asset for greater than 12 months) while in accumulation phase, and if you sell the property in the pension phase after your 60th birthday the capital gains tax is zero. The pooling of money allows the super fund to buy a portfolio of property thus spreading any investment risk and cross property returns. What are the risks with SMSF s? There are a number of risks associated with SMSF s that require careful consideration before proceeding. With this much control and flexibility comes the ultimate responsibility to the nature of the investments you, as trustee, undertake. Various types of securities and investments can be more risky, harder to liquidate if required and can increase the administrative burden on the fund when it comes to valuations. Ensuring you make investment decisions that are compatible with your risk strategy is essential. Professional advice from your Blackburne Finance & Investment advisor can assist you in determining your risk profile and suitable investment strategy to suit. Inappropriate estate planning for a member can result in the wrong person assuming control of the fund and the death benefits being distributed at their discretion. Professional management of binding death nominations by your Finance & Investment advisor should be considered. When considering using borrowings in a SMSF, it is essential that the correct gearing model is complete before committing to an investment. Incorrect cash flow modeling within the SMSF can inadvertently lead to the SMSF becoming non compliant at the time of audit. Your Finance & Investment advisor can provide appropriate and conservative modeling BEFORE making any investment commitments. Many trust deeds do not contain the correct provisions to allow the establishment of borrowing to purchase property which can leads to delays in settlement and penalty interest being charged by the seller. Do Trustee s Need Personal Insurance? Under the ATO recommended steps for establishing a SMSF, SMSF trustees are obligated to consider the most appropriate personal insurance cover as part of their investment and risk management strategy. SMSF trustees are usually able to take out insurance cover for any of the SMSF members. The range of insurance products and the benefits available to SMSF s is generally greater than those that are offered through regular public offer superannuation funds. In many instances, the cost of the premiums can be met from the SMSF. Trustee s should be aware, however, that they have an annual compliance obligation to the type and level of cover each member of the fund may need and whether or not this should be held in the fund. In making insurance policy decisions, trustees should also understand the conditions of release. Some benefits paid by insurers, such as partial income protection benefit, may get stuck inside the fund if the circumstances of the claim fail to meet the conditions of release. 5
Report Summary The decision about how to structure your SMSF is not a straight forward one. It is important to consider all your options when deciding where to invest your retirement funds. A Self Managed Super Fund is an excellent option for many people to potentially provide a comfortable retirement and as such SMSF s are a popular super choice across Australia. However, it is essential that you receive the correct advice before deciding to establish a SMSF. SMSF s are not the easiest of super funds to set up or to subsequently manage. However Blackburne Finance & Investment will be able to assist you in the process and make it a lot easier. Once you begin to learn its intricacies, you will understand why SMSF s are such a popular and effective retirement vehicle. However you must also be willing to take on the significant responsibilities that being a SMSF trustee entails. With the correct team of consultants, much of this responsibility is met for you. Is SMSF potentially right for you? Take this quick quiz to see: Do you want more control over your super investment strategy? Would you prefer to invest in direct property that you choose? Do you have at least 10 years until you are 65 years old? Would being able to use bank funding potentially increase your super returns? Do you, or combined with three other people, have at least $150,000 in your super now? Thank you for taking this quick quiz. If you ticked the last box and any other boxes, you might be able to benefit from a self managed super fund. Please feel free to call Blackburne Finance & Investment on 08 9429 5757 to discuss your quiz results. If you are prepared to take the step into a SMSF, then the potential for better returns, tax control, effective wealth transfer, asset protection and peace of mind become a potent combination. This can take the quality and security of your retirement to a new level. 1050 Hay Street West Perth, WA 6005 PO Box 422 West Perth 6872 P: blackburneinvest.com 6