So far in this book we have talked about how super choice will affect you and how you can go about choosing a super fund that suits you. But what if you want to manage your superannuation yourself, rather than give your money to someone else?
By Alex Dunnin

KEY POINTS
Most people will use super funds operated by someone else, but you can do it yourself by setting up a self-managed superannuation fund (SMSF). When you set up an SMSF, you are in the business of running a super fund and the rules you have to follow are much more complex than if you are just a member of a typical super fund. If you want simple, easy superannuation then you should not start an SMSF. SMSFs have a range of special rules and requirements. You can handle these yourself, or you can work with a financial adviser, accountant or specialist SMSF adviser. Your SMSF is just a structure for how you want to organise your super. You still have to get the investments working properly to achieve good returns. Just because you run your own SMSF doesn't mean you can do anything you like with the investments. But the SMSF investment rules are fairly straightforward and shouldn't cause too many problems for investors serious about running their SMSF properly.

In examining all the types of super funds available, we have talked about workplace and personal super funds, and we have also talked about public offer super funds (funds that are open to the public). In all these types of funds, we have been referring to funds that are run by someone else. But what if you want to manage your super for yourself?

If you want to run your own superannuation fund, you can. But this means you become responsible for the fund as you become the fund trustee, and you therefore have to arrange its administration, compliance, and organise its investments. You can of course arrange for other people to look after these tasks for you, but when you run the fund the buck stops with you. After all, that's why they are called self-managed superannuation funds.

Self-managed super is one of the hottest segments in the superannuation market. They are in fact so popular that according to the Australian Prudential Regulation Authority (APRA), around 30,000 new SMSFs are created every year and reflecting this, while they account for only 6 per cent of all super fund members they nonetheless account for a whopping 23 per cent of all superannuation assets. Little wonder these funds have so quickly become a very powerful force in the market and are now a major concern to other groups who would obviously rather you put your super money into their funds than try to do it yourself.

Under super choice they are expected to become even more popular because provided your SMSF complies with all the government rules (which should be no problem if you run it properly and have good advisers) you can now nominate it to become your preferred “choice” fund to receive your employer paid contributions.
When thinking about whether you should set up and run an SMSF, you should however consider the following issues:

SMSFs can't invest in anything they want
Running your own SMSF doesn't mean you can do anything you want with the investments. When you run an SMSF, you are a trustee and you are responsible for everything the fund does. To make sure SMSFs are run properly, the Government has created a range of special rules for SMSFs to make sure the money in them is used and invested properly and that the funds themselves are operated appropriately. If you think that running your own SMSF means you can bend the investment rules and, eg, to use your super to buy your house or your business, then think again.

An SMSF is just a structure
An SMSF is just a way to structure - or organise - your super. SMSFs are quite unlike regular super funds where you hand your super savings to other people and they organise everything for you and manage the investments. In fact, if SMSFs had a weakness it is that sometimes people running them put too much of their energies into setting up the fund and being independent rather than focusing on the investments.

Your SMSFS must out-perform to justify the costs
To justify the costs and extra hassles, your SMSF should significantly outperform regular super funds. Trustees of SMSFs should always compare their fund's investment returns with the investment returns that regular super funds are achieving because there is no point going to all the trouble of establishing and operating an SMSF if you don't actually make more money - after all fees and taxes, including the fees paid to your accountant, financial adviser or SMSF specialist - than if you had just iven your super to a regular fund.

You'll need around $300,000 to justify an SMSF
If you have enough money in super, running your own SMSF can be surprisingly cost effective - but it still won't be cheap. In most cases, it will cost several thousand dollars each year to run, taking into account initial set-up costs, ongoing administration and compliance costs, and the investment transaction and management fees. Running an SMSF therefore really only makes sense if you have lots of money, with the start point being around $300,000.

