CHOICE guide to DIY super

We give you the facts without the advertising hype and expose the dangers.
 
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01 .Do it yourself or not?

Money in nest

If your accountant or financial planner recommends setting up a Self-Managed Super Fund (SMSF) make sure it really will give you the best deal before you jump.

The number of self-managed super funds, or ‘DIY’ funds, almost quadrupled in the last twelve years. By June 2007 nearly 360,000 funds with almost 690,000 members held over 25% of total super assets.

However, some accountants and financial planners may be advising people to open an SMSF when this isn’t necessarily the best option for them. For example, we found material recommending people with as little as $40,000 to invest open their own fund, which clearly wouldn’t be cost-effective. And statistics from the Minister for Superannuation and the Australian Taxation Office (ATO) throw doubt over whether SMSFs are the best option for many people:

  • Too expensive DIY funds, particularly those with small balances, can be very expensive to run. High costs detract from investment returns. The ATO found that the proportion of operating expenses for SMSFs with balances under $50,000 is 10.5% of assets. In comparison, low-cost (non-SMSF) funds charge as little as 0.75% each year, while offering professionally managed investments along with the ability for you to control your own money — for example, through share trading. SMSFs with balances between $50,000 and $200,000 cost 2.63% to 3.55%, and SMSFs worth more than $200,000 had average costs of around 2.3%.
  • Not enough money 30% of SMSFs have less than $200,000, which is generally the recommended minimum. However, the average balance per member is over $400,000, so plenty of wealthy people have DIY funds too
  • Don’t know the rules An ATO survey found that 21% of SMSF trustees had ‘low’ or ‘low to medium’ knowledge of their legal obligations. 15% didn’t have an investment strategy, and 25% were unaware of the restrictions on the type of assets that could be bought from ‘related parties’ such as friends or business associates.

Please note: this information was current as of May 2008 but is still a useful guide to today's market. For more recent information, see our article on Future-proof your super 2012.


DIY super swindlers

Unscrupulous advisers have opened self-managed funds for consumers, giving them illegal access to their super. In some cases consumers were swindled out of some or all their money. In others they were charged up to 20% as a fee. In addition to the risk of losing their super, consumers are faced with large taxation penalties.

If you’re under 55 you can only gain access to your super money in exceptional circumstances, for example, if you’re suffering severe financial hardship or you’re permanently disabled. For information go to www.apra.gov.au or call 1300 131 060.

 
 

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SMSF’s are regulated by the Australian Taxation Office (ATO) and perform the same role as other super funds: collecting and investing your contributions and making them available to you when you retire. The difference is that as a fund member you’re also a trustee who controls how to invest your contributions and pay your own benefits.

An SMSF can have up to four members. They will almost always be family or close business associates.

You’re responsible

As trustee you’re ultimately responsible for running the fund. You need to know the legal requirements and administrative responsibilities.

The ATO has recently announced it will take a “firm approach” with trustees who don’t comply with its rules.

Each fund needs to be independently audited annually. The audit includes an assessment of the fund’s overall compliance with the rules and a financial audit. Auditors previously reported problems and breaches to the trustees who could then take appropriate action, but they must also report them directly to the ATO, which means the ATO may prosecute.

Penalties can range from asking the trustees to offer an undertaking to the ATO to correct the problems, to civil and criminal actions with high financial penalties and/or five years’ imprisonment.

The ATO can also make the fund non-complying, which has dire financial consequences for its members as it means that the fund’s assets and income may be taxed at a penalty rate instead of the concessional super tax rate of 15%.

Suitable for you?

A self-managed super fund is usually only worth your while if you:

  • Have a minimum of $200,000 to $250,000 to invest. For smaller amounts retail and especially industry super funds are likely to be more cost-effective;
  • Have some investment expertise and understand the importance of proper investment strategies;
  • Have the time and interest to be involved with your fund;
  • Are disciplined and understand the responsibilities of being a trustee; and
  • Are in a position where your mandatory employer super contributions can be paid or rolled over into the fund.

To find out whether DIY Super would be an option for you, use our quiz.

Advantages

  • Self-managed super gives you control to choose your own investments. As long as you follow the rules and the fund’s investment strategy, you have a lot of flexibility;
  • Greater flexibility in choice of investments under certain conditions;
  • Can be more cost-effective than other types of super, but this depends on how much you have to invest and how much professional advice and administrative assistance you need; and
  • A tool to minimise tax on your other investments. For example, you may be able to integrate your share portfolio into the fund. However, you won’t be able to access the funds until retirement and access may be affected by changes in legislation; you can also decide when to buy or sell investments and thereby minimise Capital Gains Tax.

