Setting up an SMSF – What do you need to consider?

Setting up an SMSF can be complicated.  Not getting it right can materially affect your financial situation and retirement plans.

The first question you need to be sure about is whether an SMSF is the right fit.  Seeking specialised financial advice can help you determine this answer. Some considerations include:

Low balances

You must ensure you have an appropriate superannuation balance before considering an SMSF. While a low balance can be a red flag, it is not always a barrier to entry.  Establishing an SMSF with a small balance may not be in your best interests. This is because SMSFs tend to be more cost-efficient with larger balances. Therefore, before rolling over your superannuation balance to an SMSF, you should establish and justify that by doing so you are likely to end up in a better position in retirement.

Motivation

You must also understand your motivation for establishing an SMSF. The most common motivation SMSF trustees indicate is control. Control of an SMSF allows individuals to have a wide range of investment choice, flexibility and engagement with their superannuation. However, superannuation law is complex and you need to ensure your ambitions are allowed under the law and will be able to achieved in an SMSF.

Costs and time

SMSFs incur a wide range of costs in establishment and the day to day running of the fund. Ensure you are across the estimated establishment, accounting and audit costs that will be incurred by your SMSF. Speak with your advisers so you are across all other incidental costs, which unlike large super funds generally occur with fixed rates rather than as a proportion of your balance.

SMSFs also require dedicated attention from trustees which will take time out of your daily life to manage. Understanding from the outset your legislated responsibilities and obligations before establishing an SMSF is important.

Establishment process

Once you have decided that an SMSF is right for you, the process of establishing the fund can commence. A Specialist SMSF adviser is the best person to help you with this process which generally involves choosing a trustee structure, selecting a trust deed, completing the ATO registration,  opening a unique fund bank account, getting an electronic service address and arranging for rollovers to the fund to occur.

Investment Strategy and Insurance

Upon establishment you must also create an investment strategy which must be regularly reviewed.

Your investment strategy should be in writing and must consider:

•             Diversification (investing in a range of assets and asset classes).

•             The liquidity of the fund’s assets (how easily they can be converted to cash to meet fund expenses).

•             The fund’s ability to pay benefits (when members retire) and other costs it incurs.

•             The members’ needs and circumstances (for example, their age and retirement needs).

•             Whether to hold insurance in your SMSF.

Property investment

It is also common for SMSF trustees to be motivated by investing in property when establishing an SMSF. You should be sure that any investment in property, particularly when gearing is involved, is appropriate for your circumstances. Holding properties in an SMSF can also require some complex structures to ensure the law is being followed and specialist advice may be needed before making an investment choice. A lack of diversification, low balances and inappropriate property investments can have a detrimental impact on your retirement savings.

How can we help?

If you are considering an SMSF, please feel free to give me a call to arrange a time to meet so that we can discuss your particular requirements and circumstances in more detail.

Is your SMSF adequately diversified?

SMSF trustees need to truly understand diversification and better diversify their portfolios.

The benefits of a well-diversified portfolio are numerous but the key ones that SMSF trustees should focus on are the benefits of mitigating volatility and short-term downside investment risks, preserving capital and the long-run benefits of higher overall returns. By spreading an SMSF’s investments across different asset classes and markets offering different risks and returns, SMSFs can better position themselves for a secure retirement.

However, did you know that 82% of SMSF trustees believe that diversification is important but in practice many do not achieve it?

This is because half the SMSF population cite barriers to achieving diversification. The top being that it is not a primary goal for SMSF trustees, and they believe they have a lack of funds to implement it.

Furthermore, 36% of SMSF trustees say they have made a significant (10%) asset allocation change to their SMSF over the last 12 months. This demonstrates that SMSFs may not be actively restructuring their portfolio on an annual basis to respond to changing market conditions.

Another clear problem regarding diversification is the amount of SMSFs with half or more of their SMSF invested in a single investment. SMSF trustees say they primarily invest in shares to achieve diversification in their SMSF, while just a quarter say they invest in at least four asset classes to achieve this.

The bias and significant allocation to domestic SMSF equities conversely may highlight the fact that SMSFs are not adequately diversified, especially across international markets and other asset classes.

So what can you do?

Some of the steps you, with the help of an SMSF Specialist, can take to diversify your retirement savings and control your investments in a disciplined and planned way include:

  • Ensuring there is a clear and demonstrable retirement purposes in the choices you make.
  • Ensuring you have an investment objective and a strategy to achieve that objective in place.
  • Reviewing your portfolio and assessing it against the objectives you have set as often as you feel is necessary.
  • Minimising concentration to any one asset class.
  • Ensuring your Australian share portfolio is sufficiently diversified.
  • Considering the benefits of geographic diversification.
  • Ensuring your cash allocation is appropriate.
  • Considering the benefits of exchange traded funds, listed investment companies and other digital investment platforms that allow low cost access to different markets.

