Is DIY super right for you?

zoe fielding

Setting up your own super fund has many benefits. But you need to make sure it works well for you. By the time most of us reach retirement age, our superannuation should contain a large amount of savings. Throughout our working lives, most of us have to contribute at least 9 per cent of our salary into super each year. And the super environment’s tax advantages make it appealing to increase this amount if there’s cash available to do so.

For such an important investment pool, we have little control over when and how we can get our hands on the money. While the strict regulations that govern these details may be beyond our influence, at least we can dictate how the money is invested.

The most flexible type of superannuation by far is a do-it-yourself, or self-managed, fund. With an SMSF you assume complete responsibility for the fund, its operations and investment decisions.

You can set one up just for yourself, or you can include as many as four members. Each member is also either a trustee of the fund or a director of a company that acts as the fund’s corporate trustee.

If you’re thinking about starting one up, you’re not alone. More than 27,000 new DIY funds were established in the 2009/10 tax year, Tax Office figures show. Additional funds are still being registered at a rate of about 2500 a month.

At last count there were about 428,000 SMSFs in Australia with more than 815,000 members. While they do hold appeal for an increasing number of people, they are not for everyone.

Managing the fund yourself does not give you free rein to do what you like with the money. The superannuation laws still apply and there are special rules that relate specifically to SMSFs. Also, remember that you need to live on the money you have accumulated in your super when you retire, so if you are going to manage it yourself you must treat it with respect.

As the ATO notes: “Setting up an SMSF is a major financial decision and you need to have the time and skills to do it. There may be other, better options for your superannuation savings. Either way you should certainly get professional advice.”

Before you launch your own self-managed fund, you should think hard about whether it’s the right choice for you.

DO YOU QUALIFY?

The first thing to confirm is whether you are eligible to act as a trustee. Most people can do so if they are over the age of 18 but not everyone will qualify.

You can’t act as a trustee, for example, if you have been convicted of an offence involving dishonesty or if you are an undischarged bankrupt.

Normally, you also won’t be allowed to fill the role if you’ve been subject to a civil penalty under super laws or have been disqualified by the Tax Office or Australian Prudential Regulation Authority.

People and companies that are insolvent also won’t qualify.

Each of the trustees needs to sign a declaration saying they are not disqualified from starting an SMSF. But don’t give up straight away if you have been disqualified for one of these reasons; you can still apply to the ATO for a waiver that will let you run your own fund.

Another condition is that management decisions about the fund’s investment strategy as well as performance reviews must be carried out in Australia most of the time. These duties are usually performed by the trustees.

As long as all parties live in Australia this probably won’t be a problem but if you or other members are going to be overseas for more than two years the fund may not comply with its residency tests. And if any of the trustees is to move permanently overseas, the fund won’t comply.

SMSFs that fail the residency tests are taxed at the top marginal tax rate, so if there’s a chance any members will be going overseas for an extended period you should seek professional advice about how to manage its status.

COSTS VERSUS BENEFITS

Assuming you are one of the majority of Australians who are eligible to start a self-managed super fund, the main question to answer will be whether the advantages are worth the costs and the effort.

Everyone has a degree of choice when it comes to allocating their superannuation assets, regardless of whether they run their own fund. Most publicly available super funds offer a range of investment options. If you don’t have much money accumulated or you don’t have the time or inclination to handle the administration that goes with DIY super, you might be better off leaving it up to the professionals.

The costs of running an SMSF can also be substantial and it is generally agreed that you need a balance of at least $200,000 within your super for the returns to outweigh the administrative costs of running it. Some experts advise having a minimum balance of $250,000.

Self-managed funds must pay a supervisory levy of $150 a year to the Tax Office. There are also other services for which you will usually need to pay. These will include an auditor to review the fund, an accountant to prepare annual returns and perhaps an administration service to help you report on its results. These add up and you can’t cut corners.

As a trustee, each member is ultimately accountable for all the decisions that relate to their SMSF. All trustees must make sure it complies with tax and super laws and only make investments that are in line with the members’ best interests.

It takes time and effort to keep up to date with changes to these laws.

The trustees also have to maintain proper records and monitor and report on the performance of the fund.

If anything goes wrong, the trustees must take the blame. Even if you seek advice from an accountant, lawyer or financial planner, the buck stops with the trustees. The Tax Office won’t accept excuses that you didn’t know or didn’t understand the rules. It’s up to you to make sure you do.

Making a mistake, or intentionally breaking the rules, can be costly. You might be liable for tax penalties. If the breach is serious enough you could face fines or even be sent to jail.

But as long as you do things by the book and get expert help if there are questions you can’t answer by yourself, you should stay out of trouble.

NEXT STEPS

DIY super is the only type of super that lets you select the individual assets that your fund buys and when they are bought and sold, which you can’t do in a pooled super scheme. You can also buy direct property and alternative investments such as art or wine through an SMSF.

This level of control over investments is great if you’re confident you can pick assets that will perform well for you over the long term.

But before you start up your own fund, ask yourself whether you believe you can outdo the experts.

Over the 10 years to January 31, 2010, the median balanced super fund – holding between 60 per cent and 76 per cent in growth assets like shares – returned 5.28 per cent a year, says SuperRatings’ data from the 50 largest super funds.

This might sound like a small return but it does include the tech wreck and market turmoil during the global finance crisis. In the recent downturn, almost every asset class lost value and few investors escaped the losses.

Do you believe your investment decisions would have fared better than those made by professional super fund managers?

If your SMSF can’t at least match this performance, after fees, the work you put into managing it will hardly be worth the time and effort.

INVESTMENT STRATEGY

To give your self-managed super fund the best chance of success, you must formulate an investment strategy and monitor its performance against its goals. This is the key task of a trustee since the whole point of DIY super is to accumulate money for its members to spend during retirement.

Ask yourself if you have the confidence to set up this strategy and the time to monitor the results. You can always get help from a financial adviser or stockbroker but this, of course, adds to its costs and takes some of the control out of your hands.

As with all other aspects of super, there are conditions. Any investment must be made for the sole purpose of providing a retirement benefit to the fund’s members. This might sound like an obvious goal but the sole purpose test, as it is called, stops you or anyone else related to the fund from using its assets in a way that might conflict with the longer-term aims.

Your SMSF can’t buy a property that you then live in or use as a weekend retreat, for example. It can’t buy jewellery for your mother to wear. And it definitely can’t lend money to relatives or be used to prop up a struggling private business.

It also can’t buy assets from people who are related to it. This includes all of its members and their relatives, the members’ business partners and the spouses or children of these business partners, as well as companies or trusts that its members control or influence.

The main exception to this rule is that the fund can buy from a related party land and buildings that are used exclusively for a business. This is the most attractive feature of DIY super for many small business owners because it can be used to get a property off the business’ balance sheet or quarantine it from the individual owner’s personal financial affairs, which can have tax advantages.

Any purchase must be strictly commercial – the fund must pay a fair market price for the property and charge the business rent at the market rate.

It’s possible for the fund to borrow money to buy property, or other assets, although there are rules about how this must be done.

As well as allowing you to choose what assets it invests in, a self-managed fund lets you dictate when assets are bought and sold. This can provide tax benefits.

For example, if the SMSF buys an investment that appreciates in value, the trustees can hold on to the asset until the members are eligible to start a pension. The asset can then be rolled into the pension fund before it is sold and the capital gain is realised.

Earnings on investments held in super funds that are in the pension phase are tax free so the fund doesn’t have to pay tax on the capital gain.

The Australian Financial Review