However, you should also remember that you don't run an SMSF because you want cheap super; instead you run it because you think you can make more money - after all costs - than you could in a regular super fund. When comparing SMSF fees, also remember that the different prices almost always include very different things. For example, some SMSF service packages will only cover basic once-a-year compliance reporting, some will cover compliance and ongoing administration, and some will do all this and even bundle all investment costs. It is therefore very important that you understand what the prices include.

Special rules for running your SMSF
We have already talked about how the moment you decide to set up your own SMSF is the moment you cross the line from just being a fund member to being a fund operator. This means you have to start thinking of yourself as a fund trustee with all the obligations and responsibilities that apply to people running a super fund. But before you complain too loudly about Government red tape, just remember that your obligations as an SMSF trustee are nowhere near as onerous as they would be if you were running a regular super fund.

Everyone operating a regular super fund is familiar with these rules, but because you are running your own fund with your own money, the Government has actually cut many of the corners for you that trustees of bigger funds have to worry about. This means that instead of complaining about the SMSF rules, you should be thankful they are as easy as they are. The bottom line is, again, that if you want simple superannuation then don't start an SMSF.

Creating a trust deed for your SMSF

Your SMSF must have its own trust deed, which is simply a list of rules for how the fund operates, deals with its members, pays benefits, and handles its
investments. This trust deed is required for the simple reason that superannuation in Australia is based upon Trust Law, and under this law you must always have a set of predetermined and agreed rules in place so everyone associated with the fund knows what to expect and how it operates. In case of any disputes, it will be this trust deed that will be used as the basis for determining if the fund was properly managed.

Prepackaged trust deeds can be obtained from special SMSF advisers, so finding one isn't difficult. But equally you should make sure your trust deed is properly set up as it will be very expensive to fix things up later if something isn't right. Your trust deed must describe or include:

• The proper name of the fund.
• Details of the corporate trustee the fund will appoint to manage its affairs (if you choose to have one).
• A statement that the fund is established for the sole purpose of providing old-age and retirement benefits to the fund members. (Refer also to the section on SMSF investment rules for more details about this sole purpose test rule.)
• A statement that the fund trustees will not accept any payments to carry out their roles with the fund.
• Names of the fund trustees, how they are appointed, and how and on what basis they can be removed from being a trustee of the fund.
• Details of how members' benefits will be calculated and paid.
• Details of what contributions the fund will accept.
• Details of who can become a member of the fund.
• Rules for how the fund will be wound up if the need arises.

What if You Don't Want to be the Trustee?

While some people like the idea of running their own fund, not everyone wants to be the trustee. Some people are also not allowed to be SMSF trustees because they may be undischarged bankrupts or have other difficulties. This however shouldn't cause any problems if you are willing to appoint an Approved Trustee to your SMSF to act as the trustee. SMSFs that operate this way are known as Small APRA Funds, or SAFs. Because you are paying someone else to be trustee they are more expensive to operate than normal SMSFs. Despite these differences in how the trustees operate, these SAFs have all the same investment, compliance and administration rules that apply to regular SMSFs.

How the trustees of your SMSF must be organised

After you have established or obtained your SMSF's trust deed, you then need to appoint its trustees. There are several rules that apply when you do this:

• Each trustee must also be a member of the fund.
• No member of the fund can be employed by any other member, unless they are related to each other.
• There must be fewer than five members in the fund.
• Trustees cannot be paid to carry out their trustee roles.

If these rules are met, you now just need to apply to the Australian Taxation Office to formally set up your SMSF (part of which means 'electing' to be regulated by the Taxation Office). You must then arrange a tax file number and establish a bank account for the SMSF (the bank account is so you can keep the money and transactions of the super fund separate to those of the trustees as individuals). It may also help for the SMSF to have an Australian business number (ABN), though this isn't compulsory.

What super contributions will your SMSF accept?

Your SMSF trust deed must also state what types of super payments it will accept. For example, will it accept contributions from each member's employer? Will it accept roll-ins from other super funds? Will it accept contributions from each member's nonworking spouse (as so-called 'spouse accounts')? Will it accept contributions from and for children, and if so under what conditions?