Always remember to document your actions and decisions, as well as your reasons, and keep them as a record in order to demonstrate that you have satisfied your obligations as a trustee.

Given the importance of having an appropriately diversified portfolio and its impacts on quality of life in retirement trustees ought to consider professional assistance in managing this important aspect of an SMSF.

How can we help?

If you need assistance with diversification with your fund, please feel free to contact us so that we can discuss your particular circumstances in more detail, or refer to the SMSF Association Trustee Knowledge Centre.

How much money do you need to start an SMSF?

New research released

SMSFs are not for everyone, but for those individuals where an SMSF is entirely appropriate for them, the benefits can be considerable.

In the context of ongoing public debate regarding the appropriate minimum size for an SMSF, new research has been provided to provide insights into the true costs of running an SMSF. And the research shows SMSFs are cheaper to run than many people may think.

The findings allow SMSF trustees and potential SMSF trustees to compare appropriate estimates of fees for differing SMSF balances with institutional superannuation funds (commonly referred to as APRA regulated funds).

The costs include establishment, annual compliance costs, statutory fees and some investment management fees. Direct investment fees have been excluded.

What does the research tell us?

SMSFs with less than $100,000 are not competitive in comparison to APRA regulated funds (SMSFs of this size would generally only be appropriate if they were expected to grow to a competitive size within a reasonable time).

SMSFs with $100,000 to $150,000 are competitive with APRA regulated funds (SMSFs of this size can be competitive provided the Trustees use one of the cheaper service providers or undertake some of the administration themselves).

SMSFs with $200,000 to $500,000s are competitive with APRA regulated funds even for full administration. (SMSFs above $250,000 become a competitive alternative provided the Trustees undertake some of the administration, or, if seeking full administration, choose one of the cheaper services).

SMSFs with $500,000 or more are generally the cheapest alternative regardless of the administrative options taken. (For SMSFs with only accumulation accounts, the fees at all complexity levels are lower than the lowest fees of APRA regulated funds).

This research highlights that SMSFs with a low complexity can begin to become cost-effective at $100,000. This is a significant departure from what many had believed to be the case. For simple funds, $200,000 is a point where SMSFs can become cost competitive with APRA regulated funds or even cheaper if a low cost admin provider is used. With the proposed expansion to six member SMSFs, we may see many more take up this option at this threshold.

Comparing 2 member funds

From a cost perspective, the real benefit of an SMSF is when it achieves scale in balance and this can occur when members pool their superannuation savings.  The below comparison can be used to grasp the ranges you might fall into.

Combined BalanceSMSF Compliance Admin (2 members)APRA regulated fund Low fees (2 members)
$50,000$1,689$503
$100,000$1,690$863
$150,000$1,691$1,216
$200,000$1,693$1,566
$250,000$1,694$1,942
$300,000$1,696$2,301
$400,000$1,699$3,013
$500,000$1,703$3,725

But it’s more than cost

When determining whether an SMSF is right for you, your analysis must go further than just a simple comparison of the costs versus APRA Regulated Funds. It should also factor in your retirement and income goals and whether you have the desire, time and expertise to take on the role of an SMSF trustee. It’s also worth factoring in SMSF members may not receive the same level of protection in the event of theft or fraud that members in APRA regulated funds do.  

2020-21 Federal Budget Update – Government spends on jobs

The 2020-21 Federal Budget is all about jobs, jobs and jobs. COVID-19 has resulted in the most severe global economic crisis since the Great Depression. This Budget provides an additional $98 billion of response and recovery support under the COVID-19 Response Package and the JobMaker Plan.

The centrepieces of the Budget are a new JobMaker Hiring Credit for businesses and lower taxes for individuals.

Pleasingly, the Government committed to their election promise that there will be no adverse tax changes to the superannuation system. In addition, for the first time in a number of years, there were no measures specifically relating to SMSFs in this year’s Budget.

However, the Government did announce a ‘Your Future, Your Super’ package to address APRA superannuation fees and poor performances. The four measures in this package are outlined below:

‘Stapled’ superannuation accounts – A new default system

From 1 July, existing superannuation account will be ‘stapled’ to a member to avoid the creation of a new account when that person changes their employment. Employers will be required to pay super contributions to their employees existing superannuation fund if they have one, unless they select another fund.

A ‘YourSuper’ portal

The Australian Taxation Office will develop systems so that new employees will be able to select a superannuation product from a table of MySuper products through the YourSuper portal. The YourSuper tool will provide a table of simple super products (MySuper) ranked by fees and investment returns.

Increased benchmarking tests on APRA funds

Benchmarking tests will be undertaken on the net investment performance of MySuper products, with products that have underperformed facing stringent requirements. Products that have underperformed over two consecutive annual tests prohibited from receiving new members until a further annual test that shows they are no longer underperforming.

