Self-Managed Super Funds (SMSFs) are an appealing option for many Australians seeking greater control over their retirement savings. While the potential benefits of an SMSF are substantial, it’s important to weigh them against the potential downsides.
Given the strong opinions on both sides, often driven by vested interests, it can be challenging to get an unbiased view. Proponents of SMSFs may emphasise the advantages while downplaying the complexities and costs involved. To provide a balanced perspective, this article will begin by outlining the challenges and risks associated with SMSFs before exploring the benefits.
Ultimately, the decision to set up an SMSF should be based on a clear understanding of both the advantages and the potential pitfalls. If you’re considering an SMSF or want to ensure your existing one aligns with your goals, scheduling a meeting with an SMSF-qualified financial adviser can help you make an informed choice.
Downsides of Self-Managed Super Funds
Cost to setup and manage
At its most basic level, a SMSF is just a trust. As such, typical legal and accounting costs to set up the trust will apply. Depending on the choice of trustee (individual or company) the cost to set up can range from around $500 to over $2,000 in complex scenarios.
Such a complex scenario may be required if you want to invest in property in your SMSF – one of the primary reasons they are opened in the first place. In order to purchase property in a SMSF with a loan, a distinctly separate trust (called a bare trust) also needs to be established. This will of course attract additional costs.
The costs do not end after the setup either. There are certain annual requirements imposed by the ATO that need to be completed for every SMSF. These include:
- Audited financial statements
- Tax returns
- Updated investment strategy document
These requirements, alongside annual registration fees can be quite costly. Generally, this starts from around $1,500 per annum and can climb much higher depending on the complexity of the fund.
Trustee responsibilities and compliance
Generally, each member of a SMSF will be a trustee of the fund itself (or a director of a corporate trustee). This comes with significant responsibilities and potential penalties for non-compliance. Such duties include:
- Acting in the Best Interests: Trustees must prioritise the financial interests of all members at all times.
- Compliance: Ensuring the fund operates according to its trust deed and complies with the relevant legislation.
- Investment Management: Formulating and reviewing an investment strategy that meets members’ needs and circumstances.
- Record Keeping: Maintaining accurate and up-to-date records, including financial statements, member contributions, and benefit payments.
- Reporting: Lodging annual returns with the Australian Taxation Office (ATO) and undergoing annual audits by an approved SMSF auditor.
- Administration: Managing contributions, benefit payments, and ensuring fund assets are kept separate from personal assets.
Trustees must also ensure compliance with the sole purpose test. This mandates that the SMSF is maintained for the sole purpose of providing retirement benefits to its members. Non-compliance can result in significant penalties and the potential loss of the SMSF’s concessional tax status or even deregistration.
Australian Residency Requirement
It is becoming more popular in retirement for people to move overseas for an extended time period. This is usually not a problem if you are in a typical super fund, however it may cause issues if you are in a SMSF.
An SMSF must meet the “Australian residency” requirement to maintain its complying status and tax benefits. This involves ensuring the fund is established in Australia, central management and control are ordinarily exercised here, and the fund does not have active members contributing more than 50% of its total assets who are overseas. Failure to meet residency requirements can result in severe tax penalties.
There are ways to remedy this issue by utilising an Enduring Power of Attorney for example, however it will involve additional planning and potentially cost.
The reason this is not an issue for typical super funds is that you aren’t the trustee, another entity is. You are simply a member of that particular fund hence residency remains in Australia.
Lack of Access to Dispute Resolution Services or Compensation
Self-Managed Superannuation Funds are not eligible for external dispute resolution schemes or government compensation, unlike retail or industry super funds. This means if an SMSF suffers losses due to fraud, theft, or misconduct by a service provider, trustees cannot access the Australian Financial Complaints Authority (AFCA) for resolution or compensation.
This makes it ever more important that trustees conduct appropriate due diligence before deciding what to invest in. One wrong choice could result in significant financial losses without any external recourse for recovery.
