The latest federal budget has focused attention on Australia’s best-paid super fund members – an estimated 128,000 individuals who earn more than $300,000 a year from their employment, businesses and non-super investments.
Under a controversial budget measure – which could cost as much to administer as the extra tax it will collect – the salary-sacrificed, compulsory and personally deductible contributions of these high-earning members will be taxed at 30% from July. This is twice the contributions tax being applied to other fund members.
The government’s strike against wealthy super fund members raises fascinating questions for all astute fund members; no matter their income and super balances. Just who are these high-earning fund members? How do they invest their super money? Can I learn anything from them?
It is a safe assumption that most of these members earning $300,000-plus would have their own self-managed super fund (SMSF). And it is a fairly safe assumption that their fund balances are high because most wealthy people would ensure that they, along with their families, take as much advantage as possible of concessionally-taxed super.
A few of Australia’s biggest SMSFs have more than $40 million each in assets – an asset value that will never again be replicated by self-managed funds given the annual caps on super contributions. And there are many SMSFs with balances of $6 million to $20 million.
As highlighted in a recent ATO publication, Self-managed superannuation funds – a statistical overview 2009-10, rich SMSFs have plenty to teach trustees of SMSFs with vastly smaller assets. In short, SMSFs with huge balances have, on average, much higher performance once costs and taxes are taken into account.
However, this out-performance doesn’t appear to be associated with doing anything extraordinary with investments – the asset allocation of rich fund portfolios is surprisingly similar to an average-sized fund. The out-performance would largely be attributable to their low costs relative to asset size and their assumed willingness to take quality professional advice.
ATO statistics for 2009-10 show that 1.3% of SMSFs (about 6,000 funds) have assets of $5 million to $10 million, while just 0.2% of SMSFs (less than 1,000 funds) have more than $10 million in assets. By contrast, SMSFs have average assets of $870,000.
Here are six strategies pursued by the trustees of Australia’s richest six that are worth considering:
1. Cut costs
The ability to shave costs is the great advantage of high-asset SMSFs. Funds with upwards of $10 million had average costs in 2009-10 of only 0.25% of assets. This compares with costs of 0.67% for SMSFs with $500,000 to $1 million, and a breathtakingly high 7% for SMSFs with up to $50,000 in assets.
The message for all SMSFs is that costs really matter. And if your fund’s costs seem comparatively high to an average-sized fund, find out why. Keep a close watch on funds management and fund administration fees. And ensure that your fund is not unnecessarily triggering capital gains tax and transaction costs through excessive trading.
The reality is that many high-cost SMSFs are too small to be financially viable. Rich SMSFs are able to spread their fixed costs over much more valuable portfolios.
2. Question performance
SMSFs with $10 million-plus returned an average 8.9% in 2009-10 against a return of 6.87% by SMSFs with $500,000 to $1 million, and a negative average return of 8.64% by funds with $50,000 or less.
If your SMSF is underperforming, question whether it should be revamped with professional help or whether your money is better served in a big public-offer super fund. The ability of wealthy SMSFs to minimise their costs really lifts their net returns.
3. Boost family contributions
The trustees of rich SMSFs would typically ensure that their family members – including spouses with no employment income and their children of any age – contribute as much as possible into the concessionally-taxed super system.
Anyone under 65 can contribute to super, even minors who are not in the workforce. And anyone age 65-69 can contribute if doing at least some paid work.
However, fund members under 18 are not entitled to tax deductions for any contributions unless they earn an employment or business income.
Despite the $25,000 concessional contributions cap applying to all fund members from July, it is still possible to put large amounts into super.
Even from 2012-13, fund members will be able to contribute $25,000 a year in concessional contributions plus $150,000 in non-concessional contributions. This means that a four-person fund (the maximum membership for an SMSF) could receive contributions of up to $700,000 in contributions a year with each member contributing up to their individual caps.
4. Watch for the dangers of owning only one type of asset
SMSF tax and regulatory returns show that rich funds are much less likely than small SMSFs to fall into a potential trap of having most of their assets in a single investment or investment asset class such as shares, cash or property.
For instance, 38% of SMSFs with $50,000 or less in assets have all of their money in a single asset class compared with 2% of funds with more than $10 million in assets. And just 5% of funds with $1 million to $2 million have all of their money in a single asset class.
The logic of not putting everything into one asset or type of asset is simple: a fund with a diversified portfolio diversifies its risks and opportunities.
5. Think twice before putting all of your investments in super
As last week’s federal budget illustrates, governments are too willing to turn to super in an attempt to raise extra taxes.
Well-informed trustees of SMSFs would understand the case for holding both super and non-super investments to reduce the risk of government interference.
Some investors may be surprised at how much can be earned outside super in a tax-effective way.
In 2012-13, an individual investor can earn fully franked dividends of about $100,000 from shares held outside super without having to pay any additional tax – once franking credits are claimed. (This assumes the taxpayer has no other taxable income.)
A $2 million share portfolio paying a 5% dividend yield is necessary to produce a $100,000 income.
6. Consider tax-savings strategies outside super
As confirmed in the budget, the largest concessional contribution that all members can make to super from next financial year is $25,000 a year without exceeding their contribution cap. This is likely to encourage more super fund members to pursue tax-savings strategies outside super.
These strategies include the negative-gearing of shares and property where appropriate from an investment perspective as well as income-splitting by holding assets in the name of low-earning spouses and in family trusts. Such strategies have long been favoured by trustees of rich SMSFs for their non-super money.
But, never forget, gearing multiplies potential losses as well as gains.