While it would be easiest for your SMSF to simply say it will accept all types of super contributions, the nature of super is that the rules for an SMSF have to be more specific because there is no one-size-fits-all definition of what the term 'super contribution' actually means. Strange but true.

Reinforcing these rules around super contributions, SMSFs cannot accept contributions from related parties and cannot allow assets belonging to members to be transferred into the fund unless they satisfy special provisions in the general superannuation rules; eg, they must not make up more than 5 per cent of the fund's assets, they must be listed securities assets (such as shares or bonds, or interests in a managed fund), or they are real business assets. See the later section in this chapter on SMSF investment rules.

Your SMSF's investment strategy

Self-managed funds, like all other super funds, are fundamentally about making investment returns year after year after year so that when the members retire they will have enough money to live on. To enable your SMSF to earn the required rates of investment returns the fund obviously has to make investments; that is, buy assets. However, because the members of the SMSF are also the trustees, the Government has imposed a range of investment Guidelines, rules and restrictions to make sure the greater flexibility that most SMSFs provide is not abused by people running an SMSF to, say, try to avoid paying tax. These rules if properly followed will not prevent SMSFs from being able to make good investments, but instead they are intended to stop the shadier practices of some SMSFs that try to bend the rules.

The first aspect of these rules is that SMSFs must establish a broad investment strategy, or framework, that outlines what they will invest in and how they will manage these investments. Examples of questions your investment strategy may cover include:

• What types of assets will your SMSF invest in? For example: domestic or overseas shares; bonds; listed or direct property; residential or commercial property; derivatives; managed funds; cash deposits; collectibles.
• What proportion, or range of proportions, of its investments will it place into each asset class? For example: between nil and 55 per cent in shares, between nil and 25 per cent in cash, and nil and 40 per cent in property.
• How will the investment decisions of the SMSF be made? For example: by a vote of the trustees; with the advice of a financial adviser or a stock broker.
• How often will the fund's investments be reviewed, and how will this review be conducted? For example: will the SMSF's investments be reviewed each year, each quarter, each month? And who will conduct the review?
• How should the investments be assessed and measured? For example: by comparison against a benchmark, and if so what benchmark?

Your investment strategy is not restricted to these issues, but if it covers these then it will be a very tough and robust strategy that should easily pass muster. As part of your fund's compliance procedures (more on this later), you are also required to document the strategy and to keep minutes of meetings held by the trustees to discuss the investments of the fund. These minutes must be kept for at least ten years.

Investment restrictions

The second aspect of how your SMSF's investments should operate concerns the range of investment restrictions that the fund must follow. While the nature of these restrictions may seem somewhat legalistic, they effectively just mean that your SMSF can invest in anything it wants provided in broad terms it doesn't invest too much money in in-house assets (the 'in-house' assets rule) or related-party assets (the 'related-party' assets rule), and the fund doesn't borrow money directly in its own name. For the overwhelming majority of SMSFs, these investment restrictions should have no impact whatsoever.

The in-house assets rules were created to stop trustees using their SMSFs to, for example, buy their house or business premises, buy holiday units for themselves, buy expensive cars for themselves, or buy expensive artworks to hang in their homes. These rules were brought in because if an SMSF spends its money on these types of things then when members pay contributions they are effectively just buying these assets from themselves and so end up not actually building up any retirement savings, ie, their money is just being recycled from one part of their financial arrangements to another. This is not what superannuation is all about and so the Government works as hard as it can to discourage this type of thinking among SMSF trustees.

Similar to in-house assets, related-party assets are those where the SMSF, for example, buys a house belonging to the partner of one of the trustees. As you can easily see, these related-party assets are like an extension of the in-house assets, as they are designed to stop you setting up an extra artificial or contrived ownership layer between the SMSF and the original owner of the asset. Other examples are when a trustee of an SMSF uses money from the fund to buy assets from a unit trust established by his or her business, where the trustee is also a director of the business and where the particular trust's assets include, for example, the business premises. In this case, it is easy to see that this is a contrived way for the trustee to use the SMSF's money to buy assets from a member of the SMSF.

