Creating and running your DIY super
Tuesday, 23 October 2007
Last Updated: Wednesday, 24 October 2007
By Michael Laurence
The breathtaking popularity of self-managed super — with the number of funds opening each month surging to a long-time high of 3500 after the Federal Government announced vast improvements to the super system — truly overshadows the monthly closure of about 300 DIY funds.
More than 60,000 new DIY funds have been established since June 2004, according to estimates based on the latest-available tax office and Australian Prudential Regulation Authority (APRA) figures, against about 10,000 fund closures over the same period. These closures are the other side of the DIY super boom.
Super consultants say fund members decide to close their DIY funds for a variety of reasons, including poor investment performance or unacceptably high running costs, which is typically a reflection of a low balance. And some members begin to find the administrative and investment duties somewhat onerous given their lifestyles.
But most funds close simply because all of the members have died and the funds no longer serve a purpose. (In many cases, even the death of the founding members won’t cause the shutdown of a DIY fund — their children and, later, grandchildren become members.)
Tax office statistics appear to suggest that the Government’s remodelling of the super system — including the imminent removal of tax on super retirement benefits — may dramatically slow the monthly closure of DIY funds. (This legislation has just passed through Parliament.)
The majority of members who decide to close their funds usually wait until the last three months of a financial year, yet the closures shortly before the end of 2005-06 were way down on previous years. (The revamping of the super system was announced, of course, in the May 2006 budget.)
On the other hand, this apparent slowdown in the closure of DIY funds may be somewhat countered in the future by the tax office’s determination to get much tougher on wayward funds that are failing to meet their obligations under super law. And as this get-tough policy bites harder, some fund members will inevitably decide they want out.
Alternative to closure
Members who are thinking of closing their funds because of underperformance or because of the workload should think carefully before giving up these highly effective and flexible means to save for retirement, provide retirement income, and to conduct sophisticated estate-planning strategies.
Alan Dixon, managing director of Dixon Advisory — a Canberra and Sydney financial planning group specialising in self-managed funds — says rather than closure, a solution might be for a fund to gain financial planning and investment advice and to look for ways to ease the administrative burden on members.
Within the confines of a fund’s trust deed and superannuation law, Dixon says a member of a fund might be nominated to make all investment decisions, thus reducing the effort required from other members.
Again depending upon the circumstances, arrangements might be made so most members’ signatures are only required on a fund’s annual returns. (With a DIY fund, each member is either a trustee or a director if there is a corporate trustee.)
Dixon says a few people find that they do not have a suitable temperament to have a DIY super fund and are overwhelmed by the investment and administrative responsibilities. “The stress and pressure could upset their retirements,” he says. Such individuals could be better suited by a large, public-offer super fund.
Graeme Colley, superannuation strategy manager for DIY fund administrator Super Concepts, says financial planners and other professionals can advise on whether a fund is viable or whether it should be wound up. “And a good financial planner should be able to recommend whether a client is a suitable person to be running a self-managed fund.”
Colley says some members of self-managed funds can simply lose interest in them. Like Alan Dixon, Graeme Colley emphasises that some members of self-managed funds should consider relying more on the skills of professional advisers to complement their own abilities as a possible alternative to closing their funds.
Six steps to closure
In most cases, professional advisers guide member/trustees through the various steps that should be taken to comply with superannuation and tax laws, and a fund’s trust deed, when closing a fund.
The types of assets held by a DIY fund will partly dictate the ease in which it might be closed. Colley points out that a fund could find, for example, that the business premises of the members — a common DIY fund asset — takes some time to sell.
Here is quick guide to closing a DIY fund:
Step one: Formally decide to close your fund. The members should record their decision in writing.
Step two: Select the best time to close your fund. Typically, funds should not be closed soon after the start of a new financial year because the expense of preparing the final regulatory and tax returns will only cover a short time. And the target closure date should be set well ahead to give members plenty of time to make the necessary arrangements.
