Previous Blog Posts For SMSFs

Bellmont Featured in Strategic Super Investor Magazine – Autumn

Bellmont Research Team —  March 8, 2013

This article is part two in a four part series. To read the part one please click here.

In this case…

The Strategic Super Investor has provided three professional SMSF advisors with different investor scenarios to manage for 12 months. In our Summer issue, they allocated a portfolio according to the circumstances of their particular case. This month they track their portfolios, comment on performance and adjust if necessary.

Simon Headshot
In the last edition I examined the scenario of John and Jane Brown, who were looking to invest $400,000 from their SMSF into Australian equities. To recap: we formed a base for our investing by examining the current economic environment and the key long-term underlying issues of debt and demographics. I then introduced the buy-write strategy as an alternative investment strategy for many retirees as a way to generate a steady income stream and have exposure to capital appreciation of shares, while lowering their overall risk profile. Based on extensive long-term research undertaken by SIRCA and the CMCRC, the buy-write strategy using index options produced the following results:

• Outperformance of the ASX 200 Accumulation Index (ASX 200 including dividends) by 2.23% p.a. during periods of bull markets, bear markets and sideways markets.

• Total risk (standard deviation) of the buy-write portfolio is smaller than the total risk of an underlying index

• The risk-adjusted return of the buy-write portfolio, as measured by the Sharpe Ratio, outperforms the risk-adjusted performance of the index portfolio: 0.168 versus 0.067. That is, the buy-write portfolio is able to generate additional performance while at the same time lowering your overall risk.

Now that we have formed our strategic approach for investing the $400,000 for John and Jane, I will focus on the breakdown of the portfolio structure and holdings. Before I get started on the portfolio holdings, it is worth making a quick note about the current performance of the three major asset classes of shares, property and cash. Last calendar year the ASX 200 increased 14.60% (not including dividends), property prices of the eight Australian capital cities dropped -0.4% with an average rental yield of 4.2% for houses and 4.9% for units*, and the cash  rate is now 3.0%. Many investors have been underweight in equities and overweight other assets for a long time as an aftereffect of the GFC. However, it is important to remember that diversification and having a balance across asset classes will help smooth out your returns over the long run.

* Data as per RP Data-Rismark December Hedonic Daily Home Value Index Results, released 2 January 2013

Portfolio Construction

The Buy-Write Portfolio consists of a portfolio of stock and index call options. The ASX 200 index call options are sold over the top of the portfolio to generate income and lower risk.

For the options to lower risk (while generating income) the portfolio must have a high correlation to the ASX 200 index; without a high correlation the options will add risk. For an individual client it does not make sense to get this correlation by holding every stock in the top 200, as this would generate large brokerage costs while some holdings will be so small that it wouldn’t make it worthwhile. This issue could be overcome by purchasing a top 200 managed fund or ETF; however, there are three obvious problems in doing this.

First, the management fees would impact the returns.

Second, if you use a managed fund you would be buying into their existing tax obligations.

Lastly, not all funds or ETFs pass on the full benefit of dividends and the franking credits, which are vital for SMSF investors.

To overcome these issues and to ensure there is a high correlation, the Bellmont Buy-Write Portfolio matches the sector weightings of the ASX 200. For example, if the financial sector represents 39% of the ASX 200 Index then the portfolio will hold 39% of its stocks within the financial sector. Once the weighting is in place we then hand pick the stocks within that sector that we wish to hold. While we are limited to the sector weightings of the ASX 200, we still have the ability to stock pick within that sector and hold the best companies within each area of the market. Currently we have 22 stocks that make up our portfolio holdings.

Beta and Alpha

It is worth considering the Buy-Write Portfolio as part of an investor’s overall investment portfolio and how it impacts beta and alpha.

Beta is the measure of volatility between an investment and the underlying market; that is, how the investment performs when the market moves up and down. A beta of 1 indicates that the investment will move in line with the market. A beta of less than 1 means the investment will be less volatile than the market, for example if the beta of a portfolio is 0.5 then if market moves up 2% the portfolio is likely to only be up 1% and vice-versa: if the market is down 2% then the portfolio will be down only 1%. A beta of greater than 1 indicates the investment will be more volatile than the market. For example if the beta of a portfolio is 1.3 and the market moves up 2% then the portfolio is likely up 2.6% and vice-versa: if the market is down 2% the portfolio is likely to be down 2.6%.

Alpha is a measure of performance compared to the risk-reward profile of the investment. For example an alpha of 2.0 would mean the investment has outperformed its benchmark by 2%, and vice-versa an alpha of -2.0 would indicate an underperformance of 2% against its benchmark. For managers to generate positive alpha they usually have to take on more risk. An investor will look to add positive alpha (outperformance) to their portfolio, but will limit their exposure due to the added risk.

During the construction of the equities component of an investment portfolio many financial advisors and investors will look to balance their holdings between a portfolio, fund, LIC or an ETF that provides them with beta while then adding smaller components of alpha through more targeted strategies.

The nature of the Buy-Write Portfolio means that as an investor or advisor you will be obtaining beta, because the portfolio has a very high correlation to the ASX 200 while the option provides alpha and this is achieved with lower risk (volatility) than a standard managed fund, ETF or LIC that is used for obtaining beta. For John and Jane Brown, given they are in their late 50s and are not searching for large growth, the Buy-Write Portfolio will sit nicely with their overall investments as it will provide them with beta and alpha at lower risk.

Strategic Super Investor Autumn 2012SSI Feb 13 pg1SSI Feb 13 pg2

 

You can read previous editions here.

