Is a self-managed super fund right for you?
Investing with a self-managed super fund, or SMSF, is one option to grow your super, but it’s also a tricky one. As you and the other trustees are in charge of the fund, all your investment decisions come with huge responsibility and small print. Here are a few things to consider when setting up an SMSF.
You’ll need free time
Creating your own SMSF or joining other members in an SMSF may not be right for you if you’re time poor. After policy changes to Australian SMSF laws in July 2017, there are even more laws and regulations governing SMSFs. Not only are the laws tough, but the auditing process is too, so you’ll need to understand even the fine print.
If you’re starting your own SMSF, you’ll need at least $200,000 in self-funded super or more. If you have less than this amount, starting an SMSF may not be a cost-effective option for you.
Maintaining an SMSF requires readily accessible cash flow to pay administration expenses, income tax and minimum income stream payments when they’re due. You’ll likely wish to enlist an advisor and accountant to help you manage the fund, so you’ll need accessible cash for these fees too.
Why be part of an SMSF?
Investing with an SMSF has its benefits. Avoiding capital gains tax (CGT) is the most obvious benefit if you use your SMSF to buy a property, plus you can make a profit on the rental income.
If the fund owns a property for more than 12 months, the CGT lowers from 15 to just 10 per cent. Even more exciting is if you sell the property during your pension stage of life, the CGT will drop to 0 per cent. This drop can make a huge difference to the income gained from a property sale.
The key SMSF investment rule: The arm’s length rule
When investing with an SMSF, you and other members must conduct all transactions at ‘arm’s length’. This rule essentially means every transaction made by an SMSF must adhere to all the standard market rules and rates. Usually, this is easy to do unless conducting business with a friend or family member related to someone within the fund.
Examples of breaching the arm’s length rule
For example, $500,000 which was the current market value of the property. Instead, Dan sold the property to his son for $400,000, which was far below the market price. By accepting less than market value, the fund has breached the arm’s length rule.
Alice’s SMSF loaned money to her friend. Three years later the loan was repaid without interest. Normally, a commercial rate of interest would have been paid, so Alice has breached the rules governing an SMSF.
Judy owns a business, and her business leases its shopfront from her SMSF at half the market value of rent. This isn’t the true market rate of return, so she has breached the rules.
Why does the arm’s length rule exist?
This rule is established to protect you and your fund’s investments. If your assets are not sold at arm’s length, the value of the fund’s assets will suffer. Not only that, but you are at risk of serious fines and penalties, not just through your fund, but you’re also personally liable.
The sole purpose test
Before you get too excited about setting up an SMSF to invest in property, it’s important to remember your SMSF must always pass the sole purpose test for super funds to be eligible for tax concessions.
This means your fund needs to be maintained for the sole purpose of providing retirement benefits to your members, or to their dependants if a member dies before retirement.
Simply put: your fund will fail the sole purpose test if it provides a pre-retirement benefit to someone.
Investing with an SMSF can be a wonderful way to save on capital gains taxes, but remember the arm’s length rule, and sole-purpose test must always apply.