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SMSFs: 8 reasons they are over-spruiked and over-rated

(Editor’s note: This article may be construed as anti-SMSF, but far from it. In fact, the author has one, as does the Editor. We both believe that in the right circumstances, SMSFs offer tangible benefits over institutional super funds. But they’re not for everyone …)

SMSFs have become the must-have financial fashion accessory for high-income earners and those seeking control over their superannuation investments. According to the ATO, there are 556,000 SMSFs in existence, comprising almost a third of the superannuation pie. For some, SMSFs offer a perfect mix of better control, inheritance planning and tax savings. For many, however, SMSFs are expensive, onerous and unnecessary. Too frequently, SMSFs are established by accountants and financial planners with an eye on revenue generation rather than with the best interests of the clients at heart. Despite their overwhelming popularity, here are eight reasons why you might pause before jumping on the SMSF bandwagon.

1. ‘Til death do us part

An SMSF is like a marriage – it takes a significant commitment and a lot of hard work to make it run smoothly. If you are the type who doesn’t like to commit for the long term, then an SMSF may not be for you. Even if you engage an army of advisers, accountants and auditors, you (as the trustee) are legally responsible for all the decisions made by the SMSF, for running the fund, completing the end of year tax return and audit, and for complying with superannuation laws. If this commitment is too much, then choose a retail or industry super fund as all the administrative, compliance and management responsibility is done for you.

2. Keeping up with the Joneses

Investment seminars, websites and ebooks on SMSFs are everywhere, and your golfing buddy has probably set one up. ‘Best thing ever,’ he says. Before calling your accountant demanding one, first determine what you want to do with an SMSF. If you see your current superannuation savings as readily accessible money to start trading today and making millions tomorrow, then you are most certainly going to end up disappointed.

3. Honey, trust me, I know what I’m doing

The ATO is quite clear about your responsibilities and the potential penalties.

As a trustee of an SMSF, you need to act according to your fund’s Trust Deed, the Superannuation Industry (Supervision) Act 1993 (SISA) – Superannuation Industry (Supervision) Regulations 1994 (SISR), the Income Tax Assessment Act 1997 (ITAA 1997), the Tax Administration Act 1953 (TAA 1953) and the Corporations Act 2001.’

Got that? The ATO continues rather more menacingly: ‘If you do not follow the rules, you risk one or more of the following: your fund being deemed non-compliant and losing its tax concessions, being disqualified as a trustee, prosecution and penalties.’

What does non-complying mean? ‘A complying fund that has been made non-complying will suffer serious tax consequences. Your fund’s total assets … are subject to tax at the highest marginal rate. Any income received in a financial year in which a fund is non-complying is taxed at the highest marginal rate.'

And the penalties? ‘If a trustee is prosecuted and is found guilty of either a civil and/or criminal offence under a civil penalty provision, the maximum penalties that may apply under Part 21 of the SISA are $340,000 (civil proceedings) and five years imprisonment (criminal proceedings).’

Engaging a financial adviser or an accountant to ensure you stick to the (highly complex) rules makes sense. But you are then up for another layer of fees. And what will you do if something should happen to you and you are no longer capable of running your SMSF? One-third of people aged 85 years and older have dementia. Will your partner know what to do in your place? Will they want to?

4. An SMSF! My kingdom for an SMSF!

In a report published in 2013, ASIC commissioned consultants Rice Warner to examine whether there was a minimum cost-effective fund balance for an SMSF. Rice Warner found that SMSFs with balances in excess of $250,000 were more competitive than the alternatives, provided the trustee was willing to undertake some of the fund administration. Those requiring a full administration service needed a balance of $500,000 to be more competitive.

As there are a range of fixed costs that an SMSF must incur (e.g. financial advice, administration, accounting, audit and actuarial costs) it is generally not cost effective for members with small balances to hold their superannuation through an SMSF. The cost of administering an SMSF and filing the tax return has fallen rapidly in recent years with the advent of better technology and you should not really be paying much more than $2,000 for this job (more if your SMSF has real complexity). Unless you are seeking advice about purchasing a property in your SMSF, planning to transfer in some business property or wish to gear up, there may be other more cost-effective options. Whilst there is no need to ransom your kingdom, for most, $250,000 should be the minimum.