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Bellmont Featured in Strategic Super Investor Magazine – Summer

dmontuoro —  December 20, 2012

In this case…

The Strategic Super Investor has spoken with three SMSF professionals and provided each advisor with a different SMSF investor scenario. We asked them to allocate a portfolio according to the circumstances of each case. In each issue for the next 12 months, SSI will track each portfolio and our expects will comment on performance and adjust asset allocations where appropriate.

Simon Says

Simon Headshot

John and Jane Brown are in their late 50’s they have both recently retired and have approached me saying they wish to invest in Australian equities using $400,000 from their SMSF. They have a long term time frame and have a conservative risk profile. Before launching into any stock selection I believe it is vital to understand the current economic environment and then ensure you have the right strategy to meet your objectives. Many investors jump straight to the stock selection and end up having a scattered portfolio with no real strategy defining their investment selection.

Current Environment

Looking firstly at the current economic environment, I believe there are two key long term economic trends that are going to affect the equity market for many years. That being debt and demographics. We are all well aware of the current debt situation in Europe and the fast approaching “fiscal cliff” in the United States.

While our government balance sheet is the envy of most Western economies our household balance sheets are highly indebted.

However, Australia also has a significant debt problem. While our government balance sheet is the envy of most Western economies our household balance sheets are highly indebted. The current debt to income ratio as quoted from the RBA sits at approximately 150%, one of the highest in the developed world. Over the past 20 years this has risen four-fold as households around Australia took on more liabilities; as we accumulated this debt it fueled economic growth and asset prices went through the roof. However, we have reached a tipping point, where this debt has become unsustainable. We are now starting to see households paying down their mortgages, credit cards and increasing their savings; this deleveraging is occurring worldwide and while increasing debt pushes up asset prices, unwinding debt has the opposite effect in suppressing asset prices.

Demographics

While global debt issues have been highly publicised, the second long term economic trend of demographics has not received near as much attention but is likely to have just as big an impact over the long term. In Australia, as in most Western nations, we’ve got an ageing population. The significant ageing population has been brought about by two factors: the explosion in population growth post World War Two, namely the baby boomers – those people born between 1946 and 1960, and the decline in birthrates since the introduction of the contraceptive pill in the 1970’s.

The economic trend of demographics is likely to have just as big an impact over the long term.

In 2011 we entered the period where the proportion of working age Australians who are actively contributing to some form of economic output is about to decline substantially as the first of the baby boomers (those born in 1946) reach retirement age. On top of the drop in economic output, domestic consumption is likely to drop significantly, as retirees spend on average much less than younger households.

Given the long term economic trends of debt and demographics it’s highly unlikely that investors will obtain the sorts of returns that were achieved in the lead up to the GFC when for many, investing was as simple as purchasing an asset and watching it increase in value. Looking at the Australian equity market since the end of September 2009, the S&P/ASX 200 Accumulation Index (the ASX 200 including dividends) has had a very mediocre return of 5.64%*. In order to generate reasonable returns across all asset classes, but especially in equities investors need to have an intelligent investment strategy and be disciplined in its implementation.

The buy-write strategy

As it is unlikely that capital appreciation is going to be the main driver of returns, the standard index portfolio, index tracking ETF or managed fund is not suited to this new investment environment. Instead we are focusing on generating additional income and growth through the use of index call options to substitute the lack of capital appreciation and reduce risk. By incorporating an index option over our portfolio we are agreeing to cap potential capital gains in a particular period, in return for certain income. The income generated cushions against share price falls and enhances returns in slowly falling, sideways, or slowly rising markets.

This approach to investing has been around for many years and is known as the buy-write strategy. While it is common among investors to adopt this approach using individual stocks and stock options, it has generally had a poor performance due to high transaction costs, lack of liquidity, and limited diversification. However, by slightly tweaking the buy-write strategy to incorporate a portfolio of stocks and writing index options (instead of individual stock options), many of the shortcomings associated with the buy-write are easily overcome.

The buy-write portfolio using index options is not a new strategy; numerous academic studies have been undertaken examining the success of the buy-write portfolio strategy from both a return and risk perspective. The most applicable study for the Australian Market was a paper released in 2004 by SIRCA and the Capital Markets Cooperative Research Centre (CMCRC) which examined the buy-write strategy involving the purchase of a portfolio underlying the S&P/ASX200 and simultaneously writing just-out-of-the-money S&P/ASX200 call options. The study looked at a 15 year period from 31st December 1987 to 31st December 2002 and produced some key results including the following:

  • The buy-write portfolio outperformed the S&P/ASX 200 Accumulation Index by 2.23% pa
  • Total risk (standard deviation) of the buy-write portfolio is smaller than the total risk of the portfolio – 5.78% vs 6.15%
  • The risk-adjusted return of the buy-write portfolio, as measured by the Sharpe Ratio, outperforms the risk-adjusted performance of the index portfolio – 0.168 vs 0.067

In summary

“The results confirm that the buy-write strategy generates a higher return than the index portfolio, and the standard deviation of returns on the buy-write portfolio is less than the standard deviation of returns on the index portfolio. On both a total risk and beta-risk adjusted basis, the buy-write strategy outperforms the index portfolio.”

On the back of the study produced by SIRCA & CMCRC the ASX introduced the S&P/ASX200 Buy-Write Index, XBW, which tracks the performance of writing index calls against the S&P/ASX200 Accumulation Index. While you cannot invest directly into the index, it is a tool that enables investors and advisers to independently track the performance of the buy-write portfolio strategy. Since the 1st of July 2004, the inception date of the index, to the 1st July 2012 the XBW has outperformed S&P/ASX 200 Accumulation Index by 36.73% during this period.

