The Key Benefits of SMSFs

posted on November 9th, 2011 by Bellmont Research Team

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’.

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.

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.

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.

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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