Assessing the suitability of an SMSF for your clients

Financial planners need to be across the legal and regulatory concerns and risks of SMSFs to be able to give clients the best advice on whether an SMSF is worthwhile, specifically, for them. There are several factors that impact the potential return on an SMSF.

A checklist for SMSF investors

For investors, running their own fund may be the right choice, but only if:

• They are very knowledgeable about finance and legal matters and are not reluctant to seek advice beyond their expertise.
• They have enough in superannuation to make set-up costs worthwhile, as well as the ongoing expense of professional accounting, tax, audit, legal and financial advice. Self-management is usually not cost-effective with less than $200,000 in addition to the value of the family home; more cautious advisers suggest $500,000. In general, SMSFs work better for those considering accessing pension funds within 20 years.
• They have the time to research and check their super investments regularly and to actively manage the fund. The administrative commitment involved in tax-related record keeping, reporting and auditing obligations can be considerable. Frankly, if they have been successful in a business that they love, that may be where they should focus their time, rather than in managing their portfolio.
• They have insurance protection, including life, total and permanent disability, and income protection. These are likely provided in their current super arrangements, and will be lost when they move to self-management unless they make other provisions.
• Finally, remember that investors will be working with at least one other trustee. What is their relationship with other fund members? It would be wise to have a plan if the relationship ends or one member dies or loses interest.

What is the client’s investing acumen?

Investors need to know they should not chase every hot, new scheme. As the trustee of their SMSF, they will now have a legal fiduciary obligation to manage the fund prudently and for the benefit of all members. An SMSF should, therefore, have an internal investment plan that encourages diversification to achieve an appropriate balance of risks and safety over a longer horizon.

Nonetheless, there are some very intriguing opportunities for SMSFs. Traditional super funds are heavily weighted toward relatively risk-free shares, the steady-as-you-go performers in the investment world. A self-managed fund may allow for greater allocation toward growth shares. However, it is important that investors be realistic about their appetite for risk. Sleepless nights should not be an element of any investment strategy.

Since 2007, SMSFs have been able to borrow to buy real property for investment purposes – up to 70 per cent of the value of the property. Renewed confidence in the property market has generated a great deal of excitement and appears to have accelerated the move into self-managed funds. This, too, can be part of a balanced portfolio.

In addition to the potential for growth shares and property investment, an SMSF can take advantage of some layered tax strategies such as salary sacrifice or transition to retirement pensions. These can be very smart ways to move toward retirement. The first may provide a tax advantaged plan for those in a very high income tax bracket, and the latter may offer a way to work part time past age 55 without reducing income.

In any event, these can be very valuable ways to use an SMSF, but the planning and structuring should only be done with the assistance of qualified financial planners and tax and legal professionals.

An SMSF should also be part of a larger financial plan that includes estate planning and, in the case of a business, succession planning. Savvy investors should not think of an SMSF as a stand-alone financial element.

The law

SMSFs are strictly regulated by the Australian Taxation Office under the provisions of the Superannuation Industry (Supervision) Act 1993 and the Financial Services Reform Act 2002.

Briefly, an SMSF may have as many as four members. Each member is a trustee (or director if there is a corporate trustee). Each individual must act according to the fund's trust deed and the super and tax laws. If there is a conflict between the super laws and the trust deed, the law overrides the trust deed. Each must also:

• Carry out the role of trustee or director, which imposes important legal duties.
• Use the money only to provide retirement benefits for the members or death benefits for the members' dependents. This is known as the sole purpose test, and it may preclude early access to the funds or certain kinds of investments, such as ownership of real property in which a member lives or vacations. Trustees must maintain an SMSF so that it complies with the sole purpose test at all times.
• Set and follow an investment strategy that ensures the fund is likely to meet retirement needs. By itself, this weighs heavily in favour of safer, somewhat more conservative investing.
• Keep comprehensive records and arrange an annual audit by an approved SMSF auditor.

Although many trustees hire professional advisers, the liability for failure to adhere to these requirements cannot be delegated. It may even reach a trustee’s personal, non-SMSF assets. Through the concept known as joint and several liability, each trustee is financially responsible for the actions of every other trustee, including actions in which the innocent trustee had no role.

The penalties for failure to comply with these requirements are serious. The minimum amount is in excess of $800 and the maximum may be in excess of $10,000. In addition to paying fines, trustees may also have to rectify their mistakes out of personal funds, if necessary, and complete an education course. Failure to do so is an offence.

In exchange for greater management independence, SMSF members forfeit certain government protections. If they lose money because of theft or fraud, they do not have access to special compensation schemes. Neither do they have access to the Superannuation Complaints Tribunal to resolve disputes.

Rolf Howard, managing partner, Owen Hodge Lawyers