Step three: Calculate the fund’s assets and liabilities. Pay liabilities and expenses such as taxes, administrative costs (including for winding up the fund) and regulatory fees.
Step four: Distribute the fund’s remaining assets to members. This may involve paying lump sums to some retired members or rolling benefits into another super fund. “It’s useful to get these instructions in writing from members just in case there’s a misunderstanding in the future,” suggests Colley.
He points out that some retired members may want actual assets currently held in the DIY fund — such as real estate or certain shares — transferred into their own names.
Step five: Lodge final regulatory and tax returns to the date that the fund is being wound up.
Step six: Don’t ditch fund records. Superannuation law requires that most records be kept for 10 years.
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By Michael Laurence SME owners are responsible for much of the huge amount of money pouring into self-managed super funds. These funds hold almost a quarter of the $920-billion-plus assets in Australian super funds – with perhaps $145 billion flowing from successful SMEs.
No surprise why. SME owners, in their roles as trustees/members of DIY funds, can use the funds to develop highly favourable tax, estate planning, and asset protection strategies that are well within the stringent laws of superannuation.
Graeme Colley, technical manager for self-managed fund administrator and consultancy Super Concepts, says business owners established 75–80% of the 3000 funds administered by his group.
Owners of successful SMEs are often in a position to rapidly build up the assets in their funds, a move that is accelerating with the Government’s proposals to make super much more tax-effective from July 1.
“Business owners have a personality that likes to be in control,” Colley says, “and DIY funds give them control over their super investments.”
Mark Johnston, principal of specialist researcher Investment Trends, agrees, and points out that his current annual survey on self-managed funds shows that the biggest reason why business owners establish DIY funds is to gain more control over their super. And the trigger to actually begin a fund is often the decision to go into their own businesses, according to Johnston’s research.
Business real estate such as a strata office or a small factory are among the few assets that funds are allowed to acquire from members.
In turn, a fund can rent the premises to a member’s business for a commercial rent. And for these reasons alone, SMEs and DIY funds are often closely linked.
Advantages of DIY super
Estate planning
Remarkable estate planning opportunities for members of DIY funds have emerged with the Federal Government’s proposals, as part of its revamping of the super system, to abolish reasonable benefit limits (RBLs) from July 2007. (An RBL is maximum concessionally taxed amount that can be received in super upon retirement. Different dollar limits currently apply to lump sums and pensions.)
From July 2007, all superannuation lump-sum death benefits paid to dependants will be tax-free – no matter the amount. But under existing law, death benefits to dependants are only tax-free up to the deceased’s unused pension RBL of $1,356,291 for 2006-07.
Colley says a high earner could arrange for, say, a $2 million life insurance policy through a self-managed fund. From July 2007, the full amount would be paid tax-free to dependants in the event of death.
DIY funds are appropriate for obtaining such big insurance policies, Colley says, because of their typically flexible insurance options.
Other estate planning opportunities with self-managed funds include the ability – depending upon the circumstances – for some assets to remain in the fund after the death or retirement of some members.
A prized asset such as a valuable share portfolio or business real estate can remain in a fund between generations in the case where different generations of a family are members of the same fund – provided there are sufficient fund balances to pay retirement and death benefits when required.
The Australian Financial Planning Handbook (published by Thomson) adds: “DIY funds can have a high degree of flexibility in terms of paying [superannuation death benefits as] lump sums or pensions. Death benefits may also be paid quickly.”
Tax planning
Self-managed funds provide excellent means for managing tax on savings – particularly for business owners. These include:
- The self-employed can contribute listed shares and business property to their self-managed funds – and claim tax deductions for the contributions against other income. (Be aware that the current annual age-based limits on deductible contributions will be replaced under the Government’s proposals by annual caps on concessionally taxed contributions from July this year.)
- Self-managed funds have the flexibility to adopt a policy – if appropriate for their investment strategy – of investing in a high proportion of fully franked shares. This will provide valuable tax refunds for excess franking credits. (Earnings of a super fund are taxed at 15% in the accumulation phase and zero when backing a pension.)
