How to evaluate whether an SMSF is right for you

It may seem like everybody is jumping on the Self Managed Super Fund (SMSF) bandwagon as a new investment vehicle, but the reality is that just under 5% of the Australian population has one.

According to the Australian Tax Office, at September 2018 there were just under 600,000 SMSFs with a total of 1.125 million total members.

Since the ATO began compiling comprehensive data on SMSFs in 2014, both the number of SMSFs and total number of Australian members in SMSFs has increased by 14% which confirms the rise in popularity of this form of investment.

Number of SMSFs

Source: ATO

However, in each of the past five financial years, there has been between 12,000 and 15,000 “wind-ups” which means the number of SMSFs that have been dissolved. In the financial year to June 2018, 25,440 new SMSFs were established but 15,573 were wound down.

Number of new and wound-up SMSFs: June 2014 to September 2018

Source: ATO
Clearly each year, while more SMSFs are being established, many people are realising that running one is not for them and we’ll get to the many possible reasons for this in a moment.

What type of person has a SMSF?

According to ATO statistics, SMSF members are made up of men at 52.6% and women at 47.4% and the majority of the 1.125 million members are aged between 55 and 69.

SMSF members by sex and gender

Source: ATO
However, the appeal of SMSFs appears to begin to kick in at the age of 35 in both men and women. And contrary to popular belief, SMSFs are not limited to the the super-wealthy. Just over 40% of SMSF members declared an income of under $40,000 while around 14% declared an income of more than $150,000. (Of course, it’s highly likely that many of those declaring income of under $40,000 may be salary sacrificing into their SMSF.)

SMSF member income ranges by sex

Source: ATO

What is apparent though is that SMSFs appear to benefit those with higher balances, with just under 18% of funds holding less than $200,000. (SMSFs can have up to four members and most have at least two people in the fund.)

Total asset range table – proportion of SMSFs

Source: ATO

It confirms the often-quoted industry minimum amount to set up a SMSF, which is $200,000. ASIC commissioned an independent report from Rice Warner on SMSFs and its summary from the research states: “In many cases, a recommendation for a retail client to set up an SMSF with a starting balance of $200,000 or below is unlikely to be in the client’s best interests.”

The Productivity Commission, in its final report to the government on the superannuation sector released in January 2019, recommends an even higher balance which may appear at odds with ASIC’s assessment.

“A minimum balance is too blunt an instrument, but advisers should be prepared to justify to ASIC why they are recommending any SMSF be established with under $500,000 beyond the initial establishment years,” the report says.

What are the costs of running an SMSF?

Most standard super funds charge a fixed percentage-based fee which means the higher the balance, the more you pay, whereas many SMSF are fixed dollar costs so that means they can be relatively cheaper than being in a standard super fund. With some SMSFs, fees can be reduced in percentage terms if the value of the fund rises.

Average total expense ratio vs SMSF asset size

Source: ATO
Running an SMSF might be okay with a $200,000 balance if you are willing to do, and capable of doing, everything yourself and don’t need advisers and you plan to use low expense investments like ETFs. But there’ll still be an annual expense bill of between $2,000 and $3,000 for accounting and auditing.

That’s an absolute minimum and if you take on board an investment adviser and an accountant for the financial management of the fund, then those expenses can easily double, treble or quadruple depending upon the level of advice received.

In June 2018, ASIC released its findings from a review of the SMSF sector and one of the key results was that 32% said the set-up and running costs were more than they expected. It also found that around 90% of financial advice on setting up a SMSF did not comply with relevant laws.

So why do people choose SMSFs?

Many people embrace the challenge of taking charge of their day-to-day investments and are happy to invest their time researching the myriad of options that are available.

Generally speaking this means that if you think you can “beat” the market, such as say a highly traded index fund, and you have the stomach for making regular “big picture” decisions then you might be able to set up a fund that outperforms the big players.

Also, while APRA-regulated super funds do not allow you to purchase direct property investments, in either residential or commercial, SMSFs are able to invest in property. SMSFs can also invest in cryptocurrencies and collectibles such as artwork, jewellery, antiques, coins, stamps, vintage cars and wine. However, there are very strict rules around holding these assets in a SMSF.

What do I need to consider before setting up a SMSF?

ASIC’s MoneySmart website sums up the responsibility like this: “If you decide to set up an SMSF, you are personally liable for all the decisions made by the fund – even if you get help from a professional or another member makes the decision.”

Setting up a self managed super fund (SMSF) can potentially supercharge your retirement plans but they are also complex and it involves paperwork – lots of paperwork – which can be pretty mundane. It is also not a guaranteed road to riches and it involves a lot of work.

If you’re not at least pretty good with paperwork, then the simple fact is that a SMSF is probably not for you. The June 2018 ASIC review also found that 38% said running their SMSF was more time-consuming than they expected.

It’s also critical that SMSF trustees know the SMSF rules. Some of the other common misconceptions and mistakes that ASIC found included:

• 33% didn’t know that an SMSF must have an investment strategy
• 30% had no arrangements in place for their SMSF if something happened to them
• 29% wrongly thought they were entitled to compensation for theft and fraud involving the SMSF
• 19% didn’t consider their insurance needs when setting up an SMSF

Every SMSF trustee needs to ensure compliance with SMSF rules so they avoid penalties for non-compliance.

You can get others to do the work for you (at extra cost of course) and you need to read the paperwork from the ATO and ASIC, your accountant, auditor, investments, platforms, insurers, among others and often this requires immediate action.

Opportunities could be missed. Fines could be imposed. And if you only deal with the urgent paperwork immediately and put the rest to the side to deal with later, you will still need to deal with it, at least every couple of months.

Also bear in mind if you and your husband or wife are trustees in a SMSF and you decide to go your separate ways, things can get pretty messy. Bear in mind that around one third of marriages in Australia end in divorce. Unless the terms of the divorce are amicable, and they rarely are, then splitting your SMSF will involve family lawyers and large cheques.

Running a SMSF is all about risk and reward. For those who get it right there can be great rewards. But getting it wrong can be a disaster for your future. Ignore the noise surrounding SMSFs and accept the fact that it is not for everyone. However, there are good reasons to set up a SMSF, if you can tick enough boxes and are prepared to do the hard work.