The right and wrong reasons to set up an SMSF

The right and wrong reasons to set up an SMSF

Thinking of setting up a self-managed super fund (SMSF)? You may be doing it for the wrong reasons, according to the Australian Tax Office (ATO). 

In a speech delivered to the SMSF Association, the ATO revealed some of the most common reasons that Australians set up SMSFs, some of the mistakes these Australians make, and some tips for setting up a fund.

The right reasons to set up an SMSF:

According to the ATO, one of the main reasons Australians choose to set up SMSFs is to take an active and direct role in managing their own super.

A SMSF allows individuals to control and manage the assets for their retirement, potentially maximising returns while minimising the taxes and other expenses.

According to an article quoted by the ATO, most SMSF members start their funds at the suggestion of financial professionals.

“SMSF members do not show any greater financial skills than non-members, but they do display overconfidence, a higher risk tolerance and a more trusting attitude to financial professionals.”

Potentially bad reasons to set up an SMSF:

A second reason why some individuals consider SMSFs is so they can access their super money early, for reasons other than funding their retirement, such as paying bills, taking holidays, or buying cars.

“These individuals never had any intention of managing their own super and established an SMSF to gain illegal early access to their benefits. We also see promoters operating in this space, assuring participants that this practice is OK.”

Another reason why some Australians consider self-managed super funds is to buy a house with their super money. According to the ATO, while it is possible to use money in an SMSF to invest in property under certain specific circumstances, there are schemes “pulling on the heartstrings of average Australians struggling to enter the housing market”.

“Retirement savings are targeted by promoting the buying of the property through an SMSF, often with a complicated limited recourse borrowing attached, with no regard to the size of the SMSF or its ability to grow retirement savings.”

Tips for setting up an SMSF

The ATO advised that SMSFs aren’t for everyone, with around 12,000 funds “winding up” every year.

“In the hands of engaged and informed trustees who know when to seek professional advice, SMSFs can be a suitable retirement strategy. On the other hand, if a trustee is not engaged and not informed, SMSFs can be a high-risk or expensive option.”

The ATO advised that Australians wanting to establish a self-managed super fund should:

  • Be clear about their purpose in setting up an SMSF.
  • Consider whether an SMSF is the right vehicle for them.
  • Be aware of the costs, initial and ongoing, involved in running an SMSF.
  • Understand the risks, time and resources required and compliance obligations in running an SMSF.
  • Consider completing a trustee education course.

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Learn more about superannuation

What is an SMSF?

An SMSF is a self-managed superannuation fund. SMSFs have to follow the same rules and restrictions as ordinary superannuation funds.

SMSFs allow Australians to directly invest their superannuation, rather than let ordinary funds manage their money for them.

SMSFs are regulated by the Australian Taxation Office (ATO). They can have up to four members. All members must be trustees (or directors if there is a corporate trustee).

Unlike with ordinary funds, SMSF members are responsible for meeting compliance obligations.

How do I set up an SMSF?

Setting up an SMSF takes more work than registering with an ordinary superannuation fund. 

An SMSF is a type of trust, so if you want to create an SMSF, you first have to create a trust.

To create a trust, you will need trustees, who must sign a trustee declaration. You will also need identifiable beneficiaries and assets for the fund – although these can be as little as a few dollars.

You will also need to create a trust deed, which is a document that lays out the rules of your SMSF. The trust deed must be prepared by a qualified professional and signed by all trustees.

To qualify as an Australian superannuation fund, the SMSF must meet these three criteria:

  • The fund must be established in Australia – or at least one of its assets must be located in Australia
  • The central management and control of the fund must ordinarily be in Australia
  • The fund must have active members who are Australian residents and who hold at least 50 per cent of the fund’s assets – or it must have no active members

Once your SMSF is established and all trustees have signed a trustee declaration, you have 60 days to apply for an Australian Business Number (ABN).

When completing the ABN application, you should ask for a tax file number for your fund. You should also ask for the fund to be regulated by the Australian Taxation Office – otherwise it won’t receive tax concessions.

Your next step is to open a bank account in your fund’s name. This account must be kept separated from the accounts held by the trustees and any related employers.

Your SMSF will also need an electronic service address, so it can receive contributions.

Finally, you will need to create an investment strategy, which explains how your fund will invest its money, and an exit strategy, which explains how and why it would ever close.

Please note that you can pay an adviser to set up your SMSF. You might also want to take the Self-Managed Superannuation Fund Trustee Education Program, which is a free program that has been created by CPA Australia and Chartered Accountants Australia & New Zealand.

What should I know before getting an SMSF?

