Self-managed super basics.
Interested in a self-managed super fund (SMSF) but not sure where to start? SMSFs are becoming increasingly popular but aren’t necessarily right for everyone. The attractive tax environment and perception of more personal control are countered by very strict regulations and strong penalties for non-compliance.
This video addresses the basics of establishing and managing a self-managed super fund.
We’ll help you learn about:
- what is a SMSF?
- key considerations for setting up a SMSF.
- compliance obligations.
- is it right for you?
This video may be helpful for anyone who:
- wants to know how a self-managed super fund is different.
- is contemplating establishing a self-managed super fund.
- has a self-managed super fund and want to know more about it.
Hi, I’m Bron Lawson from Westpac’s Davidson Institute here to talk to you about the basics of Self-Managed Super. Currently making up approximately 26% of Australia’s $3 trillion super nest egg, self-managed super funds are on the increase, however there is still a lack of understanding about what they are, how they work, and whether we should be making the shift. This video addresses some of the basics of self-managed super to get you started on your education journey.
Today we are going to look at: • What is a Self-Managed Super Fund? • How does self-managed super work? • Is self-managed super right for me?
So, what exactly is a self-managed super fund? It’s essentially exactly what its name says. It’s a superannuation fund that is managed by the owners of the fund, instead of your retirement savings being managed by a professional superannuation trustee/fund. A self-managed super fund means you have more control to decide how your money is invested.
The first thing to understand is it’s not a financial product, but a legal structure … a bit like your own business … but what the business does is to manage your retirement savings within a very strict legislative environment. • The legal structure is a particular type of ‘trust’ where the trustees are responsible for managing the assets, liabilities, and income for the benefit of the fund members. In the case of a self-managed super fund, the primary purpose is to provide an income for its
members/beneficiaries in their retirement.
• The trust fund acts like a big basket where all members’ funds are pooled together, then invested as per the funds defined investment strategy. • Then of course, finally, the trustees manage the payment of funds to members in their retirement.
So, let’s have a look at how it actually works … A SMSF starts with its members. It can have a minimum of 1 and a maximum of 4 members who all act as trustees for the fund. The role of the trustees and the rules on how they must manage the trust are set out in the trust deed. The trustees are helped with the administration of the trust by their accountant or financial planner. The fund must be audited each year to ensure the trustees are complying with the legislation surrounding self-managed
super funds and their stated investment strategy.
The trust sets up a fund which will include a bank account that will be the repository for any money rolled over from other funds and future contributions, as well as receiving any income from investments of the fund. This money is then invested by the trustees in other assets such as shares, managed funds, or property. Self-managed super funds are all legislated by the Superannuation Industries Supervision Act (SIS) which is administered by the Australian Taxation Office or ATO.
As I said earlier, the self-managed super fund starts with its members; there can be a minimum of 1 member and a maximum of 4. Every member of the fund is also a trustee either as an individual or as a director of a corporate trustee. Each member has their own account within the super fund, just like in large industry or retail super funds, even though the pool of funds may be invested altogether.
One of the most important decisions you’ll make about your self-managed super fund is whether to act as trustees individually or to have a corporate trustee. Most commonly self-managed super funds have individuals as trustees however it’s worth considering whether a corporate trustee will serve you better even though it may be more expensive to set up initially.
A corporate trustee is where you set up a company to act as the trustee for the super fund. For example, instead of Fred and Mary Jones as trustee for the Jones Super Fund, it could be The Jones Company Pty Ltd as trustee for the Jones Super Fund. There are a number of potential advantages in having a company as your trustee.
The current legislation requires at least 2 individuals acting as trustee, even if there is only one member of the fund. This means that if you are the sole member then you need to find someone else who is prepared to act as a trustee with you. That person then accepts the same legal responsibilities and exposure to penalties as the member. A corporate trustee only has to have one director, so a sole member can have sole control through a corporate entity.
Another benefit of a corporate trustee is that it limits the liability of trustees. This means that if for some reason something went wrong with a borrowing for an investment that the only recourse is to the fund and the corporate trustee assets, not to any individual assets. It is also much easier to add or remove trustees as things change. For example, in the event of the death of a personal trustee or perhaps a separation of partners then a new trustee would need to be identified, added to
the trust deed; then all individual shareholdings, insurance policies, investment holdings etc would need to be notified of the change. This may take a lot of time and effort. In the case of a corporate trustee though, the same change simply requires a one-page notice of change of directorship to be lodged with ASIC … a much simpler process.
Establishing a brand-new corporate trustee at the outset also helps to ensure that all assets (whether property, investments, shareholdings etc) are kept completely separate to any other assets you own. When investments are made in an individual’s name, records of whether they are acting in their own capacity or as a trustee are sometimes overlooked and this can then cause confusion for the auditor as to who actually owns the investment.
