How to evaluate whether an SMSF is right for you

The opposite trend is evident for wind-ups. Around 22,700 SMSF were wound up in the year to June 2018, compared to an annual average of 15,000 for the previous five years.

Number of SMSFs

Source: ATO

There are many reasons for winding up an SMSF, including the death of a member. But in some cases, it can be assumed that people have realised running their own fund is not for them. More on why that may be the case in a moment.

Who has an SMSF?

According to the latest ATO statistics, 53% of SMSF members are men, while women make up 47%.

Not surprisingly, most members are aged over 55. Not only have older members had time to build up a big enough balance to make an SMSF cost effective, but retirees are likely to have more time on their hands to manage their investments and fund administration. However, the appeal of SMSFs appears to begin to kick in around the age of 35 in both men and women, with one quarter of all members now aged under 50.

And contrary to popular belief, SMSFs are not limited to the super-wealthy. While the average taxable income of all members was $117,000, just over 40% of SMSF members declared an income of under $40,000. Of course, it’s highly likely that many of those declaring income of under $40,000 are either salary sacrificing into their SMSF or married to a higher income earner who is also a trustee of their fund. It also doesn’t distinguish between members pre- and post-retirement; as at June 2018, 39% of members were in retirement phase.

What is apparent though is that SMSFs appear to benefit those with higher balances, with just under 16% of funds holding less than $200,000. This also reflects the maturing of the SMSF sector, as four years earlier almost 21% of funds had less than $200,000 in assets. (SMSFs can have up to four members and most have at least two people in the fund.)

It confirms the often-quoted recommended minimum amount to set up a SMSF of $200,000. In a report released in October 2019 titled Self-managed super funds: Are they for you?, ASIC commissioner Danielle Press said: “Our research found that SMSFs are not suitable for members with a low fund balance, particularly where they have limited ability to make future contributions. This is important because consumers starting off with a low balance need to be aware that they may not be in a better financial position in the future by holding an SMSF compared with investing in an APRA-regulated fund.”

While stopping short of nominating a recommended minimum SMSF balance, ASIC pointed to the findings of the Productivity Commission report on the superannuation sector released in January 2019. This identified that SMSFs with balances below $500,000 produce lower returns, on average, after expenses and tax, when compared to industry and retail super funds. In fact, average returns of funds with balances below $200,000 were negative after expenses and tax. Conversely, ASIC says SMSFs with balances above $500,000 have, on average, returns that are competitive with industry and retail super funds after expenses and tax.

ASIC’s research also found that SMSFs are not an appropriate investment option for people who want a simple superannuation solution, particularly if they have a low level of financial literacy or limited time to manage their own financial affairs. ASIC estimates SMSF trustees spend more than 8.4 hours a month, on average, managing their fund. That’s over 100 hours a year you could be out fishing or meeting up with friends.

While time is a real cost, there are also significant financial costs associated with SMSFs.

What are the costs of running an SMSF?

Most public super funds charge a fixed percentage-based fee, which means the higher the balance the more you pay. Whereas many SMSF fees are fixed dollar costs, so the larger the fund balance the lower the total fees as a percentage of funds under management.

Running an SMSF might be cost effective with a $200,000 balance if you are willing and capable of doing everything yourself, without using advisers, and you plan to use low-expense investments like ETFs. But there will still be an annual bill for accounting and auditing.

Or you may be prepared to wear the extra costs in the early years because you expect to be able to contribute substantial amounts into your fund in the not-too-distant future.

In a controversial report released in October 2019, ASIC estimated the average cost of running an SMSF is $13,900 a year. On top of set-up fees, you will need to pay an annual SMSF supervisory levy, costs for an annual financial statement, tax return and independent audit, a fee for annual actuarial certificate (if required), ongoing SMSF administration costs and professional investment fees. Then, eventually, wind-up fees.

However, the industry questioned ASIC’s figures and particularly their inclusion of set-up fees, which are not ongoing. Based on an analysis of more than 190,000 SMSFs on its platform, SMSF administration software provider, BGL found the average annual cost of running a fund was $5,720, while the median cost was $3,718.

In an attempt to improve reporting of costs, the ATO provided a more granular breakdown of expenses in its latest SMSF statistical overview. It found that the average expense ratio for all SMSFs was 1.19%, or $14,900, up 32% over five years. However, this figure was distorted by a small number of very large funds. Median expenses were $7,700. Furthermore, when optional costs such as insurance premiums, interest and investment expenses are stripped out, the median operating expense was closer to $3,400.

Even so, the ATO supported the general observation that low balance SMSFs are most expensive to run. In 2017-18, funds with a balance of less than $50,000 had average expenses of $3,800 and an average total expense ratio of 15.37%. While funds with over $2 million in assets had average expenses of $29,500 but a total expense ratio of just 0.69%, making them a cost-effective super solution and competitive with most public funds.

So why choose an SMSF?

Many people embrace the challenge of taking charge of their day-to-day investments and are happy to invest their time researching the myriad options available. If you think you can beat the market 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.

SMSFs are also the only type of super fund that allow couples to combine their super in the one fund. This can have tax and other advantages when it comes to managing your finances, especially as you move into retirement phase and begin drawing down income.

Another big attraction of SMSFs is that, unlike APRA-regulated super funds, they allow you to purchase direct property investments in residential and commercial real estate, including your own business premises. SMSFs can also invest in cryptocurrencies and collectibles such as artwork, jewellery, antiques, coins, stamps, vintage cars and wine. However, there are strict rules around holding these assets in an SMSF.

What else do I need to consider before setting up an 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.” In other words, the buck stops with you.

Setting up a self-managed super fund (SMSF) can potentially supercharge your retirement plans, but they are not an automatic road to riches. They are also complex to run and involve lots of paperwork that can be time consuming and, let’s face it, boring.

If you’re not good with paperwork, then the simple fact is that an 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 trustees understand 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 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 an SMSF and you decide to go your separate ways, things can get messy. 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.

Difficulties can also arise when the more active partner in the fund dies, leaving their spouse unprepared and under unwanted pressure at what is already a stressful time.

Running your own SMSF is not a magic bullet. It is simply an alternative investment vehicle for your retirement savings. For those who get it right, the rewards can be great. But getting it wrong can be costly, both in terms of your future financial wellbeing and your stress levels. So ignore the noise surrounding SMSFs and ask yourself if running your own fund is right for you.