At Bellmont Securities we have taken the theory of the buy-write portfolio and applied it in practice with great success. The portfolio has generated a performance of 40.50% since inception*. As the world enters a fundamentally different investment environment of continual low growth and high unemployment, underpinned by substantial debt issues and an ageing population, investors must adapt their strategies. For Mr & Mrs Brown I would be advising the Bellmont Buy-Write Portfolio for their investment strategy. In this article I have examined the current economic environment and strategy that would be applicable for Mr & Mrs Brown, in the next edition I will focus on the breakdown of the portfolio structure and holdings.

This article is part one in a four part series. To read the part two please click here.

*All returns are before fees, not including franking credits (except for the BHP Buyback – Jun11); Inception date is July 23rd 2009; Returns up to 30th June 2012 are for the Bellmont Direct Accounts. All subsequent returns are from the Bellmont Managed Accounts; Past performance is no guarantee or reliable indication of future returns.

Strategic Super Investor Cover Dec 2012Strategic Super Investor Dec 2012 pg1Strategic Super Investor Dec 2012 pg2Strategic Super Investor Dec 2012 pg3

You can read previous editions here.

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The Yield Gap

Bellmont Research Team —  November 7, 2012

Many investors have been squeezed on their term deposits with the best 12 month deposit currently being offered by the major banks only yielding 4.45% (see table below). This is creating a significant yield gap between cash and equities and we are starting to see money move out of cash into equities to lock in yield with many investors happy to pick up dividends even if there is no growth in the stock.

The below chart shows this yield gap with the cash rate (white line) vs the dividend yield of the ASX200 not including franking credits (green line).

div-vs-cash-cut-2

Source: Iress

12 Month Term Deposit Rates

BankInterest Rate
Macquarie4.45%
ANZ4.35%
Commonwealth4.35%
NAB4.40%
Westpac4.35%
  • As at 2nd November 2012
With the Bellmont Buy-Write Portfolio we have been adding additional income on top of the dividends with the use of index options. The average annual income yield from the Bellmont Buy-Write Portfolio is 9.54% more than double the highest paying term deposit rate. This does not include franking credits.
PeriodBellmont Buy-WriteASX 200 Accumulation IndexRelative Performance
3 mths1.68%8.15%-6.47%
6 mths3.52%15.66%-12.14%
1 yr (pa)9.25%19.97%-10.72%
2 yrs (pa)6.14%6.35%-0.21%
3 yrs (pa)7.48%5.52%1.96%
Since Inception (pa)11.59%12.04%-0.45%
  • Data current as at 31st October 2012
  • Returns are before fees, not including Franking Credits (except for BHP Buyback – Jun11)
  • Returns up to 30th June 2012 are for the Bellmont Direct Accounts. All subsequent returns are from the Bellmont Managed Accounts
  • Past performance is no guarantee or reliable indication of future returns
With more rate cuts predicted the yield gap is likely to close quickly, to speak with an adviser about the Bellmont Buy-Write Portfolio please call 1300 368 395
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Property & SMSFs: Loosening The Rules

Bellmont Research Team —  February 8, 2012

If your SMSF has borrowed money (or is thinking of borrowing money) to acquire ‘bricks and mortar’ property then there are a few things you need to know.

A new ATO ruling released last month helps to clarify what you can and can’t do with property that is under a limited recourse borrowing arrangement (LRBA).

The ruling addresses three key areas:

  • Under the borrowing rules in the Superannuation Industry and Supervision (SIS) Act, the borrowing must be used to acquire a “single acquirable asset.”  The ruling seeks to define what constitutes a single asset.
  • The borrowing rules allow an asset that is held under a borrowing arrangement to be improved, however, the trustees cannot use borrowed funds to make the improvements. There is a fine line between what is a repair or improvement and the ruling attempts to clarify how the ATO assess the difference between these terms.
  • Also, if you do improve the property, any improvement must not result in the asset becoming a different asset.  The ruling looks at the factors the ATO considers, and what your SMSF auditor needs to consider, when they assess whether a property has been changed to such an extent that it is no longer the same asset.

If a fund falls outside of these rules, the fund must sell the asset.  Imagine having to sell a property your fund recently acquired, leaving your fund with the stamp duty, legal and agent’s fees (or perhaps making a loss because the market conditions were not as good as they were when you purchased the property).

Is the property a single asset?

Assuming the fund is able to purchase the asset, the borrowing rules require that the money is used to acquire a single asset.  For example, if the fund purchased a block of units, is the block considered to be one asset or are each of the units inside the block individual assets?

In the ruling the ATO concedes that “it may be possible … that the trustee is acquiring a single object of property notwithstanding that it is comprised of two or more proprietary rights. However, this will only be so where … the separate proprietary rights is distinctly identifiable as a single asset.”  The bottom line is that if the rights can be dealt with separately, then they are not a single asset regardless of how the trustee wants to treat them.

Common examples include:

where the fund acquires a property and the car park is held on a separate title but laws do not allow separation of ownership then there is a single acquirable asset.

where a warehouse is constructed on multiple titles, then there may be a single acquirable asset

Maintenance, repair or improvement?

There has been confusion in this area as ‘maintaining’ ‘repairing’ and ‘improving’ are common terms and not defined in the legislation.  In the ruling, the ATO states:

  • Maintaining generally means work done (or in anticipation) to prevent defects, damage or deterioration of an asset provided that it merely ensures the functional efficiency of the asset is maintained in its present state.
  • Repairing generally means remedying or making good defects in, damage to, or deterioration of, an asset and contemplates the continued existence of the asset.  The ATO goes on to state that “an asset may be acquired in a state in which a part of the asset is defective, damaged or suffering some deterioration of what would be considered to be its normal level of functional efficiency. Restoration of that part of the asset to its functional efficiency would be a repair for LRBA purposes.”