- Self-managed funds, again if appropriate for their investment strategies, can adopt a buy-and-hold approach for their investments that may minimise CGT while a member is still saving. Once investments of a fund are backing a super pension, CGT no longer applies.
David Shirlow, a division director of Macquarie Bank, says many public super funds, however, apply a nominal CGT when switching from saving phase to pension phase – even within the same fund. This is not the case with DIY funds. Shirlow says a decision by self-managed fund trustees to adopt a buy-and-hold strategy should not be driven by tax.
- Under the proposed new super system, super benefits will become tax-free for retirees over 60 from July this year.
Asset protection
Stephen Mullette, a partner of solicitors The Argyle Partnership, names superannuation as an "absolutely smart way to gain asset protection". Under current law, trustees in bankruptcy do not have immediate access to super savings up to the pension RBL of more than $1.3 million for 2006-07. And in a signification development, the Superannuation Legislation Amendment Simplification Bill, introduced into Parliament early in February, provides for the complete removal of the RBL cap from the Bankruptcy Act from July 1, making super much more attractive for asset protection purposes. From that date, unlimited amounts of super are protected from being immediately divided among creditors of a bankrupt member.)
By contrast, the savings of bankrupts in, say, bank accounts are simply included in his or her bankrupt estate for division among creditors.
However, Mullette says trustees in bankruptcy can seek to recover money or assets contributed to super with the intention of defeating creditors. And he says other long-proposed amendments to the Bankruptcy Act intend to make this point clearer.
Mullette suggests that fund members should regularly contribute to super as part of an asset-protection strategy. A trustee in bankruptcy would have difficulty in establishing an intention to defeat creditors if a regular savings pattern through super had long existed.
Disadvantages of DIY super
Low balances
Although views differ widely, a minimum balance of, say, $150,000 to $200,000 is widely considered necessary in order to be cost-effective compared with large public funds – but some advisers recommend much more. So much will depend on the actual investments selected by a fund.
If a fund’s balance is likely to remain low for a long time, an SME owner should carefully consider the alternative of a large public super fund with, if required, many investment options.
Low balances can also mean that a fund cannot afford adequate diversification in the investment markets as a means to increase possible returns while lowering risk.
Tougher regulator
A cashed-up tax office, in its role as DIY fund regulator, is adopting an increasing tougher stance against funds that breach superannuation laws. This is one of the tax office’s core compliance thrusts.
Stringent limits
DIY funds are subject to stringent legal bans on borrowing (except in limited circumstances), making loans to members and their relatives, and buying most types of investments from members (with the main exceptions of listed securities and business real estate). Investments and leases involving related parties generally must not exceed 5% of a fund’s assets. (Again, one of the exceptions is business real estate.)
Time-consuming
DIY funds can be extremely time-consuming in regard to tax and compliance obligations, and with looking after the investment portfolios. Would-be member/trustees of self-managed funds should satisfy themselves that they won’t panic whenever the sharemarket takes a dip. Professional help is, of course, available for dealing with the administrative/compliance requirements and with the investments.
Untouchable
Savings in super funds cannot be accessed before retirement – apart from in cases of severe financial hardship or some limited compassionate grounds. This generally means that younger people, in particular, will want some alternative savings.
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By Michael Laurence
A comprehensive new study confirms a long-held suspicion: the self-employed are dominant among the ranks of Australians with little or no super.
There is a shortfall in the superannuation balances held by businesses at the very small end of the spectrum. The main reason is fundamental. Operators of unincorporated small businesses do not have employers who are compelled to make super contributions on their behalf.
Ross Clare – the author of the report and research director of the Association of Superannuation Funds of Australia (ASFA) – believes the super savings of the self-employed can much depend on age.
“Many younger among the self-employed, those in their 20s and 30s, have next to nothing in super, and their businesses are worth a modest amount,” says Clare. Some older self-employed business owners have, of course, not only large super balances but highly valuable businesses with valuable goodwill.