5. Nothing is certain except death and taxes

You spend your whole life paying taxes. Wouldn’t it be great if you could recoup at least some when the curtain closes? An anti-detriment payment (ADP) is a refund of contributions tax you have paid during your working life. This is an additional payment that can be made to your spouse or children if they receive your death benefit as a lump sum. It can be substantial. For example, a retail super fund with a $1 million balance and 50% taxable component, will spit out an ADP of some $37,000. You are unlikely to receive this if you are still running your SMSF, as funding ADPs in an SMSF can be problematic. Having your super in a larger retail fund can be more advantageous (albeit for your spouse or children) as these funds will have sufficient reserves to pay the ADP in addition to your death benefits. Beware single member funds with large hidden ADPs. If you are unsure, ask your accountant or adviser. Note, however, that the government is considering abolishing ADPs.

6. All your eggs in one sliced basket

According to the ATO, cash accounts for 31% of SMSF assets, even those with $500,000 - $1 million balances, and 53% of the assets of those funds with less than $100,000. Australian shares appear to comprise another third of the asset base, though the figures are not too reliable. Multiport studies suggest that cash is more like 20%, but Aussie shares may be higher at 40%. Either way, most SMSFs comprise bank term deposits, bank hybrids and a whack of bank shares – akin to owning the senior, junior and mezzanine tranches of a single name Collateralised Debt Obligation (CDO).

7. You’ve got to call Australia ‘home’

An SMSF must have the ‘central management and control’ (CMC) in Australia and the member must meet the Active Member Test so that the SMSF remains compliant. Therefore, if you are offered a long term position overseas, Houston we may have a problem. If you plan to leave Australia indefinitely, the SMSF will often need to be wound up as the CMC test will not be met and you cannot make contributions into the fund or any investment decisions.

8. I can beat the market!

And we save the best for last. SMSF providers regularly promote the benefits of running your own investment portfolio. Wonderful if you have a thorough understanding of financial markets, diversification, correlation, behavioural economics, volatility and the patience of Job. Otherwise, you are suffering from the over-confidence bias, the most well-documented of all the financial behavioral heuristics. The chart below from The Motley Fool uses research from DALBAR which shows investors underperform the market due to poor timing of entry and exit points.

DALBAR 2014

DALBAR 2014

 

Recep Peker, a senior analyst with research firm Investment Trends, says that trustees of many new SMSFs are convinced they can outperform the big funds. Indeed, 28% of SMSFs surveyed told Investment Trends that one of the reasons they set up an SMSF is a belief that, ‘I can make better investments than the big fund managers’. And in Lake Wobegon, all the children are above average intelligence.

Make sure it’s suitable for you

In the right circumstances and for a well-informed trustee, SMSFs can offer significant benefits over traditional retail super funds. But remember Stanford Brown’s Golden Rule of Investing No. 8 – Don’t Copy Your Mates at the Golf Club. Just because it is right for them, doesn’t automatically make it right for you.

 

Jonathan Hoyle is CEO of the Stanford Brown Group. This article is for general purposes only and does not consider the specific needs of any individual.

11 Comments
Graham Hand
February 23, 2016

Hi Brett, we cover the broad range of superannuation structures and try not to favour any. You'll be pleased to know, coincidentally, we have an article this week in praise of SMSFs. Then I expect 'retail super funds' will complain that we favour SMSFs too much. Can't please everyone all the time. Cheers

Brett
February 23, 2016

Hi, I started up a SMSF due to the horrendous mistakes made by the retail super fund that I was a member of for 15 years. They didn't deduct the 15% contribution tax for over 10 years because they repeatedly printed employer contribution deposit books with the wrong account number even though the form stated that it was an employer coontribution it was classified in the super fund's system as a personal contribution. I didn't pick this error up for a number of years because the fund provided no definitions of the terms used in their statements not even in the prospectus. The terms used in the statements also changed over this period. Due to this huge error and the other errors that I found when I did a forensic analysis of my super contributions, I did not receive a correct statement for the first 13 years of being a member of this fund. Also, the error with the 15% contribution tax was identified by myself just as the GFC hit, which in conjunction with the error wiped over 35% from my super fund value. And of course the then federal Labor government under Kevin Dudd decided to limit superannuation contributions to persons under 50 to $25,000 so I couldn't make good the reduction in balance by extra contributions. And then 6 months before I turned 50 the next Labor government reduced the $50,000 contribution limit for 50 year olds and over with low balances to $25,000. I summarized my experience with this "Professionally Managed" retail super fund  with an e-mail to the CEO of this fund in which I stated "I would have lost less money if I had taken my Superannuation contributions and buried them in a steel box in my garden".

I don't see how I could do any worse with an SMSF. I have not had a negative return since I started the SMSF unlike my old retail fund which frequently had very bad years which took all of the previous good years gains away, whilst the fund managers continued to charge their fees for all of the "Professional Management" of the fund.

