What is a self-managed super fund (SMSF)?

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As the name implies, a self-managed super fund or SMSF (also known as DIY super) is a private super fund that you manage yourself. So it’s no surprise that control is the number one reason people give when asked why they chose to fly solo.

SMSFs give their members control, flexibility and choice over how their retirement savings are invested. Other reasons for choosing an SMSF include poor performance of an existing public fund and advice from an accountant or financial planner.

According to the latest statistics from the Australian Taxation Office (ATO), there are nearly 600,000 SMSFs in Australia. More than 1.1 million Aussies are members of these funds.

So how do SMSFs work and how do they compare with public super funds?

An overview of SMSF rules

An SMSF must be set up for the sole purpose of providing retirement benefits to its members (or to their dependants if any of the fund members die before retiring).

Setting up an SMSF involves creating a trust (a legal tax structure) with either individual or corporate trustees. Trustees manage the SMSF’s assets and are ultimately responsible for ensuring the fund’s ongoing legal compliance with superannuation and taxation legislation. That compliance includes annual auditing, reporting and taxation obligations to the ATO.

Who can be a member of an SMSF?

All members of an SMSF must also be its trustees. If a fund chooses to have a corporate trustee, each SMSF member must be a director of the company concerned. The company must be registered with the Australian Securities and Investments Commission (ASIC) and each director of that company must also be a member of its corresponding SMSF.

From 1 July 2021, an SMSF can have up to six trustees/members, up from four previously.

To be eligible to become a member (and therefore a trustee) of an SMSF, a person must consent to becoming a trustee and accept their responsibilities by signing a trustee declaration. SMSF members/trustees cannot:

• Be a registered bankrupt
• Have previously been disqualified as an SMSF trustee by a court, the ATO or ASIC
• Have an employer/employee relationship with another fund member (unless they are a relative).

Young people under the age of 18 can become members of an SMSF provided they are represented by a trustee who agrees to act on their behalf. This is generally a parent or guardian.

How does an SMSF work?

Trustees manage SMSF funds by making investment decisions. It’s a legal requirement for SMSFs to have a documented investment strategy. This investment strategy should satisfy the sole purpose test and be used to guide trustee decision-making.

Important factors to consider when developing an SMSF investment strategy include:

• The individual characteristics of fund members, such as their age, current financial situation and risk profile
• The benefits of diversifying the fund’s investments to reduce risk. The major investment options are fixed interest products, direct shares, managed funds, listed property and real estate
• How easily its assets can be converted to cash to pay future member benefits when required
• The current insurance needs of members to ensure appropriate coverage is arranged.

What are some of the benefits of SMSFs?

Some of the main benefits of SMSFs include:

Greater flexibility with tax

Super can be a tax-effective investment vehicle. SMSFs that comply with super legislation are generally entitled to have their member’s contributions and fund earnings taxed at the concessional rate of 15% in Australia (up to certain limits).

In addition, benefits received after the age of 60 are tax free. Fund earnings when an SMSF is in pension mode are also tax free.

These tax benefits are common to all super, not just SMSFs. However, SMSFs have more flexibility to use tax strategies around capital gains, taxable income or franking credits.

Greater control over investments

SMSF trustees have more control over how their funds are invested. They can invest in many of the products available to public funds, as well as some products that aren’t. For example, SMSFs can invest directly in residential real estate, rather than being restricted to property trusts as many public funds are.

Business owners may use their SMSF to purchase their business premises or other commercial property, which can then be leased to a related party.

Potentially lower fees on higher balances

After years of heated debate about the real cost of running an SMSF, a comprehensive report by Rice Warner for the SMSF Association provided some much-needed clarity.

The Costs of Operating SMSFs 2020 report broke down the ongoing costs for different balances and the amount of administration outsourced to external service providers. It also looked at funds with and without direct property investments.

The report found that SMSFs with a balance of $200,000 or more provided equivalent value to industry or retail funds at all levels of administration, while SMSFs with $500,000 or more were generally the cheapest alternative.

By their very nature, SMSFs are tailored to the preferences of their members, so there is no such thing as an average fund or average fees. Once your SMSF is set up, the ongoing fees you pay will depend on various factors including:

• The number of members
• The combined member balances
• The type of investments (for example, SMSFs with direct property pay higher investment fees on average than funds without direct property)
• The amount of administration you outsource.

Taking the example of a total super balance of $250,000, the report found average annual fees for various types of super funds were:

• $2,728 for industry funds
• $2,502 for retail funds
• $2,959 for SMSFs ($10,198 for funds with direct property and $2,720 for those without direct property).

Estate planning

One often overlooked advantage of SMSF funds is that they can provide greater flexibility with member death benefits than public funds.

For example, an SMSF member can arrange for:

• Death benefits to be paid to a dependant as a pension rather than a lump sum, allowing the SMSF to continue operating
• Funds to be distributed to future generations tax effectively
• Non-cash assets (such as property or shares) to be transferred directly to a beneficiary.

Asset protection

SMSFs provide an effective way of protecting their member’s assets against any future risk of bankruptcy or other claims by creditors. This can make them especially attractive for business owners and professionals.