But, overall, Clare says, “the balance of the self-employed would struggle even to support a modest standard of living in retirement. Often owners of personal-service businesses in particular would be misleading themselves about the value of their businesses [if put on the market to help finance their retirement].” Clare is working on a second report that looks specifically at the super of the self-employed.
It is clear that many of the self-employed are missing out on some great super opportunities. Here are just three strategies for small-business owners with growing businesses to get money into super.
Unincorporated small business
Opportunity: From the beginning of the new financial year, super contributions by the self-employed are fully-deductible for the first time. This should encourage many more of the self-employed to make pre-tax contributions. The contributions are subject only to the 15% contributions tax upon entering the fund.
“This is the most significant change in the simpler super system for the self-employed,” says Sydney consulting tax adviser Leo Hollestelle. “It puts them on an equal footing with employees making salary-sacrificed contributions.”
Fine-print: Previously, the self-employed were treated unfairly by being only allowed tax deductions for the first $5000 of contributions plus 75% of the remainder.
Warning points: Under the simpler super system, the limit on tax-effective deductible contributions – now called concessional contributions – is an indexed $50,000 a year if aged under 50, or $100,000 a year until 2011-12 if over 50. If you overshoot these caps with pre-tax contributions, the excess is taxed at 46.5% – a real sting.
Younger business owners should be aware that super is locked away until their retirement – after reaching 60 (if you are aged under 44).
Lower-income business owners
Opportunity: From the beginning of the new financial year, the self-employed became eligible for the first time to Government co-contributions. Again, it is extraordinary that the self-employed were locked out of this great benefit for lower earners.
“There is no better way to give your super a kick-start,” says Hollestelle. The Government contribution is made automatically – provided you are eligible and make an after-tax contribution.
Fine-print: Under the co-contribution scheme, the Government will contribute $1.50 (to a maximum of $1500 a year) for every after-tax $1 you contribute to super. Couples working together in a small business could, of course, each be entitled to co-contributions.
Warning points: The Government’s maximum co-contribution of $1500 applies if your assessable income is less than $28,980. And the Government’s co-contribution progressively reduces, phasing out completely when your assessable income reaches $58,980.
Spouse working part-time in family business
Opportunity: Maximise salary-sacrificed super contributions for a spouse who works only part-time in your family business. (This strategy is for incorporated businesses, which are not classified in the ranks of the self-employed.)
Sydney tax and super lawyer Robert Richards says this strategy is designed for businesses in which the spouses of the owners work part-time for perhaps a few days a week. The strategy is intended for businesses that are making good money and are looking for ways to legally and simply minimise tax payable by the company, and eventually the owners.
Richards says tax law allows the value of salary-sacrificed contributions paid for part-time employees – even if related to the majority shareholder – to greatly exceed the commercial value of their part-time work.
“Any money salary-sacrificed into super is taxed at just 15% on entering the funds instead of being eventually caught by personal tax rates of perhaps double (that) or more,” he says. The businesses are entitled to a tax deduction for the contributions.
Fine-print: Richards says this strategy works best for couples who work together in a family business, with each maximising their contributions.
Warning points: Only incorporated businesses can make salary-sacrificed contributions for employees. Contributions should be within the annual concessional caps of an indexed $50,000 if under 50 or $100,000 if over 50.
Many small businesses whose income relies on the personal services of a single person are caught by the alienation-of-personal-income rules, with severe restrictions placed on their tax deductions including on salary-sacrificing contributions for spouses.
Richards says the strategy of making large salary-sacrificed contributions on behalf a spouse working part-time is generally only effective for trading companies where the alienation-of-personal business rules do not apply.
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By Michael Laurence
Thousands of self-managed super funds – the favoured means of investment for SME owners – will borrow to invest over the next 12 months. And their investments in residential property, the premises of members’ businesses, and listed investment companies will rise significantly.
