SMSF RISKS YOU MAY NOT KNOW ABOUT

As trustee of your SMSF (self-managed superannuation fund), you would be aware of the responsibility you have to manage investments that will produce a comfortable income in retirement. You may have outsourced the fund administration to professionals such as SMSF Assure and engaged a licensed financial advisor to assist with investment decisions, but ultimately, the final responsibility for the fund performance is yours.

Apart from the usual market forces that affect any type of investment you make, there are some other, lesser known risks of which we should be aware. Three risks in particular are not directly linked to any investment category, which is most likely why they are often overlooked by SMSF trustees.

Risk No. 1 – Sequencing

The first is known as a sequencing risk and needs some explanation. You already know that investments perform better in some years than in others, but you may not have realised that the sequence in which these changes occur are just as important as the actual investment returns.

This particular risk came to prominence during the GFC (global financial crisis) when people close to retirement lost heavily as their share portfolios crashed. Those affected retired with less than they expected had the GFC not occurred, or in some cases, stayed in employment for much longer to recoup as much of their losses as possible.

Sequencing is all about timing. Losses made in the early stages of your working life can be recouped over time so that the fund balance is healthy at retirement. Those same losses later in life will likely have a profound negative impact on the balance available as members retire.

There is no single way to manage this sequencing risk. However, ensuring that the fund assets are diversified across several investment classes spreads that risk and lessens the overall long-term affect. Changing the asset mix over time to reduce volatility and having enough liquidity to avoid selling assets will maintain capital and keep the fund healthy.

Risk No. 2 – Liquidity

Liquidity then, or lack of it, is the next risk. A healthy SMSF needs cash on hand throughout its existence. Cash is required for administration, auditing, investment fees and other expenses. Fund members in the pension stage will need cash for pension payments or, in the case of bereavement cash to pay the family a benefit. Having cash in a high interest cash account is the best way to manage this risk.

Risk No. 3 – Underinsurance

Having the fund underinsured is the third major risk. Superannuation rules require fund trustees to consider insurance cover for its members, but some SMSFs choose not to do so. This places the fund at risk if assets must be sold, whatever the market conditions, in the event of the death or total and permanent disability of a fund member.

If members are insured against these or similar events, this insurance will most likely cover much of these expenses, leaving the fund assets intact and working to keep the fund balance healthy. These additional risks should be discussed with your financial advisor and plans put in place to manage them.

IS AN OVERSEAS PROPERTY INVESTMENT A POSSIBILITY FOR AN SMSF?

Trustees of SMSFs (self-managed superannuation funds) have, for some time, been able to purchase residential property in Australia on behalf of their fund. Although our property market may be “coming off the boil”, prices are still high, and many SMSFs are looking elsewhere to build retirement income.

Interest in overseas properties has been a hot topic in the media lately, especially in parts of Europe where the long-term effects of the global downturn are still being felt, and property prices are low. Some cashed-up Australians are taking advantage of this situation; however, does this mean that trustees of SMSFs can also invest fund money in overseas property?

The current advice is that there is nothing to stop an Australian SMSF from acquiring property abroad, but continued compliance with our tax laws still must be considered. Here, the key issue still, is whether an overseas property investment meets the sole purpose test, along with some other factors that need to be checked and addressed.

The sole purpose of superannuation is to provide retirement benefits to members and beneficiaries of the superannuation fund. Provided the trustees or members do not use the overseas property for their own benefit prior to retirement, such property should meet the sole purpose test.

Before going any further, it would be wise to check that the trust deed allows for overseas investments. Most deeds do, but a quick check will allow you to proceed with certainty. You should also ensure that the purchase of property abroad is also included in your written investment strategy, with a thorough description of how you intend to make money for the fund. This should also include insurance to protect the investment.

Thoroughly investigate any legal compliance issues before committing any funds to this type of investment. For example, because SMSFs are a uniquely Australian vehicle, do not assume that our laws and rules will apply outside of the country. Here, the SMSF trustee is legally required to hold the title to the property. This may not be the case elsewhere and, in fact, it will vary from country to country.

Some foreign countries do not recognise our trust structure for SMSFs, and many do not allow a foreign entity to hold property directly. As a result, you may be required to set up a limited liability company in a foreign country and open a bank account in its name. It is the limited liability company that purchases the overseas property and the SMSF then invests in shares in that company. This will have tax implications both here and overseas, so make sure you check these out before proceeding.

There will also be additional costs involved, as there is no getting around the Australian Tax Office (ATO) audit requirements for SMSFs. This may involve having to hire a local accountant in the country of your investment to assist with tax and auditing issues. This will be an additional cost on top of the audit costs here in Australia.

If you do your research and purchase an overseas investment property, knowing all the costs involved as well as the legal, compliance and tax requirements in both countries, there is no reason for you not to proceed. Like any other investment, do your research, balance risk and reward, so that your fund may have a very lucrative asset working for its members.

What Is The Right Structure For My SMSF?

Making the decision to set up your own self-managed superannuation fund (SMSF) is just the first of many other important decisions you will be called upon to make, and these decisions will impact on the performance of your fund. Getting it wrong with this first decision would not be an ideal start, so the recommendation from people in the industry is to talk to a professional advisor before going ahead.

What is this decision that is so vital that you should be seeking advice at the onset? There is plenty of advice available regarding the different types of investments available; the Australian Securities and Investments Commission (ASIC) has some general information available on their web page, but it is the Australian Taxation Office (ATO) web page that sets out the two types of structures you can have for your fund.

Getting the structure right at the beginning is a much easier option than trying to change it after everything has been set up. You can choose between setting up a corporate trustee and using an individual trustee. There are benefits and limitations to both, and the chances are that only one will be appropriate for your individual needs.

