Pro’s and Con’s of having a Self Managed Super Fund
Do you think you could do a better job of managing your superannuation than a lot of the big name superannuation funds?
If your answer is a resounding “yes”, you are far from alone.
In 2011 alone, almost 32,000 Self Managed Super Funds (SMSFs) were established – an annual total only exceeded in 2006-07 when the then Federal Government announced it would significantly improve the tax effectiveness of super. (In short, tax on superannuation pensions and retirement lump sums were abolished from July 2007 – without a limit on the dollar value.)
Now, despite the GFC and its aftermath, annual SMSF setup numbers continued more or less steady trend since the revamping almost eight years ago. And although the world’s financial woes have taken their toll on contributions to self-managed funds, the determination of people to establish them hasn’t seemed to have been dented.
However, before establishing an SMSF, you should carefully compare their possible advantages and disadvantages. Here are a few pointers:
1. Allows you to hold your business premises:
Many small business owners keep their business premises in their SMSFs for tax-effectiveness, asset protection, succession planning (for family enterprises) and security of tenancy.
Your company would have to pay a commercial rent to your SMSF, but in turn, your fund would only pay concessional tax on the rent
You would typically benefit from many of the usual tax breaks available to landlords.
Including tax deductions like negative gearing on a property loan.
2. Ability to quickly buy or sell assets:
SMSF members can instantly change their investments and the asset allocation of their portfolios. With large institutional funds, there is sometimes a frustrating lag between when investment changes are requested and when those changes are executed.
3. Way to invest differently:
SMSFs enable members to invest in ways that may not be available in most large super funds. For instance, SMSFs can hold direct property, unlisted shares, artwork and other exotic or not-so-common investments.
4. Potential to cut costs:
SMSFs with larger balances – say, above $200,000 or so – may have lower fees as a percentage than many large super funds, depending on circumstances.
This is because administration costs of a self-managed fund are more or less fixed – no matter the fund balance. And SMSFs that invest directly rather than through managed investment funds are not liable for fees based on a percentage of their investments.
5. Avoid administrative weaknesses of large super funds:
Have you ever had a large fund miscalculate your super balance, would you even know? Or have you had a struggle for a large fund’s call centre to give a satisfactory answer to queries? (It can be potluck about who picks up the phone.)
With an SMSF, the trustees – meaning you and the other members – are very much in control. You can act decisively when making investment decisions, and you can ensure, more or less, that no mistakes are made in the running of your fund.
6. Manage or eliminate CGT:
Many SMSFs have a general policy – subject to investment conditions – of trying to minimise the sale of such assets as real estate and shares
Until their funds begin to pay a pension. As a result, there may be no capital gains tax (CGT) payable as the asset is backing the payment of a pension.
7. Invest in assets you can not otherwise afford:
The establishment of an SMSF allows up to four people – commonly family members – to pool their super savings to buy costly assets, such as direct property, which may otherwise be beyond their reach.
And under strict conditions, SMSFs can borrow to invest using instalment warrants or similar arrangements. Gearing is not available in large super funds.
Operating your SMSF will require your personal attention and time even when using a professional SMSF administration service and even if paying a good financial planner to help guide the fund’s investments.
By contrast, a large fund takes over all of the administration and many of the day-to-day investment decisions – working with your asset allocation or investment choice.
2. Need for investment knowledge:
Ideally, SMSF members should have a much more thorough understanding of at least the basics of sound investment practices than members of significant funds.
SMSF members should understand, for instance, how an appropriately diversified investment portfolio can spread their risks and the potential for returns. SMSF members should have enough investment knowledge to quiz their financial advisers.
3. Penalties for non-compliance:
The Tax Office, as a regulator of self-managed super, has the power remove a fund’s complying status, unleashing a tax shocker. This is one of the ultimate sanctions against wayward funds.
The result of being a non-complying fund is the potential to have all non-concessional (after-tax) contributions, taxed at the highest marginal rate.
Which could destroy much of the retirement savings of every member of an SMSF. Additionally the trustees can also face civil and criminal sanctions for serious breaches.
4. The risk of reduced diversity:
Some SMSFs are established specifically to buy a valuable single asset such as business real estate. This means the fate of the Fund depends on the performance of that asset.
Depending on what other superannuation and non-superannuation assets the members hold, they may be inadequately diversified for risk and return – a danger that intensifies if an SMSFs sole asset is geared.
5. High costs for small balances:
Before setting up an SMSF, members should compare its likely costs with those of a large super fund. SMSFs with small balances are not nearly as cost-effective as, say, large industry funds.
As mentioned as in the Pro section – SMSF are faced with a fixed cost for compliance each year and where the balance of the fund drop or contribution levels decrease as a percentage these fixed costs quickly eat into the balances.
6. Hazard of a dominant trustee:
Most SMSFs would have one member who is the dominant force in all aspects of running the fund, including its investment decisions.
Apart from signing documents presented to them by the dominant member, passive members typically have no involvement with the fund. And, unfortunately, inactive members usually do little to safeguard their superannuation interests.
7. Tight control over investment practices:
Although an SMSF can provide members with more investment freedom than ample funds – much more in certain circumstances – there are stringent restrictions on their investments.
For instance, super funds must be maintained for the sole purpose of providing retirement benefits – not to subsidise pre-retirement lifestyles – and funds are prohibited from providing loans to members and their relatives.
8. The risk of losing interest:
Many people set up SMSFs with high ambitions and then lose interest. Perhaps the funds have not performed to their expectations. Perhaps the members have been unable to boost the balance as planned. There is also the risk that as a the main member becomes too frail or ill to look adequately after the SMSFs the returns may diminish this is particularly common after spouses die.
Want to get a better understanding of Self Managed Super Fund. Why don’t you join the next session of the Awesome Investment Club. Where professionals will be speaking about this very topic.