Self-managed super funds (SMSFs) are trust structures set up by a trustee or group of trustees to appropriate their assets in investments to save up for retirement.
Most industry experts, websites and other literature have given variations of the basic definition above to explain what SMSFs are, but there are still many misconceptions surrounding the structure.
It is true that SMSFs open up more investment choices for trustees, but that shouldn’t be the sole reason to establish one. Let’s clarify myths to explain SMSFs.
Myth #1: Only people with a lot of money to invest should consider SMSFs
Most people who consider setting up SMSFs have at least $100,000 to start off their fund, so it’s impossible to establish one for less.
Fact: Having hundreds of thousands of dollars to spare for investments is not a requirement to register an SMSF, although it would be more prudent because of all the one-off and annual expenses that come with its management.
It is just that SMSFs with lower capital have higher percentage of expenses to deal with, and that SMSFs with more capital tend to be more cost-effective.
It is not impossible to establish an SMSF with less than $100,000 as capital, especially if the trustees manage to follow through with a smart investment strategy.
Myth #2: SMSFs are special tax structures that enable trustees to have more retirement money
The Australian Taxation Office (ATO) has special rules for SMSFs, so setting one up will allow trustees to save on tax.
Fact: It is true that ATO has special tax rules that allow SMSFs to be more tax-effective; however, SMSFs are, first and foremost, investment trusts for the sole purpose of growing its members’ retirement benefits. It is an investment fund, not a tax structure.
SMSFs benefit from strategic investments with tax advantages, but the ATO also has strict penalties for those who don’t comply with the Superannuation Industry (Supervision) Act 1993 (SISA) and tax laws—a minimum of 45 per cent tax payable plus additional fines and taxes.
Myth #3: I can have a bigger and better nest egg with an SMSF
Savings from professionally managed funds are slow to grow because fund managers tend to focus on safer investments for the good of all members. This way, some opportunities for growth are passed up if it carries a slightly greater risk.
Fact: Some consider establishing SMSFs because trustees can strategise and operate the trust towards their own investment objectives, instead of relying on professionals who focus on collective gain for all members.
All investments carry risks, so simply thinking of the possible gains is inaccurate because fund managers also curb losses. The gains and losses of a fund, whether professionally managed or SMSF, still depend on the skills of the investor and the economic environment.
It is true that well-placed SMSF investments could lead to a bigger nest egg, but one mistake could also cause greater loss—and SMSFs could suffer from great loss either with investments or penalties for non-compliance.
Myth #4: SMSFs are allowed to have a diverse investment portfolio, so I can invest in anything
SMSFs give its trustees the freedom to invest in almost anything under the sun, as long as the fund can afford it and it can grow the trustees’ retirement savings.
Fact: It is true that SMSFs have more choices when it comes to selecting investments that are appropriate to its members’ objectives compared to managed supers, but they also have limits.
Before even establishing an SMSF, its trustees must discuss and agree on a valid investment strategy that will be written in the SMSF trust deed. Once established, all investments the SMSF will make must be aligned with the objectives and investment strategy—as written out in the deed. Any investment that does not align with it could cause the SMSF to become non-complying.
This means a trust that agreed to invest only in stocks and bonds cannot simply start purchasing real estate as a form of investment. For that to happen, all trustees must discuss the new investment plan, agree on it, and report the changes to the appropriate regulatory bodies, such as the ATO.
Myth #5: SMSFs can purchase residential property as ‘investment’
An SMSF trustee can borrow money from their SMSF to buy a house, fix it, and live in it.
Fact: Stop and rewind because that could be non-compliance in action.
SMSFs can only borrow money to purchase a single acquirable asset, whether real property or other identical assets, using a limited recourse borrowing arrangement (LRBA). Trustees must consider the rules and restrictions that govern LRBAs, but for the sake of brevity, let’s summarise how it works to debunk this myth.
An LRBA means the SMSF has to set up a new trust whose sole purpose is to hold onto the acquired asset. This is to ensure that a lender’s claim is limited to the asset that was purchased with the borrowed money;
The SMSF is only allowed to fix a property to a certain degree, and any change must not alter the original character of the property when it was purchased.
The borrower can pay to fix or change broken pipes, but they cannot renovate the house to make it look good even if they use their own money.
The new trust will serve as the legal owner of the asset, and the borrower (intended owner of the property) is the beneficial owner. This will be the set up until the borrower finally pays off all the debt;
The beneficial owner cannot simply take the property once they have paid off their debt. The condition of release for the property must be allowed in the trust deed;
Any and all trustees and/or related parties are prohibited from residing in a property owned by the SMSF—unless they pay rent at a commercial arm’s length basis or their presence is essential to run a connected business. Giving discounts are not allowed either.
Myth #6: SMSF members can access their money earlier
SMSF trustees are allowed to gain access to their money earlier since they manage their own funds.
Fact: Unless an SMSF trustee has met a valid condition of release, such as entering into a transition to retirement (TTR) upon reaching 55 years of age, accessing SMSF contributions is illegal.
Doing so without meeting any valid condition of release could mean paying a penalty plus any or all of the following:
- Additional fines
- Additional taxes
- SMSF wind up due to non-compliance plus more fines and taxes
- Jail time (plus one and two or all of the above)
Myth #7: SMSFs have better protection for their investments
Since SMSFs have more control over their assets and investments, its trustees can protect their money better.
Fact: Whether a commercial Super fund or a SMSF has better protection depends on the steps taken by trustees to protect their investments.
SMSFs can avail of insurance to protect their assets and other investments if they wish, but they may also opt to risk not having insurance. This means SMSF trustees run the risk of losing any or all their investments should they opt to go without insurance.
On the other hand, a member’s contributions and investments in managed supers are usually insured, especially in cases where the company is at fault.
Myth #8: SMSFs are DIY funds so it should be easy to handle alone
SMSF trustees are responsible for handling the tasks required for managing the fund, which means the government is confident that they can handle things by themselves.
Fact: The acronym SMSF means ‘Self-managed super fund’, not “Self managed super fund” (take note of the hyphenated words).
This means the focus of SMSFs is self-management, which in turn means a lot of work, obligations and responsibilities. All trustee work are unpaid as stated in the law, by the way.
In most cases, trustees will need to seek the (paid) advice of legal, financial, super and tax law experts to help draw up legal agreements and investment strategies, as well as prepare annual reports in compliance with SMSF regulations. It is virtually impossible for SMSF members to do things completely by themselves year after year.
What SMSFs are
Now that it has been established what SMSFs are not let’s get to the point and determine what they are.
Simply put, SMSFs are strategic investment structures with special ATO tax rulings established for the sole purpose of its members’ retirement benefits. Its trustees must actively and responsibly manage the fund to ensure that its investment objectives are met in compliance with SISA and tax laws.
SMSFs means a person needs a lot of time to focus on the workload and responsibilities of actively managing a trust fund because, even if trustees end up paying accredited professionals to do the brunt of the work for them, the trustees are still ultimately responsible for the SMSF.
This is why people who are interested in running their own SMSF should first consider all the facts to determine whether registering a SMSF is the right choice.
This information has been sourced from ATO, ASIC's Moneysmart and Moneyclip.