I'm sure there are many other people out there who have started SMSFs due to very bad experiences with a retail super fund. I suggest that you write some articles about that instead of bashing SMSFs because it's the trendy thing to do at the moment.

Liam
November 14, 2015

Jonathan, SMSFs are definitely not for everyone and not a decision to take lightly. From experience 2-3 out of every 10 enquiries I get are suited to and capable of managing an SMSF.

However I would pick you up on the "I can beat he market" comments. People are not trying to beat the market, they are trying to beat their previous or average retail or industry fund return.

A Rice Warner analysis of APRA and ATO statistics commissioned by NAB indicates that during the period from 2005 to 2012 SMSFs generated an average annual return of 7.7 per cent compared to the average 4.9 per cent return produced by the rest of the superannuation industry.
Taking fees into account, SMSFs produced a return of 6.8 per cent over the eight years compared to 4.1 per cent for the rest of the superannuation industry.

Indeed SMSFs are big users of index funds and ETFs as well as reliable direct commercial property so they often track the market better than the more active options.

I do believe they are "flavour of the day" for some but a good option for 25% to 35% of the population willing to take a more active role in management of their superannuation.

b0b555
November 14, 2015

#4. Financial advice is not a cost that MUST be incurred by a SMSF. We are much happier and performing better than when we were lining the pockets of a FA.

#8. We've opted for the blue bars rather than the red bars by simply investing in a number of ETFs. Not trying to beat the market. Happy to match it.

John McLennan
November 13, 2015

Jonathan makes some good points. I started an SMSF in 1998. In the early days I sought advice from financial planners and accountants for exorbitant fees but gained very little real advice and direction. Accordingly, I set out to run the show myself and read widely and deeply, especially Trish Power's book and her super newsletters. A relative uses a financial adviser who charges a hefty fee. He meets with her once a year and organises her annual return and audit; in her ignorance she has to rely on him. When I compare her ROE with mine I am 'miles ahead'.

But I am now 73 years of age and have nobody in the family who is ready or inclined to take on our SMSF in my 'absence'. So your article has heightened my concern about this and the need to take action now.

David
November 13, 2015

I know too many people who have come unstuck "managing" their own super. Sadly, for some investors, an SMFS is just too much rope. The flexibility and the ability to participate in highly speculative investments can bring them undone. Several people I know will probably now be a burden on our declining social welfare because as it turned out, they couldn't actually do better than the market. Indeed much worse.

I use a retail super fund that provides me with the ability to invest in about 50 different managed funds, from 17 different well known providers, covering everything from fixed interest and bonds, to property securities and geared equities. Sure, I could get more options if I ran my own fund, but I think that's enough flexibility for the average person.

Jerome Lander
November 13, 2015

One of the reasons that SMSFs should be popular is the lack of good investment product available through mainstream channels. SMSFs widen the available opportunity set to potentially include good product, particularly for high net worth investors. Frankly, they shouldn't otherwise have much or a role at all - or wouldn't if the mainstream alternatives were better.

The truth is that most of our industry does a great job of ensuring mediocre product is readily available to nearly everyone. High net worth clients, in particular, do themselves a great disservice by investing in mainstream offerings, which is what most of the industry would have them invest in (often because it is more scaleable and convenient for their business models, sometimes because it is cheaper). Instead, many people sadly feel forced to resort to investing in equities themselves, with predictably poor results in many cases.

Instead, high net worth investors should be looking to invest with the best fund managers and investment offerings, by aligning themselves with investment experts - and genuine investment talent. This can and should be transformational in terms of results achieved.

Jonathan Hoyle
November 13, 2015

Smsf Trustee, you obviously have a sound adviser. There are many out there. Our industry does indeed have an undeserved poor reputation.

SMSF Trustee
November 13, 2015

OK, so they're not for everyone. How does that justify the title of this article?

And my planner showed me the relative pros and cons of all sorts of options before I decided to use my SMSF. I'm really sick of planners being accused of self-interest so easily when my personal experience of them is that they have a passionate interest in what's best for their clients. That's why they keep them for decades.

John
November 13, 2015

There should be some sort of mandatory training required before someone can become trustee of a SMSF. Many of my peers (early to mid 30s) with no interest in investing have been talked into 'taking control' of their super by their trusted accountant, and they now have an expensive tax structure invested in the same way they could invest in a retail fund. To them the fund is easy to run as the accountant does it all for their $4,000 pa fee.

Alex
November 12, 2015

Points taken, but I enjoy my SMSF. I can add direct assets not in super funds, I keep costs down through automation, and control my own destiny rather than outsourcing it.

 

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