Should you DIY your super?
Tuesday, February 13, 2007/
SME owners can use a DIY fund to develop great strategies for tax planning, asset protection and estate planning, especially given recent Federal Government proposals. But there are drawbacks, reports 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
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.”
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.
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
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.
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.
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.)
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.
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.