Not for higher investment returns …
There has been an above trend increase in the number of self managed super funds (“SMSF”) set up recently. Such spurts usually occur when investment returns have been poor. The expectation appears to be that better returns will be achieved with a self managed fund.
However, there is no clear link between investment performance and super fund structure i.e. self managed, industry, corporate or retail public offer. While industry fund advertisements suggest otherwise, their claims relate to the relatively higher costs of the alternatives. Before costs and taxes, no structure has any inherent investment performance advantage.
Five potential SMSF benefits …
But a SMSF offers at least five potential benefits over other super structures:
- Control If you want control, an SMSF structure is your best solution.You are the trustee of the fund and, as such, you manage the trust on behalf of the members (yourself). Within the bounds of the law, you make trustee decisions that take your personal circumstances into account.This can be important in matters such as estate planning. Imagine if you had managed your affairs to take advantage of the pre June 2007 $1 million contribution opportunity, only to die in July 2007. With any structure other than a SMSF, the third party trustee would in most cases transfer your funds out of the super environment.
However, with a SMSF the trustee (usually your surviving spouse) could retain the benefits within the fund, allowing for a pension to be drawn offering potentially huge future tax savings.
- Increased Choice and FlexibilityYour ability to implement strategies and adapt to legislative changes is much greater with a SMSF. So is the choice of investment options available to you.These are potentially significant advantages. But for some, added choice and flexibility can result in procrastination. For others, it can lead to poor decisions because the pros and cons of alternatives are not well understood.Choice and flexibility are sometimes blessings and sometimes curses.
- Better Tax ManagementWith most (but not all) industry and public offer fund structures, your account is taxed on realised and unrealised earnings. But with a SMSF, only realised earnings are taxed.This means you have more money working for you. A smart investment strategy that defers unrealised capital gains until the pension phase can add up to an estimated 0.5% p.a. to your after tax investment returns.
- Improved Cash Flow ManagementWith transition to retirement pension strategies, you can contribute to and withdraw from super simultaneously. A SMSF allows you to manage this within one pooled account.Instead of selling assets in a pension account (to fund a pension withdrawal) and simultaneously buying assets in an accumulation account (to invest new contributions), the cash flows are able to be netted eliminating unnecessary transaction costs.
- Investment Risk ManagementWith most public offer and industry funds, when contributions are received they are immediately invested according to a previously nominated investment strategy.A SMSF allows the separation of the contribution strategy from the investment strategy, enhancing the flexibility of your investment risk management.A decision to make a large after-tax contribution now does not commit you to immediately investing those funds. The timing of any investment will be driven by your independently determined investment strategy.
But not for everybody …
While there are potential benefits of a SMSF, there are some downsides. There are the significant responsibilities and obligations you take on as trustee.
And the costs of running an SMSF can be higher than other structures. Generally, we think it only makes sense to set up an SMSF if the projected super benefits are expected to exceed $1 million (in today’s dollars).
While the Australian Tax Office recommends a minimum balance of $140,000, we think this only makes economic sense if your benefits are expected to grow substantially. Any decision should be heavily based on your expected future superannuation position, rather than where you are now.
Ultimately, the decision to set up an SMSF is quite personal. A cost/benefit analysis is useful but may not be conclusive. Many of the perceived benefits are not easily measured in dollars and cents.
One thing we do advocate is making an early decision. The earlier you choose the right structure, the more chance you have of maximising the benefits.