Strengthening obligations on superannuation trustees – Large APRA funds

By 1 July 2021 super trustees of large APRA funds will be required to comply with a new duty to act in the best financial interests of members. Trustees must demonstrate that there was a reasonable basis to support their actions being consistent with members’ best financial interests.

This will affect those large APRA funds to ensure they are spending in the best interests of the members, rather than SMSFs.

In addition to previous COVID-19 relief, there are also further economic payments for pensioners

The Government will provide two separate $250 economic support payments, to be made from November 2020 and early 2021 to eligible welfare recipients and health care card holders. 

This includes the:

  • Age Pension
  • Disability Support Pension
  • Carer Payment
  • Family Tax Benefit, including Double Orphan Pension (not in receipt of a primary income support payment)
  • Carer Allowance (not in receipt of a primary income support payment)
  • Pensioner Concession Card (PCC) holders (not in receipt of a primary income support payment)
  • Commonwealth Seniors Health Card holders
  • eligible Veterans’ Affairs payment recipients and concession card holders.

Personal income tax changes brought forward

The Government will lower taxes for individuals by bringing forward its ‘stage two’ tax cuts that were due to start in July 2022.  This means from 1 July 2020, the 32.5% tax rate will apply to incomes up to $120,000 (previously $90,000).

In 2020–21, low- and middle-income earners will receive tax relief of up to $2,745 for singles, and up to $5,490 for dual income families, compared with 2017–18 settings.

Other announcements and changes

  • A deficit for 20-21 of $213.7 billion (11% of GDP).
  • Gross debt is $872 billion (44.8% of GDP).
  • A JobMaker Hiring Credit will give businesses incentives up to $200 per week per employee to take on additional young job seekers

Additional $14 billion in infrastructure projects across Australia over the next four years.

COVID-19: Negative returns – looking for the positive?

Despite well formulated investment strategies and appropriate investment advice, no trustee could have foreseen the impacts of COVID-19 on financial markets globally. Whilst history suggests that a strong recovery is likely within a relatively short period after large market corrections, it is still too early to know the impact of COVID-19 on members’ retirement plans.

If your SMSF has experienced some negative returns, there may be an opportunity to ensure member benefits are restored in the most tax effective manner. Particularly if members are approaching retirement and do not have the luxury to wait for markets to recover.

A member’s superannuation interests comprise two components — the tax-free component and the taxable component. Under the proportioning rule, when a superannuation benefit is paid as either a lump sum or as a pension, the trustee must split the benefit between these two components. Members cannot select their tax components.

If a member has an accumulation interest, their tax-free component is based on a prescribed formula. All residual benefits, including all investment earnings, then make up their taxable component. By the same token, any negative returns reduce their taxable component until it is exhausted before notionally reducing the tax-free component.

Where the value of a member’s account falls so that it is less than their prescribed tax-free component, any notional or temporary reduction in the dollar value of a member’s tax-free component can be recouped.

In essence, whilst a member’s balance remains less than their prescribed tax-free component, they are able to restore their tax-free component. This presents an opportunity to reclassify what would ordinarily be treated as taxable component as tax-free, until a member’s prescribed tax-free component is restored. For example:

  • Investment earnings can be treated as a tax-free component.
  • The net amount of concessional contributions made based on the annual cap and any unused carried forward cap can be treated as a tax-free component.
  • Any taxable benefits rolled over by a member from another super provider can be reclassified as a tax-free component.

Once a member’s prescribed tax-free component has been restored, as trustee, you must revert to treating the above-mentioned amounts, as part of a member’s taxable component.

Once a member has restored their tax-free component, they may be eligible to nominate to start a pension. Where they opt to start a pension, as trustee, you must apply the proportioning rules to work out the tax-free and taxable components of their pension. All benefits subsequently taken from the pension will be taxed based on the same proportion, which does not change.

Get the timing right and a member can essentially ‘lock in’ the components of their pension with a high tax-free component, ensuring that all future earnings are classified as tax-free component. This has significant estate planning benefits where they potentially have adult children beneficiaries.

If a member is only eligible to start a transition to retirement income stream (TRIS) the proportioning rules operate in the same way. Although the TRIS would not be in retirement phase and enjoy a tax exemption on income generated by the pension assets, all earnings and capital growth will increase the tax-free component of the pension proportionately. The alternative of retaining benefits in accumulation would see all earnings only increase the member’s taxable component. This opportunity is also not restricted by the $1.6m transfer balance cap limit and the member can enjoy a higher proportion of tax-free pension payments, even where they are under 60.

As a trustee you need to be aware of the different tax components that make up members’ benefits to ensure that member records are accurate and that the correct amount of tax is withheld.

It is also important for member’s to be informed to ensure they do not make the wrong decision. For example, should a member decide to roll-over their entire benefit before recouping their prescribed tax-free component, the proportioning rule will be triggered, and their reduced tax-free component as calculated on the day of the rollover will be fixed. Their decision permanently reducing their prescribed tax-free component.