ASK THE RIGHT QUESTIONS BEFORE STARTING YOUR SMSF

Self-managed superannuation funds (SMSFs) continue to attract interest from potential fund trustees eager to make the leap into taking control of their own retirement income. The problem that many of them face is in knowing what questions to ask and where to go to find the answers. To get them started, the most important information they need to know is how to go about setting it up.

At the start, many people assume that there is only one way to structure their fund, so when they find out differently, the first question they ask is about the differences between two options. They then find that the first option is to have individual trustees and the other is to establish a company acting as trustee for the fund. Both of these options should be discussed with a professional before making any decision, as they are difficult to change later.

The next question to be asked, naturally enough, is usually about costs. They find that there are no Australian Securities and Investments Commission (ASIC) fees for a fund with individual trustees, resulting in reduced establishments costs and lower ongoing administrative requirements. However, ASIC charges a fee for the initial registration of a corporate trustee, followed by annual review fees. In the case of both structures, trustees or directors cannot be paid fees for their duties or services relative to the fund.

The ownership of the fund assets is often the next question asked. For an SMSF with individual trustees, the title of the fund assets must be in the name of the current trustees, “as trustees” for the fund. If the trustees change, then the titles must also be changed, which can be expensive. In the case of a corporate trustee, when a person leaves the fund, they cease to be a director and although ASIC must be notified of the change of directors, the titles of the assets remain unchanged.

Often, potential trustees already hold personal assets that are not intended to be part of the fund. They want to know before going any further what will happen to those assets. The answer to this question is quite simple. The assets of the fund must be kept completely separate from any personal assets held by the trustees. The fund assets must be in the name of the fund. Corporate assets are exactly the same except that companies have limited liability.

Finally, the question of penalties for non-compliance arises. Trustees must always be mindful that if superannuation laws are breached, each trustee is liable individually for the administrative penalties. If the same penalties were to be levied on a corporate trustee, they would only be applied once.

There are many other questions to be asked and answered in much more detail than is possible here. Suffice to say that there are companies such as SMSF Assure that will assist trustees with all the administrative details involved in running an SMSF, so they are in a perfect position to give complete and comprehensive answers to these questions.

ORGANISING YOUR SUPER FUND – THE KEY STEPS

If you have a good understanding of the mechanics of superannuation and a flair for spotting a good investment, you may be thinking about establishing your own SMSF. The initial organisation is not particularly difficult, especially as all the steps required are set out clearly by the ATO (Australian Taxation Office).

However, getting it right is important because only a compliant fund is eligible for tax concessions and it can receive contributions. You could engage SMSF professionals to help you set up the fund but if you prefer to organise the fund yourself, there are important things you must do.

The first thing you must do is choose between having individual trustees or a corporate trustee, each of which differs in terms of the member and trustee requirement, costs, ownership and separation of the fund assets, penalties and succession. These are all critical decisions, which, once made, are very difficult to change.

Next is to choose your eligible trustees or directors, depending on which fund structure you choose. All trustees and directors must consent in writing to their appointment and sign the Trustee declaration. You must keep these documents secure for the life of the SMSF and for ten years after it is wound up.

Now you must create a trust deed; this is the legal document that establishes the rules by which the trust is managed. This must be prepared by someone with the relevant legal qualifications. There must also be a nominal initial contribution of assets to give legal effect to the fund.

Within 60 days of signing the trustee declaration, you must register the SMSF with the ATO by applying for an ABN (Australian Business Number). Now you can open a bank account in the fund’s name. This account will be used to manage the fund operations.

You may also need an electronic service address, which is a special internet address that is different to an email address. Finally, even at the start of this venture, you will also need an exit strategy. Such a strategy reduces the effects of an unexpected event such as a death, a relationship breakdown between the trustees or some other occurrence.

If you still want to go ahead with the SMSF but daunted by the prospect of the day-to-detail now that you have a taste of what is involved, all that is needed is to enlist the assistance of companies such as SMSF Assure to do the administration, while you divert your energies to building a retirement nest egg.

Now think carefully before you decide to go it alone. Many important decisions are needed that can be provided by a range of professions covering accounting, administration, legal, financial and tax advice. Not using their expertise could have a huge impact over your final retirement balance.

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?