Thinking about setting up an SMSF? Read on

The superannuation and tax provisions offer incentives for Australians to save for their retirement. These savings may be handed over, typically to a public offer fund to manage on one’s behalf, or they may be managed directly by you. Managing your own retirement savings however is a huge responsibility and one that should not be viewed lightly.  How you live and how comfortable your life will be when you’re no longer earning an income will depend largely on your efforts of saving and the investment performance and management of your super fund. And while there is no greater way to take control of your retirement savings than setting up a self-managed superannuation fund (SMSF), this is not something that can be recommended for everyone.

We consistently report on matters pertaining to SMSFs, from compliance requirements to tax obligations. For those who are interested in establishing an SMSF but do not currently have one, the following may provide some insight into managing such a fund.

There are strict rules and tangible risks to setting up an SMSF, but at the same time you can choose how to invest your fund’s money and exercise full control as well as having greater flexibility over your investment choices. With an SMSF, you are responsible, you are the trustee of your own fund, you need to comply with the superannuation laws and regulations and you wear the consequences of all your investment and compliance decisions.

While SMSFs will be suited to many people, they are certainly not for everyone. The Tax Office asks all prospective SMSF trustees to consider the following aspects before deciding whether they should manage their own super:

1. Consider your options and seek professional advice

What many people do is to invest their super by putting it into a large fund where it’s pooled with the superannuation of other members and professionally managed by the trustees of the fund. If you set up an SMSF, you’re very much in charge – you make the investment decisions for the fund and you are responsible for complying with the law. Another thing that larger APRA-regulated funds may have over SMSFs is a compensation scheme for fraud.

Deciding whether to take the SMSF route depends on your personal situation. Speak to this office or your professional adviser and do your due diligence before deciding.

Remember however, if you decide to establish an SMSF, you will be either an individual trustee of the fund or a director of a corporate trustee for the fund. We can provide information about the pros and cons of the different structures.

If you do decide to set up an SMSF, make sure it’s for the right reason – saving for your retirement. Don’t set up an SMSF to try and get early access to your super, or to buy a holiday home to use, or to acquire artworks to decorate your house. These actions do not comply with superannuation law, and the Tax Office considers them to be punishable offences.

2. Make sure you have enough assets, time and skills

You will need enough assets, time and skills to:

  • make investment decisions and formulate an investment strategy that you review regularly, and
  • meet all your legal obligations as a trustee.

As an SMSF trustee, your main responsibility is to ensure you have invested your fund’s money appropriately. You need to ask yourself:

  • Am I a confident and knowledgeable investor?
  • Will an SMSF do as well as or better than other super funds after I pay all the costs?

If you’re not confident you can get a better result, you may be better off using other types of funds to provide for your retirement.

The cost of establishing and running an SMSF is contingent on the number of members in your fund (no more than four) and the complexity of the arrangements, the extent to which you make use of professional service firms (annual audit is compulsory), and how much of your own time you will have to spend running your fund. All SMSFs are also subject to an annual levy from the Tax Office, which is currently $259 for the 2013-14 financial year.

Time is another construct that is rarely talked about when considering SMSFs. It may take six to eight weeks or longer to set up an SMSF, depending on the institutions you are rolling your super from. Some of the steps involved in completing the setup of a new fund include applying for your fund’s Australian Business Number (ABN) and tax file number (TFN), setting up a bank account for your fund, deciding on an investment strategy and keeping on top of administration.

The amount of time required to manage an SMSF differs from person to person. For instance, some trustees enjoy buying and selling shares, which requires frequent monitoring of the share market. Other trustees prefer to invest in assets that do not require such close attention, like investment properties. And remember, this office can always help you with the administrative tasks like record keeping, tax and your fund audit.

Don’t forget – you will also be required to stay up-to-date with the superannuation and tax laws, as well as other issues that will affect your fund, such as changes in interest rates and market conditions.

3. Understand the risks and laws

Last but not least, think carefully about your investment options and how you plan to manage the associated risks. These include the objectives of the fund and considerations of the following:

  • investment risk
  • the age of members, and
  • the impact of loss in the fund.

Avoid risking all your retirement savings in one or a few investments. By spreading your investments – in other words, diversifying, you can help control the total risk of your investment portfolio. But spreading your fund’s risk means investing not just in different stocks or sectors but also across different asset classes. Depending on the investment strategy in place, investment options might include cash accounts, term deposits, managed funds, listed Australian and international shares, listed property and direct property. That way, if one or more investments perform poorly, others may help cover those losses.

Super funds, including SMSFs, receive significant tax concessions as an incentive for members to save for their retirement. However, you need to follow the tax and superannuation laws to receive these concessions. Effective from July 1, 2014, SMSF trustees can now be fined $1,700 for a breach of failing to keep adequate records. The penalties incurred by individual trustees for not complying with the law can be severe, refer to our article in last month’s Monthly Client Newsletter to read the lowdown.

One overriding obligation that every SMSF must meet is to pass the “sole purpose test”, which basically means that the fund is legally required to be maintained for the sole purpose of providing benefits to each member on retirement, or to their dependants upon the member’s death. Buying a holiday home or yacht for use by your family is in breach of the “sole purpose test” and compliance with this provision is fundamental; straying from it can lead to severe penalties.

Another essential role of an SMSF trustee is to keep proper and accurate tax and superannuation records. It is always a good idea to take accurate minutes of all investment decisions, including why a particular investment was chosen and that all trustees agreed with the particular decision.

Additionally, you have a legal obligation to have your SMSF independently audited every year. The annual audit will require certain records to be made available, and you may also need to provide other records to the Tax Office to keep your fund compliant.

If you set up or join an SMSF, you will also need to consider having adequate insurance in case you pass away or are unable to work because of an illness or accident. As an SMSF trustee, you are required to consider insurance cover for fund members as part of the fund’s investment strategy. However, it is not a requirement that such a policy be taken out. Life insurance can also be expensive compared to the large funds; they buy group policies that enable them to offer life insurance benefits for illness or accident at a relatively low cost.

If you decide to set up an SMSF, you’re legally responsible for all the decisions made, even if you get professional advice. Typically, an SMSF is suited for those who want greater control, but are also able to actively manage their investments while keeping up with the mandatory regulatory and compliance obligations.

Contact this office to seek appropriate advice before taking the plunge. Being at the helm of an SMSF can be a very rewarding experience, and it offers innumerable benefits – from tax savings and greater estate planning certainty to more investment control and greater investment choices. Just be sure it is the option for you.