The Pros And Cons Of DIY Super
So you've decided to join the million-plus Australians who are trustees of their own self-managed super funds (SMSFs).
You’re certainly not alone - thousands of new SMSFs are created every month. For most people, the allure of a SMSF is the control they get over how their retirement funds are invested. The SMSF has huge flexibility in what it can invest in: it can hold a wide variety of assets, including business property and investment property, and the tax treatment of superannuation can be put to work very effectively. Over 60, drawing a pension from your SMSF, your fund’s tax rate is zero – it does not get much better than that.
But for all the benefits of a SMSF, there is a huge amount of responsibility on you as the fund proprietor. The regulations governing SMSFs are strictly enforced, and breaching those regulations can bring quite severe financial penalties. Neither the Australian Taxation Office (ATO) nor the Australian Prudential Regulation Authority accept ignorance of the law or reliance on flawed advice as an excuse: if you run a SMSF, the buck stops with you.
Here’s a checklist of the pros and cons of self-managed superannuation. It’s not for everybody, the decision requires consideration over;
Control. You decide what your superannuation fund invests in, and you own those assets directly. You’re not limited to owning a small part of what a retail or industry or corporate super fund manager chooses to invest in. For example, approved residential and corporate property and even art can be assets of your SMSF. There are limitations - in that the assets must be allowed by ATO, and the ‘arm’s length’ rules apply to their use - but the point is that within the accepted limits, you decide the asset allocation and you choose the individual assets of your retirement fund. You also decide when assets are bought and sold, so you always control the capital gains tax outcome. You can use professional advice, but you don’t have to do so.
Transparency. You can see where every dollar goes; you know exactly what assets are there to fund your retirement.
Tax-efficiency. A SMSF in the ‘accumulation’ phase is taxed at 15%, so it gets a partial refund of the franking credits attached to the shares it owns, in cash. Once the SMSF has switched to pension-paying phase, its tax rate is zero, and it receives a full cash refund of the franking credits. This tax treatment can augment the effective dividend yields substantially.
Keeping it in the family. You can pool resources with family members. Your children can be members of the family super fund.
Cost control. You get more control over the fees you pay. There are set-up costs for a SMSF, and annual costs, some of which are not optional, but in general the costs of administering a SMSF are falling.
Flexibility. You can design how you receive your retirement benefits; you have much more flexible planning ability around how you take a pension from your fund, and how you access Centrelink benefits such as the Age Pension. You can also optimise the estate planning benefits that you get from superannuation.
The other side of control - responsibility. If you’re running a SMSF, you have to keep up-to-date with super law: remember, if you do something outside the law, ignorance or flawed advice is not an excuse.
Regulations. You’re a trustee of your fund, so you’ll have to sign a trustee declaration with the ATO, formally acknowledging that you understand your duties, obligations and responsibilities. Under the sole purpose test set out in the superannuation laws, the trustees must ensure that the fund is maintained for the sole purpose of providing retirement benefits to members. The trustees must ‘formulate and implement’ an investment strategy for the fund, covering liabilities, risk and return, diversification, liquidity and insurance cover for member.
When establishing the fund, you need to draw up a trust deed setting out trustee powers, benefit payments and exit strategy. You also need to create a separate bank account, keep accurate paperwork, produce annual operating statements, keep copies of annual returns and appoint an approved auditor. The accountant that prepares the returns cannot also do the audit.
Not only do trustees have to ensure that their fund is operating in a complying fashion for the purpose of providing benefits to its members upon their retirement (or their beneficiaries if a member dies), they must sign off that they understand (end ensure) that member benefits are only withdrawn when permitted by the super laws; that they understand that the assets of the super fund must be kept separate from their personal assets; and that there is adequate insurance.
Possible penalties. If a fund is not administered properly and loses its status as a ‘complying’ fund, the penalties can be severe, including penalty rates on the fund’s earnings. If a fund becomes non-compliant, the top marginal tax rate of 46.5% is levied on the assets of the fund.
Costs SMSFs can be expensive, with the annual costs of running a medium-sized fund estimated at $2,000. Your fund needs to be substantial enough to make this worthwhile. Many advisers say starting a SMSF is usually not advisable if you have less than $200,000 in super.