Self Managed Super Funds, commonly abbreviated to SMSF’s, have been around since the 1970’s. They were originally used by business owners who already had company and family trust structures, with the SMSF a structure dedicated to saving for retirement.
SMSF adoption broadened in the early 2000’s as a result of the combination of expensive retail super products, especially for larger account balances, the ability to borrow to invest into property, and promotion by accountants, who derived ongoing work due to the need for SMSF’s to have annual tax returns and accounts done.
Financial planners jumped on the band wagon too, myself included. In fact I even wrote a text book on the subject for a training provider.
But much has changed in the past 5 years or so. In my financial planning practice we have closed more SMSF’s than we’ve opened. So it’s a good time to ask the question, are SMSF’s still useful?
Yes….
The number one use case for an SMSF remains those wishing to invest their retirement savings into property. If this is the strategy that you wish to pursue then there really is no other alternative.
Originally, SMSF’s were largely used so that business owners could acquire the premises that they operated from. The business would then lease the premises from the SMSF, thus delivering an investment return. This remains a valid use of the SMSF structure today.
A key reason for SMSF growth back around 2009/10 was the ability for funds to borrow to buy property. In its original incarnation, whilst SMSF’s could always buy property, they needed to be able to do “all cash” transactions. No borrowings were allowed. This changed with the advent of a structure known as limited recourse borrowings, and for a while all the major banks offered a solution. The mechanics around this process however proved complex and expensive to administer, such that today none of the big four offer loans to SMSF’s. That has meant those looking to pursue this type of strategy need to go to fringe lenders, typically at significantly higher interest rates than would be the case for mainstream property loans.
Despite these challenges around obtaining borrowings, for those who wish to own property as part of their retirement strategy, SMSF’s remain a viable way to make that possible.
An SMSF structure might also remain attractive for those with large balances who wish to have high level of involvement in the management of their accumulated superannuation savings. Most off-the-shelf super funds have percentage based fees. This can mean that someone with a $1,000,000 balance pays ten times as much in fees as someone with a $100,000 balance. I’ll talk later about other solutions to this, but certainly, shifting superannuation savings to an SMSF can be a way to reduce this impact.
SMSF’s must have annual accounts, tax returns, and an audit done every year. This typically costs around $3,000 per year. Whether the balance in the SMSF is $100,000 or $1,000,000, these costs don’t tend to alter. As a result, an SMSF structure can be relatively expensive for someone with a lower balance, but for someone with a balance in excess of $1,000,000, there can be cost savings. That said, this only applies if the owner of the SMSF does most or all of the administration and investment work themselves. If you outsource all the investing to fund managers, and pay others for administration, then very often the cost of running your SMSF is not greatly different to some of the more modern superannuation solutions now available.
The final remaining valid use case for managing your superannuation savings via an SMSF structure is for those who wish to invest their retirement savings into unusual investments, most typically in recent years, cryptocurrencies. At some point, we will likely have ETF’s that cover cryptocurrencies, but for the moment there is no way, even through more advanced superannuation funds, to be able to invest in things like Bitcoin or Ethereum, let alone the likes of NFT’s. An SMSF structure is the only way to hold these types of investments with your retirement savings. As to whether such investments are suitable for supporting you in retirement is a valid question to ask, however it is undeniable that some people have become very wealthy through investing in the crypto asset class.
No…
Okay, we’ve looked at some reasons why it might be appropriate to use an SMSF, now let’s dispel a few myths and refresh some out of date narratives to consider when an SMSF is no longer the best structure to manage your retirement savings.
Back in the day, a key reason we were setting up SMSF’s for our clients, was that we could achieve significant cost savings by using ETF’s and direct shares. At the time all the regular superannuation funds were using traditional managed funds, with costs typically approaching 2%. For those with balances in the hundreds of thousands, an SMSF structure could deliver equivalent investment portfolios at a lower cost.
Today, the increased functionality and falling costs of Wrap solutions has pulled the rug out from under this use case. Wrap’s are portfolio administration vehicles. They can be used for superannuation and non-superannuation portfolios. On them you can hold managed funds, direct shares, ETF’s, term deposits, and on the most advanced ones, even shares listed on foreign exchanges such as in the United States.
What’s more, their fee structures a tiered, reducing markedly as balances rise. This means that using wrap structures to hold your superannuation can be attractive even for those with large balances.
Wrap’s can also deliver another outcome sought by people who would have once headed down the SMSF pathway. That is those who want to be more hands-on with portfolio construction, they want to see what’s happening under the hood, what is it that their retirement savings own. Wraps can deliver this. Indeed the sophistication delivered by the best of these providers makes the experience better than what was once possible via a stockbroker and an SMSF structure.
Earlier I touched on SMSF’s potentially having an application for those with large retirement balances. It’s therefore worth highlighting that SMSF’s are not suitable for those with balances under around $500,000. Indeed there would be many who would argue a balance north of $1,000,000 is required to make an SMSF structure sufficiently attractive.
I also flagged their ongoing use for those looking to invest their retirement savings in property. Often people investing in property aim to generate profits through renovations and improvements to the property. Such an approach can be problematic within an SMSF. Certainly if you borrow to purchase the property it is essentially impossible to undertake significant renovations. This has to do with technicalities around the limited recourse borrowing arrangements, and the fact that you are altering the security that the bank has taken when issuing your loan.
Even where you don’t have borrowings, renovations can be challenging in that all money used in the renovation must come from your superannuation savings. Adding new money into your super fund to facilitate the works would be considered a contribution. This has two consequences. For one you need to remain within the contribution cap limits. And secondly the money that you have put into the fund to pay for these renovations is now preserved, that is locked up, until you are over 60 years of age and retired.
Possibly a final nail in the coffin for property enthusiasts with regards SMSF’s is that you can never personally use a property owned by your SMSF. All investments held by your SMSF must be entirely for the purpose of supporting you in retirement. They can’t have an additional purpose of you using them as a holiday home, or allowing your children to live in them either rent free or at below market rates. Your SMSF is audited every year, and all transactions must be commercial and at arms length.
For these reasons, in most cases people looking to build wealth through property would be better off doing so outside of an SMSF structure.
The acronym SMSF stands for self managed super fund. Pay attention to those first two words. Do you want to self manage your retirement savings? Do you have the time and expertise to do it well? You’re talking about a lot of money, and the success or otherwise of the investments you undertake can have a huge impact on you and your families lives over the long term. Some people like to DIY the servicing on their car, others like to DIY their graphic design. If you have the skills and the interest, this is great. But if you’re contemplating going down the SMSF pathway, do give serious consideration as to whether you wish to DIY the investment of hundreds of thousands of dollars, upon which you will need to rely for the final 20 plus years of your life.
Summary
So where does this leave us? Are SMSF’s still useful? Certainly they are becoming less common, principally because Wrap services can now solve so many of the reasons that you would have once established an SMSF.
Principally, SMSF’s will continue to be used for property related investments. Many people who already have an SMSF, will likely stick with it. They have already incurred the setup costs and are settled into a nice routine in terms of administration. Some people will likely also use them where they have large amounts of retirement savings, which I would define as balances in excess of $1,000,000. And of course there will be a few DIYers, for whom the rationale for using an SMSF is all about saving a couple of bucks.
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