For many people, SMSFs are a great option for building retirement savings, but they are not necessarily suitable for everyone.

Before setting up an SMSF, it’s essential to be fully informed about the pros and cons of an SMSF structure.

There is no one right or wrong answer as to whether an SMSF is the best option for a particular individual.  Many factors must be considered and weighed up in the context of the individual’s circumstances and personal preferences, in order to determine whether an SMSF or public offer fund will provide the best outcome for them.

Below, we explain some of the key differences between SMSFs and public offer funds that need to be considered.

Management

While public offer funds are managed by professional licensed trustees, SMSFs are considerably different because management responsibility lies with the members.  Every SMSF member must be a trustee of the fund (or, if the trustee is a company, a director of that company), and every trustee (or director of the corporate trustee) must be a member.

This is an advantage for those who want full control over how their superannuation is invested and managed, however, it also means the members are responsible for complying with all superannuation laws, which are numerous and often complex. Failure to comply can result in substantial administrative penalties (which can negatively affect the members’ super balances) and can potentially affect trustees personally if they have acted negligently or recklessly.

Individuals need to consider:

• Whether the increased responsibility is warranted by the potential benefits of investing via a SMSF?
• How the complexity of the planned investments of the SMSF will impact on the trustees’ managerial responsibilities. (ie. if you are planning to invest in something obscure or unusual, the fund is more likely to be at risk of running into non-compliance issues).

Should you choose to become an SMSF trustee, you need to be prepared to seek the right professional advice.  This may include advice around tax and compliance with the superannuation legislation, as well as financial or investment advice.

Complications may also arise for SMSFs where one or more members/trustees of the fund moves overseas for some time (eg. for a job posting).  This is because legislation requires “central management and control” of a SMSF to remain in Australia in order for the fund to maintain its complying status. Failure to comply can result in significant tax penalties.  Conversely, members of public offer funds can move overseas without risking these penalties because their fund continues to be managed by a professional Australian trustee.

Costs

Costs are a key factor for anyone considering their super options.  Fees charged by public offer funds vary, but are generally charged as a percentage of the member’s account balance.  Therefore, the higher your balance, the more fees you’ll pay.

SMSF costs tend to be more fixed.  As well as establishment costs and an annual supervisory levy payable to the ATO, SMSFs must hire an independent auditor annually.  Additionally, most SMSF trustees rely on some form of professional assistance, which may include accounting/taxation services, financial advice, administration services and asset valuations.

These costs may be a more critical factor for those with modestly sized SMSFs.  This year, a Productivity Commission inquiry found that larger SMSFs have consistently delivered higher net returns compared with smaller SMSFs, and that SMSFs with under $500,000 in assets have relatively high expense ratios (on average).  Although this report has attracted some criticism, it is generally accepted within the industry that for members with modest balances an SMSF will often be more expensive than a public offer fund.

Investment flexibility

A major benefit of an SMSF is that the members/trustees have full control over their investment choices.  This means they can invest in specific assets, including direct property, which would not be possible in a public offer fund.  For example, a business owner wishing to transfer their business premises into superannuation would need an SMSF to achieve this.  SMSF members can also take advantage of gearing strategies by borrowing to buy property or even shares through a special “limited recourse” borrowing arrangement.

However, with control comes responsibility. SMSF trustees must create and regularly update an “investment strategy” that specifically addresses things like risk, liquidity and diversification.

They must also be aware of the various limitations that are placed on SMSFs in relation to investments.  For example, superannuation laws:

• prohibit investments in or loans to related parties, or the lease of assets to related parties where the investment amount exceeds 5% of the fund’s total assets;
• prohibits the acquisition of investments from related parties, except in certain circumstances; and
• place strict restrictions on how some investments are maintained, used and stored.

Failure to meet any of the requirements around investments can have dire consequences for an SMSF and its members.

Insurance

It’s possible to hold various types of insurance through your superannuation fund, including life insurance, total and permanent disablement (TPD) and temporary incapacity.

For many Australians, using superannuation benefits to pay insurance premiums makes insurance more accessible and convenient, as the member can access high quality insurance products without affecting their day to day cash flow.  Such insurance policies can be held within both SMSFs and public offer funds.

Holding insurance in an SMSF (as opposed to a public offer fund) provides the member with significantly more control over the quality of insurance product chosen, as the member/trustee is able to select their own insurance product rather than choosing from the options available from a public fund.  With sound advice from a financial advisor or insurance specialist, members/trustees are able to shop around for the policy and insurance provider that will best suit their specific circumstances.  In many cases, where the member has specific health conditions or other personal circumstances, having this choice makes the difference between successfully claiming on a policy and being left high and dry on a technicality.

While you can purchase insurance within an SMSF, large funds can sometimes offer cheaper premiums because of the group discounts these funds can access.  Also, members of large funds are automatically accepted for a certain level of coverage without needing a medical exam or detailed personal information, which is more likely to be required for an SMSF-held policy.  Alternatively, where members have an existing insurance policy held within a public fund which was commenced prior to deterioration in their health, it is often impossible or too costly to commence a new insurance policy within their SMSF.  For these reasons, some SMSF members choose to keep a separate account in a public offer fund, purely to maintain an insurance policy.

If you’re an SMSF trustee, there are a couple of things to keep in mind in relation to insurance:

• As part of your SMSF’s investment strategy, you’re required to consider (and regularly review) whether the fund should hold insurance cover for its members; and
• Not every type of insurance can be held in superannuation. For example, trauma policies aren’t allowed, and there are restrictions on some types of TPD policies.

You should also seek advice about the tax consequences of holding insurance in the fund, including deductibility of premiums and how life insurance proceeds might affect the taxation of your death benefits.

If you’re a member of a public offer fund, it’s important to check what insurance you’re signed up to and assess whether you’re getting value for money. Many members are signed up for insurance on a default (opt-out) basis, and may be unaware they’re paying for duplicate policies across multiple accounts or unnecessary coverage as part of a bundled arrangement.

Dispute resolution

What happens when you’re not happy with the trustee of your fund?  Perhaps your claim for benefits has been mishandled, or the trustee has made an error?  Members of public offer funds can complain to the Australian Financial Complaints Authority (AFCA), a free dispute resolution service that has the power to make binding decisions in order to resolve your matter.

However, dispute resolution is an entirely different matter for SMSFs. SMSF trustees may complain to AFCA about financial services problems with third parties (eg. an insurance company), but AFCA can’t hear a complaint about the decision or conduct of other SMSF trustees.  Similarly, potential beneficiaries of a deceased member’s death benefits cannot complain to AFCA about how the trustees have paid out the benefits.

In these cases, the parties would need to go through the legal system to resolve the matter.  The SMSF’s governing rules may outline dispute resolution procedures that bind the trustees, so it’s worth giving this some thought in advance to be as prepared as possible for any disagreement.

Weighing up your super options?

When considering if an SMSF is right for you, it is essential that you seek advice from a licensed financial advisor.  Catalyst Financial has associations with a number of financial advisors who can assist in the decision making process, and of course we can answer your questions relating to the process for establishing an SMSF as well as the tax and compliance obligations of SMSFs.

Contact our office to start exploring whether an SMSF can help you achieve your retirement goals.