It may have been more constructive for these investment rules to be positive, ie, to describe what the fund can invest in. But because the list of things a super fund can lawfully invest in would be so unbelievably long as to be incomprehensible, the government took the approach of describing what funds shouldn't do.
So what can't your SMSF invest in? Following are details of the main assets and types of investments your SMSF must avoid.

Investments not passing the sole purpose test
Recall the statement in the SMSF trust deed that the 'sole purpose' of the SMSF is to build up retirement savings and investments for members of the SMSF. Anything that contravenes this long-term retirement savings and investment goal is therefore not allowed as an investment. This is the most crucial test for any super fund investment, and is the most often quoted problem when trustees battle with regulators about what are reasonable investments for their super funds.

In practical terms, if an SMSF purchases or invests in anything that directly advantages, helps or benefits a member of the SMSF, the trustees must be able to show how that item is first and foremost a long-term investment. This doesn't mean that funds can't make investments that benefit members, but these benefits must be only incidental to the reason why the SMSF purchased the assets - to build long-term wealth.

Examples of investments where the sole purpose test could become a problem is if the fund purchases artworks or collectibles. In these cases, the trustees of the SMSF should make sure their trust deed allows for these types of investments, and that these items are properly valued and acquired for investment rather than aesthetic reasons. Selfmanaged funds are of course allowed to make these types of investments - in fact many SMSFs have done very well from them - but the SMSF has to be able to show that it is a legitimate investment. If this can be demonstrated, then there should be no problem regarding the investment rules.

Investments that are not at 'arm's-length'
All investments made by an SMSF must be 'arm'slength', meaning they must be on a commercial, business-like basis and there can be no suspicion that the SMSF has used its assets to pay an unreasonably high price to give any direct or indirect advantage to any member of the SMSF or an associate of a member of the SMSF. These arm'slength rules effectively mean that if an SMSF makes an investment in anything that is somehow associated with a member - for example, it buys a member's house or business premises, lends money, or buys artwork, collectibles or property from a member - then the SMSF must be able to demonstrate that the terms and conditions of the loan or investment are the same as any independent investor would have received for the same arrangement.

Acquiring related-party assets
The arm's-length investment restrictions mean that SMSFs are not allowed to acquire assets from their members or associates, with associates including relatives, employers and business partners. There are some exceptions if the fund buys listed securities, bonds, or real business property from a member or an associate. The purchase of these assets, however, must be on proper commercial terms at the same prices an independent investor would have paid on the open market. If the SMSF does acquire such related-party assets, these cannot be worth more than 5 per cent of the total assets of the SMSF.

Loans or any financial assistance to members of the SMSF
An extension of the arm's-length investment rules for SMSFs is that funds are not allowed to lend money or provide financial help to members of the fund or to relatives of any members of the fund. This applies regardless of the purpose of the loan and its terms and conditions, or the nature of the person's financial problems. If members of the SMSF are in dire financial straits and they need to access their superannuation savings to survive, then they can apply to the Australian Prudential Regulation Authority for early release of their super savings.

Borrowing money
Self-managed superannuation funds are not allowed to borrow money for investments, which means they can't negatively gear investments. Exceptions, however, are if the loans are very short term and if the amount borrowed does not exceed 10 per cent of the SMSF's total assets. This rule has been imposed on SMSFs because of government fears that allowing SMSFs to directly borrow money could encourage them to become involved in high-risk and overly speculative investment strategies, which the government would rather super funds avoided. These rules however do not stop SMSFs investing into trusts or managed funds that are themselves geared.

Excessive in-house assets
Provided the SMSF has followed all the investment rules, it can hold 'in-house' assets - investments in or loans to related parties of the SMSF - but these must not exceed 5 per cent of the total assets of the SMSF.