Disadvantages

  • Needs continuous attention more info
  • You’ll need to be able to devote at least a few hours to the fund each week;
  • High costs: in comparison with industry or even retail funds, a DIY fund can be expensive;
  • It’s only worthwhile if you have a large sum to invest and even then you can pay high fees if you make use of professional advisers;
  • There’s no guarantee you’ll have better returns than other super funds, it can be extremely difficult to beat the market, as you’ll still be selecting from the same investments and dealing with the same market ups and downs as every other super fund. You’d either have to manage your fund yourself in an active and successful manner or find someone else like a financial planner who can do this for you. They’ll charge you fees so make sure the costs don’t eat up your returns. A basic investment principle is to spread risk over different asset classes. Research by the ATO indicates that SMSFs, especially with smaller amounts invested, have a tendency to have their investments concentrated in only one asset class such as cash;
  • If something goes wrong you can’t use the Superannuation Complaints Tribunal. You may also have problems finding redress if you receive inappropriate advice from an accountant. That’s because accountants were granted an exemption from licensing requirements of the Financial Services Reform Act (FSRA) when they advise consumers on certain aspects of SMSFs such as establishment or operation and not on the underlying investments. This means accountants don’t need to fulfil the disclosure requirements under FSRA and don’t need to belong to an approved external dispute resolution scheme. You won’t be eligible for compensation under super law in case of fraud or theft; and a retail or industry super fund may offer cheaper life insurance cover because their large membership numbers enable them to negotiate low premiums. (You can still take out life cover and the premiums are tax deductible.)

To find out whether DIY Super would be an option for you, use our quiz.

When getting started, keep some basic rules in mind:

  • Each member must be a trustee
  • Trustees can’t receive payment for performing their duties
  • A member of the fund can be an employee of another member only if they’re related. For example, if you’ve got a small business that employs your son, he can be a member of your SMSF; however another employee who isn’t related to you can’t join the fund
  • As a trustee, you’re responsible for the fund complying with the regulations
  • The fund is a separate entity and needs to be separated from your own assets and
  • You need proper administrative procedures to comply with all requirements, for example, keep records of all meetings and decisions, prepare financial statements and lodge all required paperwork with the ATO.

To set up an SMSF you must follow some basic steps:

  • Appoint trustees — can be a private company of which the members are the directors, or all the individual members of the SMSF. If there’s only one member, there must either be a second individual trustee (you can appoint someone else such as a relative) or you can set up a private company of which you’re the sole director, which can act as the trustee of your fund. There are conditions about who can become a trustee, for example an undischarged bankrupt or anyone who has been convicted of an offence involving dishonesty can’t become a trustee.
  • Get a trust deed — a legally binding document setting out the governing rules of the fund.
  • Apply to the ATO to become a regulated fund within 60 days of setting up the fund, in order to obtain concessional tax treatment.
  • Obtain a tax file number and ABN.
  • Open a separate bank account in the fund’s name.
  • Develop an investment strategy.

Other things to keep in mind are:

  • Decide whether life or disability insurance should be taken out.
  • Each member needs to nominate a dependant to receive their benefits if they die.
  • Proper records must be kept, some for up to 10 years.
  • SMSFs are prohibited from borrowing money other than in very limited circumstances.
  • There are rules for buying assets from related parties.
  • SMSFs are in general prohibited from lending money to members or their relatives.

Buyer beware

Be wary of advisers that make the process seem easy, look after only a handful of SMSFs, don’t have proper industry qualifications, haven’t kept their knowledge up-to-date or have worked with DIY super for only a short time.

A large range of professionals are offering DIY super services and their qualifications and charges vary widely. Look at whether they’re licensed to give you financial advice and whether their advice is appropriate for your specific circumstances.

More info

Free information about retirement investments:

  • Centrelink Financial Information Service (FIS), www.centrelink.gov.au, ph 13 23 00.
  • National Information Centre on Retirement Investments (NICRI), www.nicri.org.au, ph 1800 020 110 or 02 6281 5744.

These associations offer education for their members:

Jargon buster

  • Arms-length provision — any investments or leasing arrangements with related parties (see below) must be entered into under normal commercial terms.
  • In-house assets — loans to, investments in and leases with a related party. These are restricted to 5% of the fund’s assets. For example, if the fund owns a holiday home, members can only use it if its value isn’t more than 5% of the total value of the fund’s assets. Business property owned by the fund and leased to a member is exempt from this rule.
  • Related parties — a member of the fund or a person somehow related to a member, including family, friends and business associates. Generally a fund is not allowed to buy assets from related parties. Exceptions are assets such as listed securities (shares, bonds etc) traded at market price, a business property bought at market value or ‘in-house assets’ (see above).
  • Sole purpose test — must be met in order for the fund to receive concessional tax treatment. The fund (and its assets) must be seen to have as its ‘core purpose’ paying benefits when members retire, or after their death. Generally, you can’t receive any other benefit from the assets owned by the fund. For example, if the fund owns shares, you wouldn’t be allowed to receive any shareholder discounts you’d receive if you owned them personally.

Is DIY Super for you?

If your accountant or financial planner recommends setting up a Self-Managed Super Fund, how can you make sure it really will give you the best deal?

A self-managed fund is really only worth your while if you:

  • Have a minimum of $200,000 to invest;
  • Have some investment expertise and understand the importance of proper investment strategies;
  • Have the time and interest to be involved with your fund;
  • Understand the responsibilities that come with being a trustee; and
  • Can have your employer contributions paid into the fund.

Disclaimer: Our recommendations are of a general nature and have not been developed with your individual circumstances and needs in mind. Consult a licensed financial services professional if you require advice about your specific financial needs.

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