What is a self-managed super fund (SMSF)?

As the name implies, a self-managed super fund or SMSF (also known as DIY super) is a private super fund that you manage yourself. So it’s no surprise that control is the number one reason people give when asked why they chose to fly solo.

SMSFs give their members control, flexibility and choice over how their retirement savings are invested. Other reasons for choosing an SMSF include poor performance of an existing public fund, the ability to acquire certain assets otherwise not available in larger funds, and advice from an accountant or financial planner.

According to the latest statistics from the Australian Taxation Office (ATO), there are over 610,000 SMSFs in Australia. More than 1.1 million Aussies are members of these funds.

So how do SMSFs work and how do they compare with public super funds?

An overview of SMSF rules

An SMSF must be set up for the sole purpose of providing retirement benefits to its members (or to their dependants if any of the fund members die before retiring).

Setting up an SMSF involves creating a trust (a legal tax structure) with either individual or corporate trustees. Trustees manage the SMSF’s assets and are ultimately responsible for ensuring the fund’s ongoing legal compliance with super and tax legislation. That compliance includes annual auditing, reporting and tax obligations to the ATO.

Who can be a member of an SMSF?

All members of an SMSF must also be its trustees. If a fund chooses to have a corporate trustee, each SMSF member must be a director of the company concerned. The company must be registered with the Australian Securities and Investments Commission (ASIC). For SMSFs with more than one member, each director of the corporate trustee must also be a member of its corresponding SMSF.

From 1 July 2021, an SMSF can have up to six trustees/members, up from four previously.

To be eligible to become a member (and therefore a trustee) of an SMSF, a person must consent to becoming a trustee and accept their responsibilities by signing a trustee declaration. SMSF members/trustees cannot:

• Be a registered bankrupt
• Have previously been disqualified as an SMSF trustee by a court, the ATO or ASIC
• Have an employer/employee relationship with another fund member (unless they are a relative).

Young people under the age of 18 can become members of an SMSF provided they are represented by a trustee who agrees to act on their behalf. This is generally a parent or guardian.

How does an SMSF work?

Trustees manage SMSF funds by making investment decisions that align with their documented investment strategy. This investment strategy should be aligned with the sole purpose test and be used to guide trustee decision-making.

Important factors to consider when developing an SMSF investment strategy include:

• The individual characteristics of fund members, such as their age, current financial situation and risk profile
• The benefits of diversifying the fund’s investments to reduce risk. The major investment options are fixed interest products, direct shares, managed funds, listed property and real estate
• How easily its assets can be converted to cash to pay future member benefits when required
• The current insurance needs of members to ensure appropriate coverage is arranged.

What are some of the benefits of SMSFs?

Some of the main benefits of SMSFs include:

Greater flexibility with tax

Super can be a tax-effective investment vehicle. SMSFs that comply with super legislation are generally entitled to have their member’s contributions and fund earnings taxed at the concessional rate of 15% in Australia (up to certain limits).

In addition, benefits received after the age of 60 are tax free. Fund earnings when an SMSF is in retirement phase are also tax free.

These tax benefits are common to all super, not just SMSFs. However, SMSFs have more flexibility to use tax strategies around capital gains, taxable income or franking credits.

Greater control over investments

SMSF trustees have more control over how their funds are invested. They can invest in many of the products available to members of public funds, as well as some products that aren’t. For example, SMSFs can invest directly in residential real estate, rather than being restricted to property trusts as many public funds are.

Business owners may use their SMSF to purchase their business premises or other commercial property, which can then be leased to a related party.

Potentially lower fees on higher balances

After years of heated debate about the real cost of running an SMSF, a comprehensive report by Rice Warner for the SMSF Association provided some much-needed clarity.

The Costs of Operating SMSFs 2020 report broke down the ongoing costs for different balances and the amount of administration outsourced to external service providers. It also looked at funds with and without direct property investments.

The report found that SMSFs with a balance of $200,000 or more provided equivalent value to industry or retail funds at all levels of administration, while SMSFs with $500,000 or more were generally the cheapest alternative.

By their very nature, SMSFs are tailored to the preferences of their members, so there is no such thing as an average fund or average fees. Once your SMSF is set up, the ongoing fees you pay will depend on various factors including:

• The number of members
• The combined member balances
• The type of investments (for example, SMSFs with direct property pay higher investment fees on average than funds without direct property)
• The amount of administration you outsource.

Taking the example of a total super balance of $250,000, the report found average annual fees for various types of super funds were:

• $2,728 for industry funds
• $2,502 for retail funds
• $2,959 for SMSFs ($10,198 for funds with direct property and $2,720 for those without direct property).

Estate planning

One often overlooked advantage of SMSF funds is that they can provide greater flexibility with member death benefits than public funds.

For example, an SMSF member can arrange for:

• Death benefits to be paid to a dependant as a pension rather than a lump sum, allowing the SMSF to continue operating
• Funds to be distributed to future generations tax effectively
• Non-cash assets (such as property or shares) to be transferred directly to a beneficiary.

Asset protection

SMSFs provide an effective way of protecting their member’s assets against any future risk of bankruptcy or other claims by creditors. This can make them especially attractive for business owners and professionals.

In most cases, benefits held within a super fund are not considered to be ‘property’ in relation to the Bankruptcy Act.

What are some of the drawbacks of having an SMSF?