The ruling seems to suggest that the repair needs to bring the item back to its original condition but not go beyond that.  The cost of the repair in the context of the overall asset is also likely to be a factor in the ATOs assessment of whether or not what has occurred is repair, maintenance or an improvement.

Defining improvement remains a grey area as it is a matter interpretation whether something is merely repaired or maintained or has been improved.

Can you improve a property?

Trustees can use money provisioned under a borrowing arrangement to maintain or repair the property but not improve it.  If the trustees use money from other sources outside of the borrowing, they can improve the property as long as the improvements do not turn it into a different asset.  For example, if the fund borrows money to acquire a vacant block of land and then builds a block of units on it, the asset would be fundamentally changed and considered to be a different asset.

If the fund does not have to borrow money to acquire the property, then the property can be improved as long as the investment decisions are in line with the funds investment strategy (don’t forget to minute key decisions) and all other SIS requirements are met – note there are some traps when using related parties to carry out the improvements.

Property and natural disasters

Trustees can now take some comfort in knowing that they can rebuild an asset that has been destroyed by flood or fire and not breach the borrowing rule.  Using an insurance pay-out in these cases to rebuild what is essentially the same asset that existed prior to the event seems to be allowed.

Get advice!

Despite the clarifications offered by the ruling, the borrowing rules remain complex and rely on subjective decision making.  Trustees should ensure that they seek advice before purchasing, renovating or changing any property held by their fund.

Alex Novello & Grant Moss - Beaver Novello Moss

 

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Superannuation Strategies for the Wealthy & the Wise – Part 2

Bellmont Research Team —  January 6, 2012

My last article was about some of the treasures that superannuation can offer both retirees and pre retirees (of any age). This month I have continued that article, with another selection of superannuation tax treats!

Transition to Retirement

The transition to retirement provisions came about as a result of the need to supplement the income of people wishing to semi-retire. The provisions allow anyone over their preservation age (currently 55) to roll over their super to a Non Commutable Allocated Pension. They can then draw an income from their pension, up to a maximum of 10%, and also subject to a minimum amount. By salary sacrificing to superannuation, and then replacing your income by drawing a monthly pension, those on tax rates of 30% or higher may be able to reduce the total tax payable.

  • Rolling over to pension changes the tax on the fund earnings from 15% to zero
  • Taking income from a pension (instead of salary) potentially reduces income tax.

There is software available where we can calculate not only your potential tax benefit, but also at what point you can equalise your income, thereby allowing your tax benefit to accumulate as a retirement benefit in your superannuation fund. This strategy is most effective for those with high incomes, high superannuation balances and those aged 60 or more. It may also be effective for anyone over 55 who is still working.

Insurance inside Superannuation

It is common for me to meet people who have cash flow issues, particularly since the Global Financial Crisis. One of the things they decide that they can no longer afford is personal insurance. The problem with this thinking is that if you can’t afford the insurance, then how will you cope if you cannot work for say, six months, and have no income protection? This happened to me years ago, and was not a pleasant experience.

For many people, the best place to hold your personal insurances (life, total and permanent disability and income protection) is inside superannuation. This means that you are not paying for it from your personal cash flow. As long as there is sufficient value in the super to fund the cost of the insurance premiums, then the cash flow problem of paying for the insurance is solved.  The cost is sometimes less inside superannuation than outside, and if you are eligible to make deductible contributions to super, you can pay for your insurance with pre tax dollars.

Large Superannuation Contributions

I have met a number of clients with large lump sums who want to get as much as they can into superannuation. This happened in June this year and my strategy was as follows:

  • Make a concessional (tax deductible) contribution to super before the end of June – the maximum is $25,000 if you are under age 50 and $50,000 if you are 50 or over (subject to work test if you are over 65, and ability to contribute ceases at age 75)
  • Contribute $150,000 as a non concessional (not tax deductible) contribution before the end of June
  • Make another concessional contribution in July up to the maximum ($25,000 or $50,000)
  • Contribute $450,000 (non concessional) in July

This allows you to contribute up to $700,000 into superannuation in the space of a few weeks. For a couple over the age of 50, this increases to $1,400,000. It is important to get advice before you contribute. If you get the timing wrong, e.g. pay the $450,000 at the end of June, then you will not be able to make a non concessional contribution (without penalty) for the next two financial years.

Superannuation and Estate Planning

Estate planning is one of those issues that in spite of the fact that most of us don’t want to address it, it won’t go away. We all need to ensure that our assets go to our nominated beneficiaries, and that they are distributed in a tax effective manner. A lack of planning could well result in a boon for the tax office, and less for those we love.

Superannuation can allow for tax effective estate planning. Super is particularly effective if left to a spouse (includes de facto/same sex spouse, interdependency relationship and financial dependant) or minor child (under age 18). There is no lump sum tax payable on the proceeds from a superannuation policy, and if left as a pension to minor children, they are taxed at adult rates. As well as this, a pension when paid to a pension dependant (includes all those listed above) receives a 15% rebate on the income. Let’s look at an example:

If Jack (age 10) receives a pension of $40,000 per annum from his mother, Jill, who died at age 40, how much tax will he pay? We are assuming no tax free portion. It is also important to note that Jack will pay adult tax rates, which are much more generous than child tax rates.

Pension: $40,000

Pension Rebate 15%: $40,000 x 15% = $6,000

Tax on $40,000: $6,000

Tax payable: $6,000 – $6,000 (rebate) = Nil tax payable.

This pension can only continue until Jack turns 25, and then it must be commuted to a tax free lump sum.

There are still a whole host of benefits that super can offer that I have not discussed here. If you have any questions, please send them in and I can answer them in my next article. Of course, for a comprehensive analysis of your own financial position, nothing beats professional advice.