Annual administration

After setting up your SMSF's trust deed, appointing the trustees, preparing the investment strategy document and deciding upon the investments, the next step is to make sure your SMSF satisfies all the annual administration and compliance rules. These include:

• lodging annual taxation and superannuation returns with the various regulators
• lodging member contribution statements
• reporting all member benefit payments
• appointing auditors to complete the annual audit review
• establishing a system to maintain the fund's records (which must be kept for at least ten years)
• ensuring that the SMSF has not violated any of the investment rules.

Remember that you can handle this administration yourself or you can outsource it to an accountant, financial adviser or SMSF specialist.
The records that have to be kept for at least five years include accounting records that explain the transactions and financial position of the fund, annual operating statements, annual statements of the fund's financial position, and copies of all annual returns that were lodged.

The records that have to be kept for at least ten years include minutes of trustee meetings where fund business was discussed, details about changes of trustees and members' written consent to be appointed as trustees, and copies of all reports that were given to members.

More specific information about record keeping and administering your SMSF can be obtained from any reputable accountant or financial adviser that specialises in SMSFs, an SMSF service provider, or by visiting the Australian Taxation Office's website at www.ato.gov.au.

(insert graph)

What it costs to run an SMSF

Running your own SMSF involves three main types of costs:

1. Set-up costs
   Up to $1000, though they usually average around $700.
2. Ongoing administration and compliance costs
   Up to $5000, though they usually average around $3000.
3. Investment costs
   These vary depending on how complex and sophisticated the SMSF's investments are and how often it, for example, buys or sells shares or property. The guide is that the investment costs should average around 0.5 per cent per annum, which for a $300 000 portfolio is around $1500.

These combined costs mean that in your SMSF's first year, the fund may cost $5200, or about 1.7 per cent of your portfolio (assuming assets of $300 000). However, as most of the fees - apart from the investment fee - are usually fixed costs, as the size of the SMSF grows these costs as a ratio of the overall portfolio should drop to 1.4 per cent in the second year, 1.3 per cent in the third year, and, as the years roll by and the fund's assets increase, the total expense ratio should reduce to 0.8 per cent within the first decade of the fund.

This is obviously a very low fee compared to the average fees you would pay to be a member of a regular super fund, especially given what you are investing in and the flexibility an SMSF offers. But it is still not as low as the average industry fund would charge. So again the message is that SMSFs can be very cost effective, but if you want simple, low-cost super then don't set up an SMSF. Analysis by SelectingSuper suggests it usually takes six or seven years before an SMSF's fees drop below the elusive 'low cost' 1 per cent barrier.

For SMSFs with around $500 000 or more in assets, these TERs can be much lower than SMSF members are likely to achieve in any other type of superannuation fund, even from a low-cost industry fund. For example, if your SMSF starts with $500 000, its fees in the first year should already be below 1 per cent, and within four years they should be even lower than the best industry funds could deliver to you.

So in their early years, SMSFs can cost around the same as regular super funds, but after they are established and bedded down they can become remarkably cost effective. Little wonder then that they are so popular for people with serious amounts of super to invest.

The SelectingSuper SMSF Checklist

Whether you want to run an SMSF yourself or outsource it to an experienced accountant, financial adviser or SMSF specialist, you still need to be sure it is being run properly because you are a trustee and you are ultimately responsible. This check list should help you keep things on track when starting your SMSF: Does your SMSF have a valid trust deed and investment strategy? Have the SMSF's trustees been properly appointed? Have you applied for and received your SMSF's tax file number? Have you set up your SMSF's bank account? Have you 'elected' to be regulated by the Australian Taxation Office? Will all of your SMSF's investments satisfy the sole purpose, related party, arm's-length and in-house assets tests? Are you sure your SMSF will not lend or give any money to any of its members? Are you sure your SMSF will not borrow any money for investment purposes? Have you appointed an approved auditor? Have you arranged for how your SMSF's annual administration and compliance will be managed?

<< Back to Learning Centre