There are several areas where the structures differ from each other. The first is in the member and trustee requirements. A fund with an individual trustee must have two to four members only; each member of the fund must be a trustee and each trustee must be a member. Also, a member cannot be an employee of another member unless there is a family relationship.

An SMSF with a corporate trustee has one to four members; each member must be a director of the corporate trustee and each director of the corporate trustee must be a member. The employee/relative requirement is the same as the individual trustee.

A further complication occurs when the fund has a single member. In an individual trustee structure, there must be two trustees, one of whom is the fund member. If the fund member is an employee of the other trustee, they must be related to each other. With the corporate trustee structure, the corporate trustee company can have one or two directors but no more. The fund member must be the sole director, or one of the two directors, and again, the employee/relative requirement is similar.

Now to the cost. The individual trustee structure does not attract any ASIC fees, so establishment and ongoing administration fees are lower. ASIC charges a fee to register a corporate trustee initially and there are annual review fees with additional conditions. In both cases, trustees or directors cannot be paid for their services in relation to the fund.

These are just the first two issues to understand and deliberate. The ownership of fund assets, the separation of assets, the penalties for breach of superannuation law and succession issues are the others. There are companies such as SMSF Assure that can assist you to set up your fund to suit your requirements. Why go it alone when there is professional assistance readily available?

Getting The Right Investment Strategy For Your SMSF

Being a trustee of a self-managed superannuation fund (SMSF) is a major responsibility and the decisions made by you as trustee will affect the retirement incomes of all members of the fund, yourself included. Since this end result may not take place for many years, getting the right investment strategy, at not only the start but right throughout the entire journey until retirement, is critical to the lifestyle you will enjoy at that juncture.

As the superannuation environment becomes more and more complex, having sound, reliable, consistent advice from a trusted financial advisor is essential, especially if you are concerned that your knowledge of the investment world is limited. You must have a written investment plan and the best way to start one is to establish financial objectives, then tailor your plan to achieve them.

If you are a trustee, it falls to you to decide what would better suit your stated objectives. Putting all of this in writing allows you and your financial advisor to examine, research, discuss and formulate a response to the investment products available at the time.

Currently, there is a disparity between the types of investments favoured by APRA-regulated funds and SMSFs, with SMSFs showing a clear preference for Australian shares, property and cash. From the information provided by the Australian Taxation Office, it seems that Australian shares are the first preference; cash comes second and property is third.

Within those three areas are variations such as listed property trusts, options, futures and others in the Australian shares strategy, bonds, debentures, fixed term and term deposits and others in the cash strategy and residential and commercial property in the property strategy.

However, identifying the preferred strategies for your fund is not the whole story. When you compile your Investment Strategy document, you must also consider the risk, cost of holding and likely return of these investments when considered against the SMSF objectives and future cash flow requirements. You must also look at all the investments as a whole and assess the likelihood of the entity being exposed to excessive risks and the benefits of diversification to prevent this.

You must also consider the liquidity of the investments to allow for the payment of tax, lump sum payments if a member leaves the SMSF and regular pension payments. The SMSF must also be able to discharge its existing and prospective liabilities.

This is a lot to manage and be responsible for and having a licensed financial advisor to assist the trustee with the many decisions that will be needed over the life of the fund will make the task much less onerous.

The administration of the fund is another area that can quickly become a burden if returns are not made on time or any of the other mandatory requirements are not met. Companies such as SMSF Assure are readily available to assist with this part of the management of your SMSF, leaving you and your financial advisor to work together to implement the investment strategy.

Keeping Your SMSF Investment Funds As Safe As Possible

The performance of any superannuation fund will eventually affect the quality of retirement that members will enjoy, so it is important that members monitor their returns. It is also worth considering the possibility that some of the products that funds have included in their portfolios are unsafe, exposing the members to reduced returns and eventually a diminished retirement lifestyle.

Just how safe those funds are, is a question worth asking. Provided you are checking that your employer is paying the required contribution to your chosen fund, and that fund has competent managers who have diversified the investments in high-quality products, there should be little to worry about. Throughout the GFC, superannuation funds experienced reduced returns but were never in real danger of collapsing.

This does not mean that such a thing could never happen, but in our highly regulated superannuation market, warning signs would be expected and acted on by fund managers. However, if you are the trustee of a self-managed superannuation fund, and you were either unaware of typical financial indicators or chose to ignore them, your funds and those of your members could be at risk.

Bear in mind that many of the protections available to other superannuation funds by the APRA (Australian Prudential Regulation Authority) are not applicable to SMSFs. For example, they are unable to claim compensation if their fund is affected by fraud or theft. SMSF members also do not have access to the Superannuation Complaints Tribunal if they are not happy with where their funds are being invested.

This is one of the reasons why an SMSF must have an investment strategy. It must be in writing and subject to regular reviews to ensure that it is meeting the needs of the members. This is particularly important when the financial and investment markets are in a state of flux. Without a proper strategy, trustees may be tempted to make quick, unwise decisions to recover losses rather than wait for market corrections.

The best way to keep SMSF investments safe is to develop an investment strategy with the assistance of a licensed financial advisor. The advisor should also be involved in the regular review, so that the fund trustee/s has the benefit of professional expertise. Licensed financial advisors must keep up to date with industry and market changes, and they share this information with their clients.

The other major issue SMSF trustees have is the administration and compliance involved. If you are a trustee struggling with the responsibility of running your fund, getting your investment strategy under control will be a load off your mind. Companies such as SMSF Assure are in the business of assisting clients with SMSF administration and compliance so with both of these areas covered, you are in the best position to keep your fund investments safe.