Janne Ashton – Plan Protect

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Superannuation Strategies for the Wealthy & the Wise – Part 1

Bellmont Research Team —  December 6, 2011

Superannuation is a topic that most people have a definite opinion on – they either love it or they hate it. You have probably already put yourself into one of the camps while you are reading this. My purpose here today is to explain to you why superannuation is a particular favourite of mine, and how it can be used to best advantage. To disregard superannuation because of the regular (and sometimes misleading) bad press it receives may mean that you miss out on benefits which are just not available elsewhere. The examples below show how you may be able to use superannuation to:

• Eliminate income tax in retirement
• Eliminate capital gains tax in retirement
• Offset capital gains tax at any age
• Have your contribution matched by the government
• Have a tax effective income from superannuation whilst you are still working

In my next article, I shall have case studies showing how you can use superannuation to:

• Minimise tax on your income whilst saving for retirement
• Contribute $700,000 (per person) to superannuation within a week or so
• Reduce the cost of personal insurance
• Use superannuation in estate planning to minimise tax when passing assets to beneficiaries

Some clients were referred to me last month who were recently retired. They had previously seen two other financial planners. Both planners correctly advised them to put their inheritance into superannuation and from there to an allocated pension, which gives them both tax free income (they are over age 60) and tax free capital gain. The value of this advice (or of using superannuation): over $3,000 p.a.

They also had a parcel of shares outside superannuation. As they were eligible to make a tax deductible contribution to superannuation, I advised them that they could move their shares into superannuation; claim a tax deduction on $50,000 of contributions to superannuation (in this financial year and next), which was enough to get rid of the capital gains tax on the shares as well. This will get their entire portfolio into a tax free environment within 13 months. The value of this advice: $55,000 in capital gains tax (CGT reduced from $55,000 to zero) plus $6,000 p.a. in reduced (to zero) income tax. This is over and above the $3,000 p.a. in the above paragraph.

When you take into account that their life expectancy is over 20 years, the value of this advice goes into the hundreds of thousands of dollars. And none of this could be achieved without superannuation. Where else can you get both tax free income and tax free capital gain? You can get tax free capital gain from your own home, but once you start earning an income from it, e.g. if you rent out a granny flat, then you must pay tax on the income and also on the capital gain derived from that portion of the building.

So, superannuation is great for retirees. But what about those who are still working? Well, there is good news for you too. How would you like a 100% guaranteed return on your investment? For those who qualify, the government will match your contribution to superannuation up to $1,000. This is only on personal contributions on which no tax deduction has been claimed, and is means tested based on your total income before deductions.

Another benefit available from superannuation is the ability to take an income whilst still working if you are over your preservation age (55 for those born prior to 30th June 1960, and increasing each year to 60 for those born 1st July 1964 and later). This strategy can be used to legally reduce your income tax, and also the earnings tax on your investments inside the superannuation environment.

Bear in mind too, that the negative press about superannuation is generally in regards to investment returns. Superannuation is not an investment style; it is a tax effective method of holding investments. You may have superannuation that is invested in cash, fixed interest, shares, property, or a mix of these. It is certainly not necessary to have superannuation invested in shares. So take advantage of the tax treats, and arrange a mix of investments that suits your present and future needs.

The rules regarding superannuation are extremely complex, so it is important to obtain advice to see what strategies are available to you. The examples mentioned here are specific examples of how I have helped particular clients, and are not applicable in all situations. There are of course, other strategies not mentioned here which may be advantageous to you. Give your financial year a positive start by finding out how you can benefit from the tax treats offered by superannuation.

Janne Ashton – Plan Protect

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The Key Benefits of SMSFs

Bellmont Research Team —  November 9, 2011

The key benefits or advantages of an SMSF are control, flexibility, taxation benefits, cost savings and estate planning opportunities.  SMSFs are typically used by small business owners, professionals and high net wealth individuals, all of whom want more control over their superannuation money.  The 2011 inaugural annual study of SMSFs by the SMSF Professionals’ Association of Australia (SPAA) and Russell Investments revealed that 71.2% of SMSF trustees highlight ‘control over their investments’ as the key driver for establishing a SMSF then ‘control over their future’ and ‘flexible tax benefits’.

(1)      Investment control and flexibility

Members of an SMSF have much greater involvement in the fund’s investment decisions and the rules allow them to select specific investments and tailor their own investment strategy thereby giving them a high degree of control over the fund’s investment portfolio.  The investment strategy of an SMSF can be changed from time to time to suit specific member needs and changing economic circumstances and to take advantage of any current investment opportunities.

Specifically, many SMSF trustees prefer to invest directly by purchasing shares, interest bearing securities and real estate as they believe that their decisions can produce better returns than professional superannuation fund managers.  In contrast, members of retail or industry funds have little (if any) control over specific assets, only broad asset categories.

SMSFs are also in a unique position as they are able to acquire certain investments from members which are not available to large corporate, industry or retail superannuation funds.  For example, a SMSF can acquire business real (commercial) property from members and related parties.  This can provide a number of taxation advantages for a client who is able to transfer commercial property they own to the SMSF.

Traditionally, there have been very strict prohibitions on superannuation funds borrowing money.  However, in 2007 the regulations were changed to allow SMSFs to borrow to purchase assets such as property and shares opening up a number of tax planning opportunities for SMSF trustees.

