More Australians than ever before are choosing to invest their retirement savings in a self-managed super fund. SMSFs remain the largest sector of the Australian superannuation industry according to the ATO, with 509,000 SMSFs holding $506 billion in assets as at 30 June 2013.
Although the financial rewards can be significant, the legal requirements of an SMSF can be hazardous for the inexperienced. The consequences of a non-complying fund can be significant with loss of tax concessions and fund assets taxed at the marginal rate of 46.5%.
The following are some key points for trustees of SMSFs to consider.
1. Doing the limbo
“How low can you go?” When it comes to the starting balance of funds in an SMSF, bigger is definitely better. Consultants Rice Warner released a report in September 2013 commissioned by ASIC which examined whether there was a minimum cost-effective fund balance for an SMSF. While there is no “one-size-fits-all” model for SMSFs, the report found that funds with a balance of less than $100,000 were not cost-effective in comparison to a large super fund unless the SMSF could grow within a reasonable time by making substantial super contributions or by transferring other super balances into the SMSF.
2. It’s not me, it’s you
- Setting up an SMSF with a friend or business partner can seem like an attractive option where you don’t have sufficient assets to start up an SMSF by yourself. But be wary of entering into an SMSF with a friend – should the relationship sour or external factors (such as a relationship breakdown) come into play, it can be a very costly exercise to have to go your separate ways.
3. Muscle in with a muscle car
In 2007, legal requirements affecting super funds were relaxed to allow trustees of SMSFs to borrow money to purchase assets to invest in an SMSF. These are known as Limited Recourse Borrowing Arrangements (“LRBAs”).
One of the key requirements of borrowing funds to purchase assets for an SMSF is that any borrowing must be used to acquire a single acquirable asset. Although property is a popular option, there is a growing trend to look outside of real estate with investors purchasing anything from wine and art collections to Europeans cars James Bond would envy. The downside to having a 70s muscle car as the single acquirable asset is that members of an SMSF aren’t permitted to benefit from assets of the fund – so no Sunday drivers allowed.
4. Buy now, sell later
One of the most attractive reasons people decide to set up an SMSF is the opportunity for more favourable tax treatment. Where an SMSF has invested in real estate, Capital Gains Tax (“CGT”) can be avoided on the sale of the property, even if the property multiplies in value. As long as the investment forms the basis of the payment of a superannuation pension, no CGT is payable by the SMSF. Waiting until the pension phase begins before selling the property is a popular way to go.
5. No room for the Brady Bunch
SMSFs have a maximum of four members allowed, so any family with more than two children wishing to participate would be forced to leave someone on the outer. So unless you want cries of “Marcia, Marcia, Marcia!” it’s best to restrict membership to parents only. (The dangers of setting up an SMSF with adult children as members has enough cautionary material for a separate article altogether).
6. It’s hip to be square
Responsibilities of an SMSF trustee including keeping proper and accurate tax and super records and to actively manage the fund. One way to keep good records is to take minutes of any decisions made by the trustee. You must also document the amount and timing of any indirect contributions. The ATO has defined a “contribution” as being anything of value that increases the capital of an SMSF where the contributor’s purpose was to benefit any member of the fund. An example of an indirect contribution would be where a related company pays the SMSFs accounting expenses without being reimbursed. The payment must be recorded as a contribution made to the fund.
7. Steve Moneghetti or Usain Bolt?
When considering your options for an SMSF you need to consider – is it going to be a marathon or sprint towards your retirement? While on the surface a commercial property may seem like a more attractive investment option, residential properties come with their own set of rewards. The type of investment you make should be influenced by the number of years before you expect to call on those funds.
8. Don’t bet your life on it
When establishing an SMSF, it is important to make sure you are protected by life insurance or income protection insurance in case of illness, death or disability. Even a relatively short time out of the workforce can have a negative effect on your finances, including superannuation contributions. Although you may think it won’t happen to you, it’s not something you should gamble on.
9. To market, to market
To prepare a fund’s financial statements and accurately report member benefits, a trustee must value fund assets at market value each year. Market value is the amount a willing seller would be paid for the asset by a buyer who is in no way related to you. While the trustee can come up with their own valuation, a qualified valuer is recommended where an asset represents a significant portion of the funds value or if valuation of a particular asset is complex or difficult.
10. There’s a ‘bare’ in there
When buying a property through an LRBA it is customary to set up a bare trust to avoid adverse income tax, CGT and GST implications. A bare trust is one where the bare trustee cannot do anything unless it is directed to by the beneficiary, which is the super fund trustee. The bare trustee does not need its own bank account and should not file separate tax returns. The only role of a bare trustee is to hold the title of the property – nothing more, nothing less.
Of course the above list is only the “tip” of the iceberg when it comes to SMSFs. If you are interested in the possibilities of an SMSF you should consider your options and seek professional advice before taking the plunge.