There is significant debate about when a Self-Managed Super Fund (SMSF) becomes cost-effective compared to low-cost industry funds. Unfortunately, unbiased analysis on the topic is rare.
Proponents of SMSFs often exaggerate the costs of industry funds by focusing on their relatively more expensive blended investment options. Conversely, advocates of industry funds tend to inflate the accounting and administration costs of SMSFs. They may even completely ignore the tax benefits that SMSFs have over pooled super funds.
While SMSFs undoubtedly provide unique benefits, such as greater investment choice, these advantages are subjective and beyond the scope of this article. Instead, this article focuses solely on the costs of running each type of fund.
To accurately compare these options, this article evaluates the lowest possible cost scenarios for both. Given the high fixed costs associated with SMSFs, it is clear that industry funds are more cost-effective for smaller balances. But where exactly does the cost-efficiency crossover point lie?
The Options
The parameters of each option being compared is as follows:
Industry Fund
The selected industry fund was chosen for its access to low-cost index investment options, which typically result in the lowest possible fees among industry funds.
This fund stands out from others that provide index investments through synthetic exposure, which can sometimes have 0% investment fees. However, those options were excluded from this analysis as they do not offer direct exposure to actual index funds.
The portfolio for this comparison consists of a mix of Australian Shares Index and Global Shares Index products.
The relevant fees for the industry fund are below:
- Investment Fee: 0.08% p.a.
- Admin Fee (%): 0.10% p.a. (up to $500k balance)
- Admin Fee (Flat): $62.40 p.a.
- Transaction Fee: 0.01% p.a.
SMSF
The costs of running an SMSF can vary significantly. This analysis uses the advertised fees of a specialist SMSF accounting firm. While cheaper options are available, they often come with limited support, potentially leading to additional fees. The analysis assumes the use of a corporate trustee.
The upfront cost to setup has not been included as this is an expense that should theoretically be amortised over the life of the SMSF, which could be many decades.
The portfolio mirrors the industry fund but uses index ETFs purchased through a low-cost, CHESS-sponsored broker. An additional brokerage cost is included, assuming one purchase per month at $3 per trade.
The relevant fees for the SMSF are below:
- ASIC & ATO Fees: $322 p.a.
- Accounting & Audit Costs: $1,500 p.a.
- Investment Fee: 0.06% p.a.
- Brokerage Fee: $36 p.a.
The Comparison
The chart below illustrates the annual fees associated with each option across a range of account balances, from $50,000 to $1,000,000.
As these lines never converge, clearly the industry fund is the lowest cost option. At least if you wanted a low-cost, passive investment strategy.
However, this graph does not yet tell the whole story.
Tax Drag
One significant factor missing from the chart is the concept of tax drag, which arises from the differing tax structures between industry funds and SMSFs.
Pooled Structure of Industry Funds
Investments within an industry super fund are less tax-efficient due to their pooled structure. In a pooled arrangement, tax is paid at the fund level rather than at the individual account level.
This structure leads to tax drag, where your investment returns are reduced because capital gains tax (CGT) is paid by the fund, even if you don’t sell any assets personally. For example, if other members in the fund withdraw money, the fund may need to sell assets to meet those redemptions, triggering CGT.
We have covered this in more detail in a previous article.
An SMSF is itself its own taxpaying structure. This means that capital gains tax is only paid when assets are sold. Theoretically, this allows the fund to hold assets with large capital gains all the way until the member retires. Once the member retires, the assets could then be transferred to pension phase, where no tax is payable at all. This allows an SMSF to be much more tax efficient than pooled investment options within industry funds.
The question is how to actually quantify this tax drag. To accurately calculate it, each industry fund would need to disclose the inner tax workings of their funds. Something that is unlikely to happen any time soon. However, credible estimates put the tax drag on an equity-based index fund at around 0.50% p.a. Some have even suggested that it could be higher.
In the interest of being conservative the following comparison has used an assumed tax drag of 0.25% p.a. This is simply applied as an additional fee. A lower amount than the estimate has been used in order to account for the retirement bonus, as well as the likelihood of the SMSF selling some of their assets prior to moving to pension phase for one reason or another.
Updated Comparison
When tax drag is factored into the analysis, a clear crossover point emerges. At this point, an SMSF becomes theoretically less expensive to run than the benchmark industry fund.
This crossover occurs at an account balance of approximately $500,000, aligning with many general recommendations regarding the minimum amount needed before considering an SMSF. However, this analysis focuses solely on costs and does not account for the subjective reasons someone might prefer an SMSF.
Multiple Members
One notable advantage of SMSFs is that their costs are largely fixed, regardless of the number of members. This dynamic can significantly lower the cost threshold per person compared to an industry fund.
To achieve the $500,000 minimum outlined above, you should only need two members to have $250,000 each. In reality it’s actually closer to $225,000 each. This is because each member would need to have two industry funds, both with their own fixed costs. Whereas you can pool assets in an SMSF with no additional fixed costs. Expand this to four members, and the required amount will drop even further.
Other Considerations
This analysis does not aim to persuade you in one direction or the other. The decision to choose between an SMSF and an industry fund depends on numerous factors unique to your circumstances. Some additional points to consider:
Complexity and Risk
SMSFs involve a higher level of complexity and greater responsibility for management, which can be daunting for some. However, they offer unparalleled flexibility, including access to investments like direct property, a feature that appeals to many SMSF trustees. The broader pros and cons of SMSFs have been addressed in a previous article.
Tax Drag
Whilst tax drag is a notable disadvantage of pooled industry funds, alternative structures can still address this issue. These include wrap accounts (available through financial advisers) and direct investment products offered by some industry funds. These have been covered in detail already.
Summary
By comparing the lowest-cost scenarios for both SMSFs and industry funds, we can achieve a more objective view of their cost efficiency.
It’s very clear that on fees alone, an industry fund is going to be considerably cheaper no matter the amount of money one has. However, when the issue of tax drag is introduced, an SMSF starts to see cost efficiency around a $500,000 balance. This balance could technically be made up of four members with around $125,000 each.
However, some people may choose to establish an SMSF even before it becomes the most cost-effective option. This decision is often driven by the desire to access investments that are not available through industry funds, such as direct property, or to capitalise on the potential for greater compounding of returns by avoiding the tax pooling effects inherent in pooled structures.
That said, cost efficiency should not be the sole consideration when deciding whether to open an SMSF. It’s crucial to seek proper, qualified advice to ensure that an SMSF aligns with your personal circumstances and long-term financial goals.
