SMSF superheroes

If you are serious about maximising your wealth, you should monitor and control the investment decisions for your superannuation as carefully as you would your money outside of super.

By having a self-managed super fund (SMSF) you can choose exactly what you want to invest in, giving you 100% control over what should become your biggest asset.

What is an SMSF?

An SMSF, like all superannuation funds, is there to provide for your retirement. They’re often referred to as Do It Yourself (DIY) super funds, because you control the underlying investment decisions yourself.

As at 31st March 2009, SMSFs held the largest proportion – 31.8% – of total Australian superannuation assets. As of June, 720,000 Australians had invested $300 billion through 380,000 SMSFs, with 2,000 new SMSFs established every month. So why are they so popular?

As the thousands of Australians who have already established an SMSF know, there are lots of benefits to be had from running your own SMSF rather than having a traditional retail, industry or corporate fund. The main advantages are:

• You have complete control over where you super is invested;

• You can maximise tax efficiency;

• They’re extremely flexible; and

• They offer potential cost savings.

Control over decisions

This is the number one reason so many Australians are establishing SMSF. Your investment portfolio may include:

• Direct investments  (such as shares or direct property)

• Managed funds (retail or wholesale)

• A business (non-related party) and business property

• Non-traditional assets such as antiques or art.

The types of investments the SMSF can hold are determined by the fund’s investment strategy, which is formulated by you, along with the other members in the fund, often advised by an investment professional. The strategy will reflect your objectives, risk profile and the investments you intend to utilise. The investment strategy can be changed as often as you wish, to suit your changing circumstances and to take advantage of new investment opportunities. The fund can also incorporate different strategies to suit each of its members, who are known as ‘trustees’.

An important effect of this control is that, during retirement, you can continue to invest in growth assets. This contrasts the approach of most retail providers, who lock ‘pension phase’ investors into income-producing assets such as cash and fixed interest, increasing the risk that the investor may outlive their retirement savings.

Tax efficiency

In traditional super funds, contributions tax is taken out up front whenever you make a contribution. An SMSF will only incur this tax when it lodges its tax return. In some cases the tax may not be payable at all after taking into account deductions or imputation credits.

Another strategy is deferring capital gains tax until pension phase. This involves holding investment assets that you believe will have high capital growth during accumulation phase, and then selling them when you retire, when capital gains tax no longer applies. 

SMSFs allow you to transfer listed shares, managed funds, widely held unit trusts, and business property held in individual names into superannuation as personal contributions. While transfers may incur capital gains tax, stamp duty and fringe benefits tax, in some cases you may be
able to claim a deduction for the superannuation contribution, offsetting these capital gains costs.

Example

Sally, aged 52, is married to Tom. The couple have been accumulating assets in Sally’s name over the past 10 years while she’s been a stay-at-home-mum, to take advantage of her lower marginal tax rate. Now Sally has decided to return to work and will earn $50,000 per year.

Sally and Tom have an investment unit in Sally’s name worth $400,000, purchased ten years ago for $300,000. They have paid off the mortgage and receive rental income of $18,200 per year. Sally has been paying tax of approximately $2,000 per year on the rental income, but this will increase to around $5,700 per year once she returns to work.

Sally can transfer the asset to her SMSF tax-free and reduce the tax payable on the rental income by approximately 50%, from $5,700 to $2,730 per year. Once Sally retires, the income will become tax-free.

Sally transfers ownership of the property into the SMSF as follows:

• $50,000 concessional contribution (pre-tax)

• $350,000 non-concession contribution (after tax, bringing forward three years’ contributions)

The transfer of the property triggered a $100,000 capital gain. Because the unit has been held for over 12 months, Sally receives a 50% discount, reducing the assessable capital gain to $50,000. This would normally incur income tax, but because Sally hasn’t been working, she can claim a personal deduction for the $50,000 concessional contribution, which will completely offset the capital gain. Contributions tax of 15% will apply to the $50,000, but this will be recouped within two years from the savings they make through the reduced income tax they’ll pay on the rental income. Once Sally retires, future income and capital growth on the unit will be completely tax free.

Flexibility

SMSFs can be tailored to suit the individual needs of all their members. For example, if you have one member in pension phase, and another member in accumulation phase, your investment strategy can be formulated to segregate the SMSF’s assets, attaching growth assets to the pension which pays zero tax. In the very long term, an SMSF can be designed to provide funds for future generations. This can have significant tax advantages over the traditional model of redeeming assets to pay inheritances. 

Example

Bob and Betty are both 52. They want to buy a commercial property worth $500,000 with a 10% rental yield per annum ($50,000). They believe the property will offer significant capital growth.

They purchase the premise as a tenant in common arrangement with their SMSF, where they will personally own 30%, and the SMSF will own 70%. The rent and future capital growth will be split accordingly.

Sharing the income with the SMSF will result in an immediate tax saving. Rental income in the fund will be taxed at 15%, and further offset by some of the investment deductions such as rates, insurance etc. As they’re only receiving 15% of the income each in their personal names they will pay very little tax. 

Ten years on, the property is worth $800,000. Now 62, Bob and Betty decide to retire.

They will have the following options:

1. Transfer the remaining 30% ownership of the property to the SMSF as contributions. Capital gains may be offset by making concessional contributions and claiming a tax deduction (subject to eligibility).

2. Retaining the property in the SMSF and living off the rental income, which will be tax free now that they are in pension phase.

3. Sell the property and invest the money elsewhere. Because they are in pension phase there is no tax payable by the SMSF on the capital gains, and any capital gains in their personal names can potentially be offset by contributing the sale proceeds into their SMSF as concessional contributions.

Control over costs

With an SMSF you control investment costs and on top of this, investors running their own SMSF often pay substantially less fees compared to those invested in retail funds.  For example, an entry fee of up to 5% could be payable on entry to a retail fund, which usually incorporates an upfront fee paid to a financial adviser. Ongoing management fees are usually charged on top of this upfront fee.

Like all investments, SMSFs carry risks. Because trustees may not be specialist investment professionals, there is a risk of non-compliance under SIS legislation, which carries heavy tax penalities. SMSFs also carry costs, including fees to set them up, accounting, and administration costs. SMSFs also take time and dedication on the part of the trustees to ensure they are well managed.