Four questions to ask yourself before taking out an SMSF include:

  1. Do I have enough superannuation to justify the higher set-up and running costs?
  2. Am I able to handle complicated compliance obligations?
  3. Am I willing to spend lots of time researching investment options?
  4. Do I have the skill to make big financial decisions?

It’s also worth remembering that ordinary superannuation funds usually offer discounted life insurance and disability insurance. These discounts would no longer be available if you decided to manage your own super.

What are the risks and challenges of an SMSF?

  • SMSFs have high set-up and running costs
  • They come with complicated compliance obligations
  • It takes a lot of time to research investment options
  • It can be difficult to make such big financial decisions

What is an SMSF investment strategy?

All SMSFs are required to have an investment strategy, which should explain what assets the fund will buy and what objectives it will pursue. This strategy must be reviewed regularly.

Issues to consider include how much risk the SMSF will take, how easily its assets can be converted into cash and how it will pay out benefits.

How do I wind up an SMSF?

There are five things you must do if you want to close your SMSF:

  1. Fulfil any obligations listed in the trust deed
  2. Pay out or roll over all the superannuation
  3. Conduct a final audit
  4. Lodge a final annual return
  5. Close the fund’s bank account

How long after divorce can you claim superannuation?

You or your partner could be forced to surrender part of your superannuation if you divorce, just like with other assets.

You can file a claim for division of property – including superannuation – as soon as you divorce. However, the claim has to be filed within one year of the divorce.

Your superannuation could be affected even if you’re in a de facto relationship – that is, living together as a couple without being officially married.

In that case, the claim has to be filed within two years of the date of separation.

Either way, the first thing to consider is whether you’re a member of a standard, APRA-regulated superannuation fund or if you’re a member of a self-managed superannuation fund (SMSF), because different rules apply.

Standard superannuation funds

If your relationship breaks down, your superannuation savings might be divided by court order or by agreement.

The rules of the superannuation fund will dictate whether this transfer happens immediately, or in the future when the person who has to make the transfer is allowed to access the rest of their superannuation (i.e. at or near retirement).

Click here for more information.

SMSFs

If your relationship breaks down, you must continue to observe the trust deed of your SMSF.

So if you and your partner are both members of the same SMSF, neither party is allowed to use the fund to inflict ‘punishment’ – such as by excluding the other party from the decision-making process or refusing their request to roll their money into another superannuation fund.

This no-punishment rule applies even if the two parties are involved in legal proceedings.

Click here for more information.

Financial consequences

Superannuation funds often charge a fee for splitting accounts after a relationship breakdown.

Splitting superannuation can also impact the size of your total super balance and how your super is taxed.

Click here for more information.

What compliance obligations does an SMSF have?

SMSFs must maintain comprehensive records and submit to annual audits.

What contributions can SMSFs accept?

SMSFs can accept mandated employer contributions from an employer at any time (Funds need an electronic service address to receive the contributions).

However, SMSFs can’t accept contributions from members who don’t have tax file numbers.

Also, they generally can’t accept assets as contributions from members and they generally can’t accept non-mandated contributions for members who are 75 or older.

How are SMSFs allowed to invest their funds?

SMSFs can invest in conventional assets such as shares, term deposits, managed funds and property.

SMSFs can also buy ‘collectibles’ such as artwork, jewellery, antiques, coins, stamps, vintage cars and wine – although there are special rules that apply to collectibles.

Investments must be made on an arm’s length basis, which means that assets must be bought and sold at market prices, while income must reflect the market rate of return.

As a general rule, SMSFs can’t buy assets from members or related parties.

How are SMSFs taxed?

Funds that follow the rules are taxed at the concessional rate of 15 per cent. Funds that don’t follow the rules are taxed at the highest marginal tax rate.

Can I carry on a business in an SMSF?

SMSFs are allowed to carry on a business under two conditions.

First, this must be permitted under the trust deed.

Second, the sole purpose of the business must be to earn retirement benefits.

How does superannuation affect the age pension?

Most Australians who are of retirement age can qualify for the age pension. However, depending on the size of your assets and post-retirement income, you might be entitled to only a reduced pension. In some instances, you might not be entitled to any pension payments.

How is superannuation calculated?

Superannuation is calculated at the rate of 9.5 per cent of your gross salary and wages. So if you had a salary of $50,000, your superannuation would be 9.5 per cent of that, or $4,750. This would be paid on top of your salary.

The ‘superannuation guarantee’, as it is known, has been at 9.5 per cent since the 2014-15 financial year. It is scheduled to rise to 10.0 per cent in 2021-22, 10.5 per cent in 2022-23, 11.0 per cent in 2023-24, 11.5 per cent in 2024-25 and 12.0 per cent in 2025-26.