On Friday, we ran a story all about how much it costs to start and manage your own superannuation fund.
Now, you can read more detail in this edited extract from veteran finance expert Noel Whittaker’s book Superannuation Made Simple (2017 edition), in which he clearly outlines what it takes to run your own fund as well as what assets you should buy to grow your self-managed super fund (SMSF).
Because the government wants superannuation funds to be run properly and provide adequate information to their members, the main thrust of the regulations is to lay down rules for the trustees’ behaviour and for adequate and regular reports to members.
For example, members of all funds must receive detailed statements of their accounts every 12 months, and be advised promptly of any material changes in the funds that may affect their investments. Funds that have fewer than five members have less rigorous reporting requirements than larger superannuation funds.
Managing your fund is like running a small business.
You have a bank account that accepts superannuation contributions as well as income from the fund’s investments, and pays out items such as fund expenses and benefits to members. Each year you, or your accountant, must draw up financial statements and prepare and lodge a tax return.
The fund must be audited every year and a report sent to the Australian Tax Office, the watchdog for small self-managed superannuation funds.
The bookkeeping is simple and there is relatively little administration to do. Once the fund is going it should be easy to maintain, as long as you keep the records up-to-date and attend to all the duties, such as having regular meetings and sending required reports to members. These jobs are the responsibility of the trustees, who face heavy penalties if they are not done properly. If you run your own fund, and do not do it properly, you may be liable for heavy penalties.
There are restrictions on what the fund can do and on the type of assets in which it can invest. The trustees must ensure any investment made by the fund is sound, is non-speculative, and is producing a commercial rate of return. Furthermore, parties cannot be associated with the transactions.
The following are just some of the assets which a superannuation fund may not invest in:
A superannuation fund may not be involved in carrying on a business because this is regarded as speculative.
If a super fund wants to borrow to buy an asset such as an investment property, it may do so by using a Limited Recourse Borrowing Arrangement (LRBA).
An LRBA means that any recourse the lender has under the borrowing arrangement is limited to the single asset purchased using the LRBA.
Unfortunately, once the rules were relaxed, property spruikers decided the changes gave them a great opportunity to sell overpriced properties to unsuspecting victims and aggressively pushed the strategy of borrowing through self-managed funds.
I agree that conservative borrowing can be a great way to build wealth, but remember that the effectiveness of negative gearing is enhanced by a high marginal tax rate to produce a large tax refund. Even if your superannuation fund is able to borrow, I suggest it would be a poor strategy to go into negative gearing using a vehicle that paid 15 per cent tax at most.
You would be negating the tax benefits. This is why I recommend that you think hard before buying property in the name of your superannuation fund. Surely it is better to buy it in your own name, or that of your family trust, and gain the benefits of negative gearing in the names of the taxpayer with the highest marginal tax rate.
The cardinal rule is that a superannuation fund must pass the sole-purpose test. That is, the sole purpose of the fund must be to provide retirement benefits for its members.
Therefore, the trustee of the fund, probably you, or a company controlled by you, must be able to justify any investment decision to the world at large. Obviously, buying a little beach house in the fund’s name for the purposes of great Christmas holidays would not pass the test.
To read more detail on SMSFs and more, you can purchase Noel Whittaker’s ebook here.