(2)      Tax efficiency

SMSFs are treated exactly the same way as all superannuation funds for tax purposes.  The tax rates for superannuation funds are shown in the table below:

Type Superannuation fund (phase)
Accumulation Pension
Income 15% 0%
Capital gains 10% 0%

 

However, SMSFs obtain tax efficiencies through the control and flexibility over investments so that buying and selling can be timed to ensure the greatest tax benefit to the fund. The decision to incur assessable capital gains rests with you. Positions can be held long enough to obtain favourable capital gains treatment.  For example, trustees can construct and manage a portfolio of assets for the very long term in order to defer any capital gains until pension phase.  This involves holding high capital growth investment assets during accumulation phase and then selling them upon commencement of a pension at which point no capital gains tax applies.

Undoubtedly, these concessions are incredibly generous and savvy trustees can reap huge taxation savings from them. SMSFs have a distinct advantage over their retail funds because the trustee role affords them the increased flexibility in the timing of asset purchase and disposal allowing them to tailor their portfolios to maximise tax efficiency and ultimately their member balance.

Finally, given the current tax rates of 30% for companies and 15% for complying superannuation funds, a tax benefit arises where tax can be partially or fully offset through the derivation of franking credits.  SMSF trustees can use franking credits to offset against tax on any income with any excess credits being refundable to the fund.  Many SMSF trustees invest in safe, solid dividend paying companies where the companies’ capacity to frank dividends on an ongoing basis is secure.

This taxation benefit is available to all complying superannuation funds however is skewed towards SMSFs who have greater potential to reap the benefits than retail funds through increased investment flexibility.  This agility allows SMSF trustees to specifically target fully franked dividend paying companies as investments thereby significantly reducing tax on contributions and earnings via the effective use of franking credits.  Conversely, members of retail funds have limited or no control over the level of franking credits they may earn because it is the fund’s portfolio manager who decides what investments to make.

(3)      Cost savings

An SMSF may be more expensive than a retail or industry fund if the SMSF holds minimal assets.  The ATO and ASIC have indicated that it is probably not cost-effective to have a SMSF with assets of less than $200,000.  However, members of retail and industry funds are usually subjected to a myriad of fees many of which fluctuate in direct proportion to their fund balance e.g. entry/exit fees, ongoing management fees, and advice fees.  In contrast, the costs associated with running an SMSF are usually quite transparent and are directly related to the advice and services provided e.g. investment or tax advice, administration, actuarial and audit services.

Rather than percentage based fees, the establishment and recurrent costs of an SMSF are usually flat dollar amounts and therefore form an ever diminishing proportion of total fund expenses as the value of the fund increases.  Furthermore, the compounding effect of cost savings reinvested by the fund can increase the amount of superannuation assets accumulated over the long term.

(4)      Estate Planning opportunities

SMSFs can provide an effective estate planning vehicle which retains investments that may be used for the benefit of future generations.  By introducing younger generations as members of a SMSF and with prudent contribution strategies, it may be possible to build up the fund to provide cash benefits to older generations and preserve assets used in the family business such as commercial real estate.

Is it too complex?

There is no denying that superannuation is complex and performing all the administrative, investment and trustee functions associated with an SMSF yourself is a daunting task. However a professional administrator can help you with the trust deed, fund establishment, actuarial services, statutory obligations, fund reporting, trustee obligations, administration, taxation and audit services. For an active investor who is concerned about their investments but may not have the time, desire or skill to administer their SMSF the job can be made relatively simple.

 

Michael Fogarty and Rodney Brown - Catalyst Super

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SMSFs – Flexibility & Options

Bellmont Research Team —  October 10, 2011

The world of Self Managed Super Funds (SMSFs) is evolving dynamically and changing rapidly, the size of the SMSF market and the rate at which new funds are forming is staggering. The flexibility and options available to SMSFs is a key driver in why the SMSF sector has continued to perform in the face of the global financial crisis. I receive calls every week from clients asking about facts and myths about SMSFs, some questions are scary and some are entirely well thought out – what is clear amongst the barrage of questions and answers is that people are very attracted to the flexibility which SMFSs offer. Gone are the days of the three investment options offered by the retail super providers – SMSFs can provide members  ways to invest which may help their children or help widowed spouses in the future.

Non Geared Unit Trusts

Non Geared Unit Trusts are an increasingly popular way to co-invest with your SMSF to purchase property or shares. The non geared unit trust allows for a range of short term and long term financial and taxation benefits for both the SMSF and the individual member when purchasing an asset.  Non geared unit trusts offer advantages on cost, compliance and purchasing power when considering assets such as property – residential or commercial. Members can co-invest with their SMSFs into a unit trust, depositing money into the Unit Trust bank account which uses the available funds to purchase a property or other allowable asset.

The unit trust is owned by the SMSF and member in proportion to the asset value.  The SMSF receives its portion of the income from the asset which is taxed at the 15% rate and the member receives his or her share of the income which is taxed at their marginal rate. This investment strategy can help people who need added disposable income, who wish to use the strategy as a negative gearing tool or simply want to enter the property market and utilise the capital available in the SMSF. The SMSF can continue to purchase units from the member and over time purchase the entire unit trust so that it is held entirely within the SMSF, allowing the member a flexible and staged approach to sell the units to the SMSF, members can salary sacrifice or use their super guarantee payments to purchase units from themselves. This method presents a cost effective and flexible way in which to invest into property. Members can claim interest deductions for their portion of the investment in their personal name and provide some tax relief and further they can control the rate at which they sell the units in the unit trust off to the SMSF.  The non geared unit trust provides an alternative to the traditional instalment warrant structure to those seeking greater tax minimisation and flexibility in their SMSF investing strategy.

unit-trust-senario-4

 Options Trading

Recently, we have received enquiries from a number of our self-managed super fund clients regarding the permissibility of SMSFs to trade in options. Amidst the turbulence in global equity markets, the clients want to implement a hedging strategy by purchasing options over the existing portfolio of shares in the SMSF.

