Editor's note: Morningstar Australia's podcast series, Investing Compass, has just released its 100th Episode. Congratulations to Mark and Shani on creating a valuable and accessible source of investment know-how.
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Recently, we released an episode on our podcast Investing Compass about my decision to switch super funds. Faced with a marked increase in fees, I jumped ship to something cheaper.
A question that naturally popped up was why I didn’t opt for an SMSF, especially considering their increasing popularity with investors. The ATO released figures for the 2021 financial year showing the largest increase in the number of SMSF establishments since the 2018 financial year. Why didn’t I join the over 25,000 new funds established?
SMSF suitability for my circumstances
The answer requires a bit of background. I’m currently 29, and I started working full-time seven years ago. Prior to that, I worked in retail jobs part-time while I was at university with default insurances eating away at relatively small contributions. Since joining the full-time workforce, I’ve salary sacrificed each year since graduation to build my super balance. I’ve recently reached an account balance of $77,000.
I’ve put that $77,000 in an industry super fund that has comparatively low fees and the ability to customise my exposure to each asset class. Both features are important to me because of the length of time I have until retirement. My long-time horizon warrants an aggressive asset allocation but also higher fees will compound and negatively impact my end balance.
Both reasons, however, are also why SMSFs are attractive to investors. They allow almost unlimited investment choice, including direct equities, funds, ETFs, antique cars, fine wines, and even Swiss Chalets (although be warned, you can’t enjoy them*). An SMSF is as customisable as anything in superannuation world. Most of the fees, excluding on the underlying assets, are flat fees. Depending on the balance, an SMSF may be the lowest cost option.
And it is this part of the equation that doesn’t add up at the moment for me. My balance isn’t enough to justify the flat fees inherent with a SMSF. A percentage-based fee model works best for my relatively small balance.
A report released by Rice Warner looked at when an SMSF made sense from a cost perspective. They found that around the $200,000 mark, it becomes competitive with industry and retail superannuation funds. At $500,000 or more, SMSFs are generally the cheapest alternative.
The cost and administrative choices
The popularity of SMSFs has expanded the choices for investors. Sensing an opportunity, fintech firms have embraced the challenge of making a no-frills alternative that is low-cost for those that want to set up a SMSF. They are hoping to replicate the successful model from the brokerage industry.
An overview from the ATO showed that the median operating expenses of an SMSF are about $4,000. Low-cost SMSF administrators are offering an alternative for around $1,000 a year. However, in exchange for the lower fee, the no-frills option comes with less support. Not only will users miss out on an annual review by professionals to ensure everything is running smoothly, but there is little capacity to answer questions.
With an SMSF, it is common to have a tax and administrative specialist plus a financial adviser for support. The accountant or SMSF specialist helps with the administration of the fund as well as ensuring that the trustees are operating in the most tax-effective way subject to super regulations. They also prepare the annual tax return. The financial adviser may provide a review of the investment holdings and assist with compliance as part of a broader advice relationship.
It may seem counter-intuitive but there is a lot of assistance required for a ‘self-managed’ super fund. Usually, complexity increases with lifestage transitions (for example, operating both accumulation and pension accounts in retirement) or the addition of more trustees. The ability to have six members means that flat fees can be spread across multiple people, lowering the per-person balance required to make an SMSF cost effective. However, this also adds even more complexity. There may be four different retirement goals, trustees with four different ages, lifestages and perspectives to consider. This is where professionals may add value.
A possible move when balances are higher
I am not ready but I think an SMSF makes sense at a higher balance. To accelerate my SMSF timeline, my husband and I can combine balances and reduce the SMSF administration work and cost. He is roughly the same age and we expect to retire at the same time.
My rough guideline is to wait until I reach a balance of $250,000, which means that my husband will also contribute around the same amount.
I realise that the flat administrative and other fees such as establishing a company to be the trustee are only setting up an empty vessel. I still need to hold investments, and that means incurring brokerage to hold direct shares and management fees to access professionally-managed vehicles.
SMSFs can really add value as you approach retirement. During this transition, the flexibility and control over investments is valuable for investors that want to take a more active role in managing their portfolio. It’s also useful in retirement to design a portfolio to achieve growth and support withdrawals.
Morningstar's Director of Personal Finance, Christine Benz, has written multiple articles about bucket strategies supporting retirees, as linked below. The basic premise is that they can commit to long-term holding periods for some assets to give growth and income, while holding cash to support near-term withdrawals. Not having to sell growth assets at inopportune times to fund withdrawals means making retirement savings last for longer.
SMSFs allow complete control to do this, whilst also allowing the choice to directly own unlisted assets such as residential property, a wider range of funds, bonds and alternatives.
Ultimately, the case for an SMSF at higher balances is compelling. I’m not there yet but I am anticipating an account balance that justifies the cost. Until then, I’ve just got to convince my husband I’m with him for love, not sharing an SMSF.
Shani Jayamanne is a Senior Investment Specialist at Morningstar Australasia.
The Bucket Approach to Retirement Allocation – Christine Benz
Retirement Bucket Basics – Matthew Coffina and Christine Benz
Listen to the full episode on Investing Compass here.
* The Swiss Chalet case is part of SMSF folklore where an SMSF purchased a Swiss Chalet and members used it for holidays and wine and dine friends and family.