Superannuation funds are not considered to be ‘property’ in relation to the Bankruptcy Act.

What are some of the drawbacks of having an SMSF?

The major drawbacks of having an SMSF include:

The knowledge, time and cost required

Running an SMSF can be time-consuming and costly, depending on the investments you choose and the amount of professional help you require. There are compliance obligations, such as annual financial statements, a tax return and an independent audit. Although many of these tasks are outsourced, SMSF trustees must still spend time coordinating and overseeing them.

In addition, a good knowledge of fundamental investment principles is generally recommended. If trustees don’t have this knowledge, it’s best to seek independent professional financial advice. This advice will, of course, incur a cost.

Higher costs on lower super balances

The flat fees typically charged for SMSF services mean that members with low balances are typically changed more than they would if their funds were invested in public funds.

For example, the Rice Warner report found that SMSFs with less than $100,000 were not competitive with industry or retail funds. While SMSFs with balances of $100,000–$150,000 were only competitive if they had multiple members and did some or all of the administration. Once again, average fees can be misleading. The actual fees you pay will depend on the investments you choose and the services you use. Also, higher fees in the early years may be acceptable if you plan to increase your balance relatively quickly.

Higher insurance costs

Public funds can usually provide lower cost insurance to their members than SMSFs can. This is because they have large memberships and can negotiate discounted bulk premiums with insurance providers.

Some SMSF members keep some money in a public fund in order to continue taking advantage of the insurance benefits.

How are SMSFs regulated?

SMSFs are regulated by the ATO (directly) and ASIC (indirectly).

The ATO ensures that SMSFs comply with their financial reporting and taxation obligations.

ASIC manages the registration process for independent SMSF auditors. SMSF auditors play a key role in ensuring overall regulatory compliance. They are required to report any breaches to both fund trustees and the ATO.

Heavy penalties can be imposed on SMSF trustees for non-compliance, including:

• Their fund losing its concessional tax treatment
• Being disqualified from their roles (meaning they can no longer be members of the SMSF, nor can they start a new fund)
• Fines or imprisonment, depending on the seriousness of the legislative breach.

What are the differences between an SMSF and other super funds?

The major differences between an SMSF and other super funds are that:

1. SMSF members are the trustees of their own fund

That means they manage the fund and are legally responsible for its compliance with superannuation and tax laws. Public super funds typically have professional, licensed trustees who take on the responsibility for legal compliance.

2. SMSFs can only have a limited number of members

SMSFs can have up to six members. This is generally not viewed as a limitation, as the majority of SMSFs are run by a couple or a single person.

There is usually no limit on the number of members that public super funds can have (other than a small APRA fund explained later in this article).

3. SMSF trustees develop their fund’s investment strategy and make all investment decisions

Public super fund members generally can’t choose the specific assets that their funds are invested in, though they usually have some degree of control over the type and mix of their investments.

4. SMSFs are regulated by the ATO and ASIC

Public funds are regulated by the Australian Prudential Regulation Authority (APRA).

5. Public fund members have access to the Superannuation Complaints Tribunal to resolve disputes

Public fund members are also eligible for a government compensation scheme in the event of trustee misconduct or fraud.

SMSF members on the other hand must resolve their own disputes, using legal avenues if necessary.

What is the difference between an SMSF and a super wrap?

A super wrap is an account that is a hybrid of some of the characteristics of a public super fund and an SMSF. Wrap accounts are the response of public funds to the growth of SMSFs.

Members own their underlying investments in a super wrap account, but don’t need to be a trustee. People with a super wrap are therefore not responsible for its ongoing administration and legal compliance. Super wrap accounts are regulated by APRA rather than the ATO.

Super wrap account holders often have access to wholesale and institutional investment products that SMSFs don’t, although their investments tend to be primarily in shares, managed funds, term deposits and cash.

SMSF members have access to a wider range of potential investment assets, such direct investment in residential or commercial property and collectables, which are not available to people with a super wrap.

What is the difference between an SMSF and a small APRA fund?

Small APRA funds are super funds regulated by APRA that have fewer than seven members and a licensed trustee (unlike SMSFs where fund members are the trustees). Small APRA funds are usually offered by large financial organisations that also have an Australian financial services licence issued by ASIC.

A small APRA fund allows investors to have greater control of their super investments than they can get with a typical public fund, without needing to become a trustee. Small APRA funds also have access to the Superannuation Complaints Tribunal to resolve any member disputes, unlike SMSFs.

The bottom line

An SMSF is a private super fund you manage yourself, giving you more control over how your retirement savings are invested.

However, setting up an SMSF is a big decision that comes with ongoing legal compliance responsibilities, which can be costly and time-consuming.

Ultimately, whether an SMSF is a good option for you depends on circumstances such as:

• Your current super balance
• How much investment knowledge and spare time you have to manage your fund
• The type of assets you want to invest in.

The information contained in this article is general in nature, so it’s best to seek independent professional advice to determine whether setting up an SMSF is appropriate for your circumstances.