Options are a perfectly allowable investment for a SMSF, subject to the following minimum conditions:

  • Ensure that the fund’s trust deed does not prevent an investment in options. Most standard deeds generally state that the SMSF is allowed to invest in any investments that are allowed by the Superannuation Industry Supervison Act 1993 (SIS Act) and Regulations 1994 (SIS Reg). As such, options would be allowable unless the trustee have specifically inserted a clause to exclude them. However, please check your deeds and obtain professional advice.
  • Ensure that the fund’s written investment strategy permits the SMSF to trade in options (SIS Reg 4.09). If it doesn’t, the strategy should be updated to include the provision. For a more meaningful strategy (from an ATO perspective), it would be prudent to include the reasons for the trustees to undertake this investment
  • As options are classified as a derivatives contract under Reg 13.15A of SIS Regulations 1994, it is a requirement for the SMSF to have a Derivative Risk Statement (DRS) in place. The DRS explains the SMSF’s risk management policies when using derivatives.
  • Ensure that the options are held under the name of the trustees and correct name of the fund (SIS Act Section 52(2)d).

The above addresses simple situations such as a SMSF buying and selling options a few times a year. For complex situations such as very frequent trading, offering collateral and complex option strategies, please consult your accountant or financial advisor first.

 

Ridhwan Hannan & Ash Haq - SuperDiligence

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SMSF’s – The Basics

dmontuoro —  April 11, 2011

SMSF’s – What are their benefits?

There are a number of reasons why an increasing number of investors have been turning to self managed superannuation funds (SMSF) as the investment vehicle of choice within Australia over the past few years. SMSF investments total about $390 billion, being almost one quarter of the total superannuation system investment pool. Traditionally employees and investors have preferred to hold their superannuation balances in retail superannuation funds that offer limited control over flexibility and investment choices, a reduced number of taxation planning opportunities and percentage based annual fees. However investors today are becoming increasingly sophisticated and financial advisors are much more active in directing their clients towards establishing an SMSF, utilising their investment flexibility and potential taxation benefits.

SMSF taxation structure

Superannuation is an attractive investment vehicle for investors due to its concessionally taxed environment. A differentiation must be made between assets held in accumulation and pension phase within the SMSF for taxation purposes. A fund member during accumulation phase will pay tax at a rate of 15% on all taxable income (10% where capital gains held for greater that 12 months), whilst in pension phase the member pays 0% tax. Now when you make the comparison to the other investment vehicle options being, companies where income is taxed at 30% or trusts where the income will ultimately be distributed out at the beneficiaries marginal tax rate, you can see the tax effectiveness of holding savings inside superannuation.

What constitutes accumulation and pension phases within an SMSF?

All members will remain in accumulation phase until such time as reaching preservation age, currently age 55, and a condition of release.

From age 55 the member has the option to then commence drawing a pension from their superannuation fund whether they continue to actively work via what is known as a “Transition to Retirement Pension“ or permanently retire from the workplace, through an “Account Based Pension”. Obviously significant benefits can then be achieved through transferring the member’s accumulation balance across to pension phase.

Whilst between 55 and 59 years of age a Transition to Retirement Pension may significantly benefit the net tax position of a member inside an SMSF, it is important to understand that in pension phase a pension amount needs to be drawn from the fund each year. The concessional or taxable component of the member account will form part of the member’s personal taxable income, however a 15% tax offset may be claimed. It is worth noting that inside a Transition to Retirement Pension a member has the option of drawing anywhere between 4 – 10% of the value of their member account at the commencement of the financial period.

Upon reaching age 60 most superannuation fund members will be advantaged by commencing a Pension. In addition to the tax free status of income on assets supporting the pension inside the superannuation fund, all pension amounts withdrawn by the member are now tax free. Keeping this in mind you can see the great benefits in holding investments within a super fund once reaching what we term a “condition of release”

From age 65, or after the member has permanently retired from the workforce, a Transition to Retirement pension will revert to an account based pension. The main difference between the two pension types is the removal of the 10% limit on pension drawdowns each year.

Why should I consider transferring my superannuation money from a retail fund to an SMSF?

An SMSF provides members with a level of flexibility and control that far exceeds any of the other offerings. Your SMSF may directly hold both residential and commercial property and invest into a much wider variety of asset classes and products, including antiques and collectibles that are not possible with a retail fund. Every SMSF must have an investment strategy that is developed and agreed to by all members, but with the flexibility to update and change as their investment focus changes. An SMSF also has the option of leveraging which opens the door to a greater variety of asset classes

Cost is a significant factor when considering retirement savings. Within a retail fund both a husband and wife’s account may pay fees of up to 3% (often hidden) resulting in a combined balance of $500,000 paying management expenses in the vicinity of $10,000 – $15,000 each year, however within an SMSF the same $500,000 balance may only attract annual fees of $2,500 for administration and $400 for audit, with the advantage of remaining relatively constant despite any overall growth in SMSF assets.

Taxation advantages of an SMSF

Investment assets accumulated within an SMSF carrying significant unrealised capital gains can be disposed of free of tax once the member reaches age 55 and commences a pension. Within retail funds it is very common for members to have all investments effectively sold off prior to entering pension phase and of course triggering “unnecessary” capital gains tax prior to commencing the pension. The timing and choice of SMSF investment disposals remains in the hands of its members and their advisers and is crucial in the overall minimisation of tax within the fund.

