The pros and cons of self-managed super funds

In mid-January the Australian Prudential Regulatory Authority (APRA) released its Annual Superannuation Bulletin, which shows the growth in SMSF numbers and assets in the last 12 months.

According to the Bulletin, the number of SMSFs has increased by a net 26,268 in the last calendar year to 428,198. At June 30, 2010, there were 815,000 people in SMSFs with $390.9 billion in assets – giving an average member balance of $480,000.

Unfortunately, the Bulletin only provides an indication of SMSF asset structure and financial performance for funds with more than four members.

Over the years, a number of commentators have predicted that SMSFs would be wound up as the weight of regulatory compliance became too burdensome and that the growth in numbers would falter and gradually be reversed. However, the Bulletin shows us that average growth in SMSF numbers over the last six years has been remarkably consistent at an average of net 22,000 a year.

The main factors that have persuaded 815,000 people to manage their own superannuation assets are cost, control and flexibility.

COST

Managing a SMSF can be expensive when you take into account the administration or accounting fees, audit fees (every SMSF must be independently audited each year), investment costs, a government levy to cover the costs of supervision and, in some circumstances, actuarial costs. Generally, SMSF trustees, who are also the fund members, should expect annual costs of between $2000 to $5000 for administration and audit.

On top of that are costs incurred for the brokerage for share investments, investment advice, and investment management. It has been suggested by APRA that a minimum fund balance of $200,000 is appropriate and it appears that this is because at an average cost ratio of 1% of fund assets to cover all costs, this is the ‘break even’ point. This does not take account of the fact that smaller funds usually have somewhat lower accounting requirements and new funds frequently have lower audit costs initially.

The costs of managing a SMSF are also highly visible in the accounts of the fund. The trustees are very aware of costs because they have to withdraw money to pay them, as opposed to simply having the money withdrawn by the manager, as happens with other funds.

CONTROL

Control of every aspect of their SMSF is frequently a consideration for trustees. They exercise control over the administrator, auditor, financial adviser, insurer or investment manager of their fund, and frequently communicate with these people. The trustees can seek out the best service provider for their fund at the best price, and if they are not happy with the service (or the costs), they can change any of the providers. With other funds, all services are usually ‘bundled’ together and the trustees have no choice other than to move the entire fund if they are not happy.

SMSF trustees also have control over when direct investments are bought and sold, and when capital gains are realised within the fund. Control over the direction of death benefit payments using advanced estate planning techniques is also an important factor for many trustees.

FLEXIBILITY

The flexibility – particularly investment flexibility – inherent in a SMSF is also an important consideration for SMSF trustees. This means that, subject to an appropriate investment strategy being formulated, SMSF trustees can invest in a full range of managed funds, shares and direct investments. Under draft legislation released on February 2, this could include art and other collectables.

Separately managed accounts (SMAs) are very attractive to SMSF trustees and increasingly fund managers are offering these as an alternative to managed equity funds.

Until a few years ago, SMSF trustees were prohibited from borrowing to invest unless the borrowing was built in to the investment product (such as instalment warrants). Under changes to legislation over the last few years, the opportunity to borrow to improve fund performance has expanded. Here are some of the borrowing strategies now available to SMSF trustees.

• Instalment warrants over “top 200” shares, Listed Investment Companies and Exchange Traded Funds on the Stock Exchange can be purchased. These investment products have a loan built into them, as well as the cost of an option over the shares, to guard against a fall in value. The SMSF trustees collect the dividends each year, pay the interest and the protection costs. The loan amount remains constant and is paid out when the warrant is sold.
• Self-funding instalment warrants can be purchased. These warrants are very similar to ordinary instalment warrants, except that the warrant issuer keeps the dividends and uses them to pay the interest and part of the loan each year.
• A property can be purchased by the fund using an instalment warrant over the property. There is complex legislation governing the use of property instalment warrants within an SMSF and you should speak to your adviser to determine whether this approach is suitable for you and the best way to implement it.
• A portion of a property can be purchased as a joint venture with someone else (usually a trustee) who borrows against other property outside the fund to purchase his or her share of the property. You should ensure that the title of the property clearly shows the percentage of the property owned by the SMSF.

Please talk to your Bongiorno adviser if you are considering establishing an SMSF, and particularly if you would like to borrow to invest within your fund.