While opting to go with individuals as trustees may reduce the set-up costs to start with, the longer-term ease of administration means a corporate trustee is potentially lower cost in the long run. One of the key responsibilities of the trustees is to ensure that the ‘Sole Purpose’ test is applied to any use of the super funds. With the members now in control of the money within their superannuation, it’s important for them to remember that the sole purpose of the fund is to provide retirement
benefits for the members.
This test of sole purpose will be applied to any use of the funds to ensure that this requirement is met. This also means that members cannot derive a current day benefit from the fund; that is, they can’t use the money for any purpose that benefits them now such as buying an asset for use now. This even extends to not being able to display artwork in the private residence of any related party. Neither can they borrow from the fund, not even with an agreement and repayment arrangement.
The money must be preserved to provide retirement benefits only. This also means there are restrictions on the use of any self-managed super fund assets. For example, if one of the fund assets is an investment property, that property cannot be lived in by the members, their family, or business partners.
So, the money that goes into your self-managed super fund can come from all the same places as previously. If you are an employee there will be your employer superannuation guarantee monies that are paid as part of your salary. You can also make personal contribution as a pre-tax salary sacrifice or post tax contribution. Spouse contributions and government co-contributions can also go into your self-managed fund, as well as any income from investments.
It is the ability to have more control over these investments, and the returns, that attracts people to use a self-managed super fund.
So, what types of investments can a self-managed super fund make? The most common types, known as core investments, are things like cash, deposits, managed funds, and Australian property. However, being self-managed means that you can also invest in other things such as direct shares, overseas property, specialised managed funds, and even collectables such as art, antiques, or jewellery, though there are very specific requirements to be met for collectables.
All investments must be done in line with the documented defined investment strategy. Your self-managed super fund investment strategy is all about creating a future retirement benefit, not a current day benefit. This helps when deciding what types of investments to make. The strategy should ensure that the fund stays solvent at all times, it should consider the diversification of investments, as well as the insurance needs of the fund members.
One of the attractions of a self-managed super fund is the ability to invest directly in Australian property, though this does have some complexities worth looking into. A self-managed super fund may be able to invest in either residential or commercial property provided this aligns with the defined investment strategy. Bear in mind that property investment is a long-term investment so this may not be the best investment choice if it is likely that the beneficiaries will be looking to access th
While the strategy may change over time, the ‘sole purpose’ will not …. to provide retirement benefits for the members.
Remember too, that beneficiaries cannot derive a current day benefit from the investment. So, if the super fund is looking at investing in a residential property this means that the trustees, or their family, can’t live in the property. However, they may be able to run their own business from investment commercial premises. The property acquisition however must be completely at ‘arms-length’. This means the self-managed super fund can’t purchase a property currently owned by a beneficiary,
family member or business partner.
Currently legislation does allow for the super fund to borrow to purchase an investment property, though, due to the inherent risk of losses in the super fund, there is regular active debate as to whether this will continue or not. Similarly, lenders view it as a riskier type of loan so there are limited offers available and they tend to be priced higher than other investment lending.
If the super fund decides to borrow to complete the purchase, then this brings into play further legislation designed to protect the other assets of the super fund. The borrowing will be what’s known as ‘limited recourse’ borrowing meaning that it is set up in such a way that the only recourse a financier will have if the loan isn’t repaid is the property itself … not any of the other super fund assets.
This is achieved by the property being bought by a separate property trust which holds the property in trust for the super fund. The property trust then pledges the property as security for the loan to the super fund.
Let me just go over that again. The property is bought by a separate trust (sometimes known as a bare trust), this trust then pledges the property as security for a loan to the super fund. The property is held in trust for the super fund. The super fund then manages the property like any other property investment, collecting the rent, maintaining the property, and repaying the loan. Once the loan is repaid then the property can be transferred into the name of the super fund.
Investing in property within your super fund has added risks and costs. The financier will look to protect their position by requiring the trustees of the super fund to obtain both financial and legal advice before going ahead. If investing in property is attractive to you, make sure you consider the fund’s defined investment strategy, the added risks and costs, and how the investment fits with the long-term purpose of the fund … to provide beneficiaries with an income in retirement.
So, having seen what self-managed super funds can invest in, what are they actually investing in? As at March 2021, Australian’s had $3 trillion invested in super … of that, $787 billion was in self-managed super funds. The majority of this was invested in equities (or shares) 30% or $236b, followed by cash and managed funds at 19 and 24 % respectively and property bringing up the rear at 16%.
As well as having more control over how the funds are invested, trustees of the super fund also manage the insurances within the fund. A self-managed super fund can insure its members income, their life, and provide any- occupation total and permanent disability protection. There are a number of advantages of having the insurances within the super fund.
Firstly, the super fund pays the premiums meaning that this money isn’t coming out of your own pocket. There may be tax advantages for the super fund too as the premiums reduce the funds’ taxable income.
Another advantage is that, when structured correctly, on the death of a beneficiary it provides liquid cash into the super fund allowing it potentially to pay death benefits from cash without having to liquidate long term investments, such as property. In the same way the insurances may be used to pay down borrowings within the fund again protecting long term assets.