Issues upon wind-up or departing of members
Leaving a retail or industry fund can be as simple as clicking a few buttons. A SMSF is certainly not that simple. When a member exits, the SMSF’s trust deed must be reviewed to ensure proper procedures are followed. The departing member’s benefits must be accurately calculated and rolled over using the proper systems. This may impact the fund’s investment strategy, as asset sales might be required to provide the departing member’s benefits, potentially affecting remaining members’ balances. Consider a scenario where 70% of the fund’s assets are tied up within a particular property. In the event of a member leaving, such an asset may need to be promptly sold.
Closing an SMSF is not any easier. When an SMSF is wound up, trustees must follow a structured process to ensure compliance with legal and regulatory requirements. This includes finalising the fund’s tax affairs, paying out or rolling over benefits to other super funds, and completing necessary audits and reporting to the Australian Taxation Office (ATO). Failure to properly wind up an SMSF can lead to penalties and complications.
Benefits of Self-Managed Super Funds
Wider range of investments
The primary reason most people look to opening an SMSF is to access investments not available in a typical super fund. Unlike traditional funds, which may limit your investment choices to a pre-selected range of assets, an SMSF allows you to invest in a broader array of assets, including direct property, direct shares, unlisted managed funds, and alternative investments like collectibles, cryptocurrencies and precious metals.
Trustees of a SMSF have ultimate control over the investment strategy and thus can tailor it to suit the needs and preferences of the members. This of course can be a risk itself, if the trustee is not experienced or doesn’t have oversight from an appropriately qualified professional.
Investing in property using debt
It would not be an overstatement to suggest that the number one reason people have for opening a SMSF is to utilise their retirement savings to purchase property. Specifically, to utilise debt in the purchase of a property. The benefits of using leverage to access more expensive assets are obvious, it allows you to greatly enhance the potential return on investment. Another advantage is the potential tax benefits; interest expenses on the loan may be tax-deductible, reducing the overall tax liability of your SMSF.
One particular strategy regarding property is for a business owner to purchase their business practice in the SMSF. The SMSF would then rent the building to the business owner and benefit from the concessional tax environment of super.
Pooling of assets
An SMSF can have up to six members. This allows for the pooling of funds in order to purchase assets that may not be possible otherwise. This can be particularly beneficial if the investment strategy is to access high-value assets such as commercial real estate.
A higher SMSF balance overall will also allow for the pooling of ongoing management expenses which may make the SMSF fees lower than even that of a typical super fund.
Capital Gains Apportionment
A typical super fund is a master trust structure. Briefly, this means that the tax implications of the investments are shared across all the members of that investment option. In practice this means that you cannot plan for capital gains tax events whatsoever as the timing of asset sales is beyond your control.
An SMSF allows you ultimate control, especially over tax outcomes. For example, an SMSF could purchase a property whilst in accumulation mode and then sell it once the members are in pension phase. This would result in a 0% tax on any capital gains that particular property made. The wiping of capital gains tax is functionally impossible in typical master trust super funds.
Some of these funds do offer a payment that is meant to help equalise the tax disadvantage of master trusts. This is called the Retirement Bonus, but ultimately it does not come near to the potential benefit that having complete control of your tax situation gives.
Estate Planning Benefits
A unique benefit for SMSFs when it comes to distributing assets after the death of the member is the ability to do so in-specie. This means that the inherited assets (or percentage ownership of) can be passed directly to beneficiaries without needing to liquidate them. This is particularly relevant for funds that hold large, illiquid assets such as property that may not be able to be sold easily.
Outside of this, SMSFs allow for more customisable succession planning such as appointing specific trustees or setting up cascading binding death benefit nominations.
Summary
Self-Managed Super Funds (SMSFs) continue to attract interest due to their flexibility and access to investment options beyond those available in typical super funds. However, it’s crucial to be aware of the potential downsides before opening an SMSF. Without the proper experience or knowledge, managing an SMSF can lead to poorer outcomes than leaving your superannuation in a traditional fund.
If you’re considering setting up an SMSF or if your current SMSF isn’t meeting your expectations, seeking professional advice is essential. Schedule a no-obligation meeting with an SMSF-qualified financial adviser to explore your options and ensure your retirement strategy is on the right track.