The funds will become more opportunistic in their investment practices, building up stores in cash management trusts to take advantage of investment opportunities.
Yet despite the expected swing to geared investments in accordance with changes to super law last week, self-managed funds will take a more cautious approach to the sharemarket, shying away from more speculative stocks to concentrate on blue-chips.
The staggering flow of contributions into self-managed funds will continue at a remarkable rate in 2007-08, yet at a somewhat slower pace than last financial year when self-managed fund assets leapt by 30%, to $288 billion, in the lead-up to the new super regime, according to the Australian Prudential Regulation Authority (APRA).
These forecasts for super funds over the next 12 months and beyond are based on interviewing professional advisers to self-managed super and, in part, on a new survey by specialist researcher Investment Trends of more than 2100 self-managed funds.
Here are five pointers to what’s coming up for self-managed funds:
GEARED INVESTMENTS
Expectations: Many more self-managed funds will be borrowing to invest under stringent new provisions.
Why: Amendments to super law unambiguously allow self-managed funds to borrow to invest. The amendments permit funds to override the long-standing provision in super law barring the borrowing to buy investments.
Until now, many fund trustees were uncertain about how the borrowing ban operated in practice because of various investment and financial products, including instalment warrants, being marketed.
Under the new law, a lender cannot make a claim against any of a fund’s assets in the event of default – other than against the geared asset – and the geared asset must be held in trust until the fund makes its final payment.
BUSINESS PREMISES
Expectations: SME owners will increasingly arrange for their self-managed funds to own the premises of their businesses. As required under super law, the businesses will pay a commercial rent to their funds for use of the premises – and that rent will be concessionally taxed within the funds.
Why: The recent amendments to super law that clearly allow funds to borrow to invest should boost this trend. Further, changes to the Bankruptcy Act from July mean that no assets in super – these might include business premises – are accessible to trustees in bankruptcy provided contributions were not made to defraud existing or future creditors.
RESIDENTIAL PROPERTY
Expectations: Investment Trends’ latest survey of self-managed funds found a strong interest in residential property investments – higher than in past surveys.
Why: This seems to reflect expectations that markets in the eastern states are in recovery. The borrowing-to-invest amendments in super law will also encourage more funds to invest in residential property.
LISTED INVESTMENT COMPANIES
Expectations: Self-managed funds will increasingly use investments in listed investment companies as a foundation for their portfolios.
These companies, such as Argo and Australian Foundation, hold massive, widely diversified equity portfolios. Argo, for example, owns shares in about 180 listed companies.
Why: Investment Trends’ survey found that self-managed funds have a fast-growing interest in listed investment companies. And self-managed fund administrator and adviser Dixon Advisory also reports that more of its clients are turning to these investments.
Mark Johnston, a director of Investment Trends, says self-managed funds have had considerable success with listed property trusts and this has given them more confidence to move into listed investment companies.
Investment Trends reports that funds surveyed had markedly increased their exposure to listed investment companies over the past 18 months – albeit from a low base. About 13% of funds surveyed had shares in listed investment companies – more than double the percentage shown in the previous survey.
Investment Trends found that more self-managed funds had early this year begun to reduce their holdings in smaller, more speculative stocks to shift more into blue-chips. And this support of blue-chip stocks will grow, according to the survey.
READY CASH
Expectations: Self-managed funds will continue to reduce their debenture holdings in favour of cash. Investment Trends also found that this switch was under way before the recent sharemarket correction.
Why: Self-managed funds have a growing policy of building up their cash to grab investment opportunities that may arise – such as in the recent sharemarket correction.
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By Michael Laurence
Is your DIY super fund in good health? Could it be time to pull the plug? SmartCompany unearths four key steps to diagnosis.
Just 386 self-managed super funds were wound up in 2006-07 – against almost 42,000 that were setup, according to the latest statistics from the tax office. The low closure rate could be a signal that something is not right with thousands of Australia’s DIY funds.