Remember though that if insurances are held within the fund that the fund is the beneficiary of the insurances and it must be satisfied, and meet legislative requirements, to be able to distribute that money to beneficiaries.
Ok, so far, we have had a look at what a self-managed super fund is and how they work and looked at some of the advantages of this type of superannuation. But is it right for you? Let’s have a look at who’s using self-managed super and some of the things to take into consideration if you’re thinking about switching to a self-managed super fund.
So, what type of people are using self-managed super? Our research has shown us that young families are unlikely to move to a self-managed fund. This would seem to make sense in that they have many other demands on their time and financial capacity at that point in their lives. In most cases, they’ll also have plenty of time to take a more active interest later in their financial journey. Low-income earners are also less likely to use self-managed super.
On the other hand, higher income earners, or those with high super balances are more likely to use a self-managed fund. These people are often small business owners, professionals, and self-directed retirees.
One of the key considerations of moving to a self-managed super fund is how much time and effort you want to put into managing it and how much flexibility and choice you want to have. Funds with a low level of responsibility also have a lower level of choice. As the degree of flexibility and choice increases so too does the amount of time, effort and responsibility needed from the fund owner.
Many people have little interest in managing their super fund and are quite happy to have someone else do that for them. The My Super funds are well suited to these people. The management of the fund, including investment strategies, is dictated by legislation and there is limited choice for the owner/beneficiary of the fund when it comes to how it is invested and managed.
Some people, while being happy to have their funds managed by a professional, want to have more control over the investment strategy. A Super Wrap style of fund allows the owner/beneficiary to select the way they want their money invested. For example, they may choose to have a higher risk strategy and invest a greater percentage of their money in the higher returning international shares and a lower percentage in less risky cash investments,
however as their needs change, they can adjust this strategy but still have the advantage of an expert managing the investments for them. To use this this style of super effectively there is a little more time and effort required than for a My Super fund.
A self-managed fund requires the most time and effort, but also gives the greatest level of choice and control. So, think about where you might be on this continuum and which style of super would work best for you at the moment. Now, I said “at the moment” because this may change throughout your lifetime and there’s nothing to say that you can’t change the type of super you have either.
Let’s have a look at few aspects of self-managed super that may also direct your decision. Firstly, as we have just looked at, self-managed super requires the most hands-on management so it’s more suitable for those who want to take control. This doesn’t mean though that you have to be flying solo. There are many independent financial planners and even SMSF-specific financial planning businesses that will help the trustees with the administration and provide investment advice and services.
A self-managed super fund can have up to 4 members. The most common scenario is for there to be 2 members, often couples pooling their money. With the option for there to be up to 4 members, there is no reason why 2 children couldn’t be part of the fund as well potentially giving them better returns, particularly early in their working life.
Self-managed super is generally more expensive to set-up and manage which is why it makes sense to have more than $200,000 invested to make it cost effective. But again, while there may not be that much in your individual super, when pooled with your partner’s this may be worthwhile.
Self-managing your super also brings with it a high level of accountability. While one of the key attractions of self-managed super is the high level of choice and control, there is lots of legislation that surrounds superannuation that trustees must comply with and there may be significant penalties if they get it wrong.
The aspect of accountability that we just spoke about largely involves ensuring the fund is compliant and managing all the administration. So, what does that entail? There’s the initial set-up where the fund needs to be established which involves setting up the trust, registering the ABN, registering for GST, opening a separate bank account, arranging rollovers from existing funds, redirecting contributions, as well as settling on an investment strategy for the fund.
Then in line with the strategy the various investments need to be implemented. This could involve managed funds, direct share purchases, or a property purchase (which may need finance arranged) just to name a few. Once the investments are set up there is the ongoing record keeping, completion of annual reporting and income tax returns. And eventually management of paying benefits! There’s a lot to make sure you stay on top of as a trustee.
So, a self-managed super fund isn’t for everyone. Our research strongly shows that confident, self-directed people, who want flexibility and value for money; and who seek help and education on the legislation and investment options; and who are prepared to spend the time and effort on managing the fund are best suited to self-managing their super.
So, even if you haven’t decided yet whether it’s the right choice for you, if you are still interested in finding out more, I’d encourage you to get more information from the Westpac website, talk to your accountant or financial planner, or perhaps a self-managed super fund specialist. BT also has a team of SMSF Consultants who can help. The better armed you are with information, the better chance you have of making a decision that you’ll be comfortable with in the long-term.
So, we’ve come a long way today. Starting out with simply looking at what exactly a self-managed super fund is, then delving into how they work, and finally looking at some of the things you need to consider in deciding if it’s the right step for you. Thank you for watching our video ‘Self-managed super basics’. We trust you found this information useful and relevant, and I encourage you to check out the other resources on the Davidson Institute website to help build your financial confidence
Bye for now.