Superannuation

  • Superannuation
  • Self-Managed Superannuation Fund (SMSF)
  • Retirement Planning
  • Age Pension
  • Centrelink Benefits
  • Transition to Retirement Pension (TRP)

A clear-eyed take on SMSFs

We might not think of it as such, but Australia’s near $3 trillion in superannuation savings is a remarkable national achievement. It’s especially remarkable when you consider that this massive savings pool is owned by a nation of just 25 million, making our superannuation system the world’s fourth-largest pension market.

The combination of superannuation, non-superannuation savings, and targeted aged pension helps to explain why Australia’s national debt is comparatively small by developed country standards.

Australia’s debt to gross domestic product (GDP) stood at around 42 percent in 2018. That’s a number most people would probably like to see lower over time, however, compared to debt levels elsewhere, it doesn’t look so bad.

Japan’s debt to GDP stood at an eye-popping 235 percent, Italy 130 percent, Canada and the UK 86 percent each, while the United States registered 105 percent.

Pension liabilities in those countries are a time bomb. Australians are often critical of our political leaders but give them credit where it’s due. They saw that we could have headed down the same track and acted before problems grew too large.

Frustratingly, both sides of Australian politics fiddle with superannuation arrangements, but also support it. For all the imperfections of our superannuation system, doing away with it would create larger problems, including potentially higher national debt.

Despite the massive pool of superannuation savings, it’s a sad reality that too many people go into retirement with super balances that are insufficient to ensure reasonable living standards and thus they need to be topped up with part-pensions.

Another reality is that too many Australians are disengaged from superannuation. For many Australians, and especially people in their 20s and 30s, superannuation is “out of sight, out of mind.”

Super, like tax, removes money from pay-packets before they even see it. It’s not until people approach retirement that superannuation enters their consciousness.

How’s this for evidence that super fits in the “out of sight, out of mind” category for many.

It’s estimated that 50 percent of Australian workers have some level of lost Super. As of 30 June 2018, there were 6.2 million lost and ATO-held super accounts valued at $17.5 billion.

That’s a serious amount of money!

SMSFs create an incentive for engagement

One of the growing areas in superannuation is the creation of a self-managed superannuation fund (SMSF). Doing so transitions super from “out of sight, out of mind” territory, to “it’s my money and I’m in charge” territory.

SMSFs make up more than 99 percent of all superannuation funds and about 30 percent of the near $3 trillion superannuation pool. More than 50 percent of SMSFs have been established for more than 10 years, and 16 percent have been established for three years or less.

So, there’s no doubting their popularity, especially with self-employed people, business owners, and those with high superannuation balances.

However, a few things need to be borne in mind before a person goes down the SMSF route.

Firstly, have realistic return expectations.

People can be frustrated with returns from fund managers, but DIY investing doesn’t necessarily deliver better returns. Investing is a full-time commitment and keeping abreast of markets and having the discipline to manage emotions when markets, especially share markets, go down from time-to-time, can be challenging.

The temptation to play it ultra-safe with ultra-conservative investments can be as damaging to the goal of achieving good long-term returns as reacting to every market twitch.

You also need to be watchful of property spruikers promising the world with investments targeting SMSF investors.  Many such properties don’t pass the smell test, but you wouldn’t know it from glossy brochures and websites, and rosy return projections.

Having a property or several properties in an SMSF portfolio can also result in an insufficiently diversified portfolio. Add the current ability to borrow money and invest into a SMSF the risk of bad investment decisions and illiquidity of a non-diversified property portfolio are amplified.

Here are our clear-eyed pros and cons of SMSF. We might not win any popularity contests for even mentioning that there could be some negatives with SMSFs, but, being responsible and honest is important. Popularity isn’t.

Some advantages of SMSFs:

  1. Means to hold your business premises:Many business owners hold their business premises in their SMSFs for tax-effectiveness, asset-protection, succession planning (for family enterprises) and security of tenancy.
  2. Ability to quickly buy or sell assets:SMSF members can instantly change their investments and/or the asset allocation of their portfolios. With large funds, there is sometimes a frustrating lag between when investment changes are requested and when those changes are executed.
  3. Way to invest differently:SMSFs enable members to invest in a way that is generally not available in most large super funds. For instance, SMSFs can hold direct property, unlisted shares, artwork, and other exotic or not-so-common investments.
  4. Potential to cut costs:SMSFs with larger balances – say, above $1,000,000 or so – may have lower fees than many alternative retail super funds, this depends on the investment choices within the fund.
  5. Ability to hold exotic assets: SMSF members have the ability to hold alternative investments such as artwork, wine, coins or gold for example within the fund. However, there are strict rules around the percentage allowed and the storing of such assets.

Disadvantages of SMSFs

  1. You are in charge: If you set up a self-managed super fund (SMSF), you’re in charge – you make the investment decisions for the fund and you’re held responsible for complying with the super and tax laws. These laws are extremely extensive and complex. An SMSF must be run for the sole purpose of providing retirement benefits for the members or their dependants. Don’t set up an SMSF to try to get early access to your super, or to buy a holiday home or artworks to decorate your house. These things are illegal.
  2. Time-consuming:Operating your own SMSF is time-consuming even when using a professional SMSF administration service (as most self-managed funds do) and even if paying a good financial planner to help guide the fund’s investments. By contrast, a large fund takes over all the administration and many of the day-to-day investment decisions – working within your asset allocation or investment choice.
  3. Need for investment knowledge:Ideally, SMSF members should have a much more thorough understanding of at least the basics of sound investment practices than members of big funds. SMSF members should really understand, for instance, how an appropriately diversified investment portfolio can spread their risks and the potential for returns. Furthermore, members should understand how excessive investment costs and taxation (perhaps arising from unnecessarily frequent trading) erodes returns.
  4. Penalties for non-compliance:The ATO, as a regulator of self-managed super, has the power to remove a fund’s complying status, unleashing a tax shock. This is one of the ultimate sanctions against wayward funds.

The market value of a non-complying fund, less non-concessional (after-tax) contributions, is taxed at the highest marginal rate. This could destroy much of the retirement savings of every member of an SMSF.

  1. Risk of poor diversity:Some SMSFs are established specifically to buy a single asset such as business real estate. This means the fate of the fund is tied to the performance of that asset.

Depending on what other superannuation and non-superannuation assets the members hold, they may be inadequately diversified for risk and return – a danger that intensifies if an SMSFs sole asset is geared.

  1. High costs for smaller balances:Before setting up an SMSF, members should compare its likely costs with those of retail super offerings. SMSFs with small balances are generally not nearly as cost-effective as, large retail funds, for example.

Whether a self-managed fund is financially feasible will depend, in part, on the types of investments (whether held directly or through managed investment funds), the expected level of future contributions to boost the balance, the size of the existing balance, and cost of gaining professional assistance such as from financial planners, accountants and auditors.

What all this distills down to is that an SMSF may be the right solution for you, but only after a thorough review of your circumstances and a clear understanding of the expenses and implications.

References

1 https://www.superannuation.asn.au/resources/superannuation-statistics
2 http://worldpopulationreview.com/countries/countries-by-national-debt/
3 Ibid
4 https://www.etax.com.au/lost-superannuation/
5 https://www.ato.gov.au/about-ato/research-and-statistics/in-detail/super-statistics/smsf/self-managed-superannuation-funds–a-statistical-overview-2015-2016/?page=2
6 Ibid

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