Income generated on SMSF investment assets is taxed at a flat rate of 15%. Unlike a retail fund where a net investment balance movement is periodically attributed to their members, SMSF investments are directly owned and all income and their various components are retained. All Imputation and franking credits associated with dividends and trust distributions generated by the fund are able to be used to offset any income or contributions tax during the year and excess credits may result in a fund tax refund at year end. Where members are in pension phase most advantage is achieved, as all income and capital gains are tax free and the fund is still able to claim back the full amount of any tax credits generated.

An advantage may be gained due to the difference in timing of tax payments by an SMSF. Any taxable contributions made to a retail fund are reduced by the 15% contributions tax on the date they are received by the fund, hence only 85% of the contribution actually makes the members account. Now compare this with an SMSF where the full 100% of the contribution is available for investment with any tax generally payable at a later date or as far as 10 months after the end of the financial year the contribution is made. By having a member in both accumulation and pension phase the fund may never have to remit any contributions tax to the government due to tax credits generated on income offsetting this amount and the annual net tax position of the fund being a refundable one.

David Petterson - Premier SMSF Solutions

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Contribution Limits & SMSFs

Bellmont Research Team —  March 9, 2011

It has been announced that contributions to SMSFs reduced by 50% last year. One of the reasons for such a large decline in contributions has been identified as the caps on contributions imposed by the ATO.

There are currently 2 types of contributions; non-concessional and concessional.
Non-concessional contributions are generally made to a super fund by or for you in a financial year and are not included in the super fund’s assessable income (for example personal contributions you make from your after-tax income). The current non-concessional contribution cap is $150,000 per year. If you are under 65 years old at any time during the financial year, you may be able to bring forward the next two years of contributions, but certain conditions apply. This effectively allows you to contribute up to three times the cap at once or at any time during the three financial years. There is a tax of 46.5% on contributions made in excess of the cap.

Concessional contributions are generally made to a super fund for or by you in a financial year and are included in the assessable income of the super fund (for example super guarantee, salary sacrificed amounts and any amount you are allowed as a personal super deduction in your income tax return). The current concessional contribution cap is $25,000 per year. This cap will be indexed annually from 2010-11 onwards to average weekly ordinary time earnings (AWOTE) and rounded down to the nearest multiple of $5,000.There is a tax of 31.5% (in addition to the 15% paid by the super fund).

Currently, there is a transitional concessional cap for those who are 50 years old or older on 30 June in a financial year and is available until 30 June 2012 and is not indexed. This cap is $50,000. Any excess of the caps on these contributions will count towards the non-concessional contributions cap.

Clearly the more amount in a member’s superannuation account the more the member will be able to access upon retirement. From July 2012 Treasurer Wayne Swan proposes to lower the contributions limit to $25,000 for all savers, unless they are over the age of 50 and have less than $500,000 in their accounts.

The Self Managed Superannuation Fund Professionals’ Association (SPAA) has made submissions to the government to have the superannuation contributions caps either raised or abolished. It has also submitted that the penalties for exceeding the limits should be modified. SPAA has suggested that the annual contributions limits be doubled to $50,000 for members under 50 years old and increased to $100,000 for members over 50 years old.

So what is a solution that can be implemented now? A possible solution is for the trustee of a self managed super fund (SMSF) to consider borrowing to purchase assets on behalf of the fund. Up to relatively recently it was not possible for a trustee of a SMSF to borrow. Section 67 of the Superannuation Industry (Supervision) Act (SIS Act) provides that an SMSF trustee is prohibited from borrowing, except in specified circumstances. Prior to July 2010 there was doubt as to whether certain instalment share warrants obtained by SMSF trustees breached Section 67.

In July 2010, the government introduced significant changes to the the SMSF borrowing rules. The end result is that the SMSF trustee can borrow to invest in shares, managed funds and property as well as traditional share warrants. It is vital that trustees borrow because such borrowing makes commercial sense and obtain professional advice prior to entering into such borrowing arrangements. A bi-product of such borrowing will enable trustees to acquire assets over and above the assets that can be obtained from contributions. The caps on contributions can therefore be “overcome” by such borrowings.

Although a trustee of an SMSF can borrow to acquire an asset, there are three requirements:

1) The borrowing must be non-recourse. This means that the lender to the trusee cannot have recourse to the assets of the fund but only to the asset which was obtained with the borrowings.
2) The borrowing must be to acquire an asset that the trusee of the fund is allowed to acquire under the SIS Act.
3) The asset must be held by a bare trustee until the loan is repaid.

A trustee should obtain professional assistance before considering borrowing funds under the new rules. There are some restrictions that a professional advisor can explain to trustees.

It may be necessary for the trust deed of the super fund to be updated as the deed may not contain the necessary powers to borrow and to appoint custodians and bare trusts.

The investment strategy of the fund may also need upgrading. Additionally, auditors may require the trustee to upgrade the risk management document.

The new borrowing powers can be exercised by trustees of SMSFs. These new powers are subject to review in two years time. Such review may result in a tightening of the borrowing powers. Therefore there may be only a two year window of opportunity.
I consider that the government has allowed trustees to borrow to address the perception that many members do not have sufficient amounts in their accounts to enable them to retire comfortably. The government is aware that the leverage gained from borrowings can result in a maximisation of “losses” as well as the maximisation of “profits”. Professional advice is therefore paramount for a trustee.

Note that there is an important underlying requirement of a SMSF trustee to always act in accordance with the sole purpose test which is contained in Section 62 of the SIS Act. The sole purpose test requires the trustee to ensure that the fund is solely for one of the three core purposes laid down in the section. Therefore while the new borrowing rules enable additional assets to be obtained, such borrowings should not be undertaken purely to “overcome” the caps on contributions.

I have provided general information in this article and have not taken into account any specific situation. No one should act on the information contained in this article without seeking prior professional advice.

Darryl Nagel
Solicitor
smsf@mywealthyedge.com

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