Most closures would be attributable to either the deaths of members or members becoming too elderly to look after their own super. In other words, there would have been no option but to close them down.
The closure numbers suggest that many members could be holding on to their DIY funds despite such factors as poor returns, excessive operating costs due to low balances, member disinterest or inertia, and lifestyle changes that leave insufficient time to properly look after a fund.
Smart fund members should treat the miniscule closure rate as a wakeup call to either ensure that their funds are competitive or to get out of DIY super – and to roll their retirement savings into large funds.
Here are four key steps to checking on the health of your DIY fund, understanding how to get an ailing fund back into shape, and knowing when (and how) to call it quits.
1. Check your fund’s performance
This is really the starting point. Members should ask themselves “Is my fund at least matching the performance of the big super funds?”
Have a look at the website of fund rating agency SuperRatings for the latest returns of the big funds’ balanced, diversified portfolios. (SuperRatings classifies balanced portfolios as those with 60% to 76% of their investments in growth assets of mainly shares and property.)
The median returns for the balanced portfolios surveyed by SuperRatings were 14.2% over the 12 months to 31 August, 11.62% annualised over five years and 9.7% annualised over 10 years. And the top quartile balanced funds recorded a breathtaking median return of 16% in the 12 months to August 31. (The returns are after investment management fees and taxes).
Of course, the asset allocation of your DIY fund – meaning its investment mix between mainly shares, property, bonds and cash – could be very different to the balanced portfolios of the big funds. You are most unlikely to be comparing apples with apples.
Research by the tax office and specialist researcher Investment Trends shows that DIY funds generally hold more cash and direct property in their portfolios than the balanced portfolios of their large counterparts. This means the returns and the levels of risk could significantly differ.
Nevertheless, a comparison with the big funds may indicate whether you are forfeiting returns by running a DIY fund.
Another useful exercise is to examine how the components of your fund’s particular investment mix – in particular its shares, property, bonds and cash – have performed against the relevant market indices such as the S&P/ASX200 Accumulation Index (comprising changes in share prices and dividend payments).
2. Understand the reasons for poor performance – and do something about it
Various studies show that one of biggest causes for lousy performance is that a fund’s investment mix is poor. Funds that are investing for the long term should have sufficient growth assets to, at the very least, counter inflation and running costs. Indeed, most funds should expect a decent margin on top.
The Australian Securities & Investments Commission’s basic tips on DIY funds are worth a look.
Once fund members are confident that their funds’ asset allocation or investment mix is correct and suitably diversified for their personal circumstances – including their tolerance to risk, time until retirement, investment goals and retirement needs – members can then question whether their actual investment selection is appropriate.
Investment advisers typically warn their clients about investing too much of their portfolios in a single investment and failing to diversify between investment managers with different investment styles.
More DIY funds are turning to listed investment companies, albeit still in small numbers, to provide low-cost foundations for their share portfolios. (See Wealth/Super October 2, 2007.) Listed investment companies have holdings in a large number of public companies.
Wholesale managed share trusts with a range of investment styles are also used as at least foundations for many DIY funds’ share portfolios.
3. Get professional help
A quality investment adviser with considerable experience with DIY funds is well-placed to advise you about how to rescue an ailing DIY fund – by mainly changing its asset mix and investment selection.
The Self-Managed Super Fund Professionals’ Association of Australia has a valuable service that enables the public to search online for specialist DIY fund advisers.
4. Know when to quit
If you can’t get your fund back into shape or have simply lost interest, think seriously about closing it and rolling your super savings into a big fund. Closing a fund is not complicated. (See the tax office’s brief summary of what should be done.)
The closure of a DIY fund involves calculating the fund’s assets and liabilities such as taxes, administrative costs and regulatory costs; distributing remaining assets to members (this may involve rolling the assets into other super funds or making payouts to retired members if requested); and lodging final regulatory and tax returns to the date that the fund is being wound up. (See Wealth/Super, March 6, 2007 for more details about closing a DIY fund.)
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