Tools ... a tailored fund adds control. Illustration: Karl Hilzinger.
More people are putting their faith in self-managed super as they mix and match to create the perfect product for their needs, writes Annette Sampson.
They're the fastest-growing sector of Australia's super industry and in terms of money under management, the largest. But according to their critics, they're sold to people who don't need them, poorly regulated and lack the transparency and accountability of their bigger rivals.
We're talking, of course, about self-managed super funds.
According to the Australian Prudential Regulation Authority, these do-it-yourself super funds managed $393 billion on behalf of 821,000 members in June 2010, or about 32 per cent of the country's super savings. In the nine months to the end of March, 23,561 new self-managed funds were set up (after deducting the funds that were wound up) and membership rose to more than 853,000.
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With an average account balance of almost $500,000, self-managed super funds represent a hefty chunk of the nation's retirement-savings kitty. But what do they have to offer that a well-run public super fund can't?
CONTROL
A key reason for setting up your own super fund is control, says the financial planner for Quantum Financial, Tim Mackay. ''When you're in a public fund and you lose control, you don't feel you're in charge of your financial destiny.''
The technical services director for Multiport, Phil La Greca, says the Cooper review into the super system identified self-managed investors as people who were not only engaged with their super but who wanted to take an active role in the decision-making process.
While self-managed funds were traditionally the realm of small-business owners, he says more employees are setting up their own funds and questioning whether the big super funds have their interests at heart. ''I'm not sure if it's due to the GFC … but people are becoming more cynical and don't trust someone else to resolve conflicts in their favour,'' he says.
La Greca says, as an example, some large super funds have not bothered to apply for compensation for clients who lost money through the Astarra collapse because only a small proportion of their clients were affected. But he says the injustice is that, as well as having missed out on compensation, these investors will be forced to pay their share of the levy to compensate others as well.
COST
There's also a perception that it's cheaper to do it yourself than to invest through a public fund, though this isn't necessarily the case. Australian Tax Office figures show in June 2009 about one in eight self-managed funds had less than $100,000 in assets and one in four had less than $200,000 - often cited as the minimum investment needed for the fund to ''break even'' compared with paying fees in a public super fund.
''You've got to have at least a couple of hundred thousand before you even get to break-even point and that's just the compliance costs,'' says a founding Partner of Matthews Steer Chartered Accountants, Geoff Steer. ''It doesn't include the cost of your underlying investments.''
If you have enough capital to make it worthwhile, however, La Greca says a self-managed fund can give you more control over what you pay for. ''You know what you're buying because you're the one buying it,'' he says. ''You don't have to subsidise the cost of features that you don't use.''
Quantum Financial's Mackay says self-managed funds are able to reduce costs by using products such as exchange-traded funds (ETFs) in lieu of more expensive managed investments. An ETF is basically a low-cost index fund giving exposure to a particular market or market segment, such as resources or financials.
''Self-managed funds are one of the key drivers of ETFs,'' he says. ''They account for 30 to 40 per cent of ETF use in Australia and are the perfect option for tailoring a fund's portfolio. They're like Lego pieces that you can snap together to create an efficient portfolio.''
While he says some of the more-complex ETFs carry more risk, the simpler products are low cost and allow investors to put together a viable alternative to a broader share fund.
Steer says ETFs are often used as the core of a portfolio, with direct shares and other investments adding extra value to the index exposure obtained through the ETFs.
Mackay says even cash investments can be cheaper, because you can invest directly in a term deposit or high-yield account rather than paying fees on a managed-cash or fixed-interest account.
FLEXIBILITY
Flexibility is where self-managed funds can really come into their own.
While a growing number of big funds and platforms are allowing super investors to include direct shares, term deposits and ETFs in their investment mix, self-managed funds still allow investors to access a wider range of investments.
The ability to invest in items such as art and collectables is one but La Greca says investments don't need to be this exotic. ''Even in terms of cash, the range is much broader because you can pick what you want,'' he says. ''You're not limited to an option that someone else calls cash.''
The head of technical at Super IQ, Kate Anderson, says self-managed funds also allow for more flexibility with investment strategies, such as accepting ''in specie'' contributions of certain assets. Rather than selling a portfolio of shares to fund a super contribution, for example, they can be transferred to the fund as a contribution. You get to keep the shares but simply switch to a more tax-effective way of holding them. And while the transfer represents a capital-gains-tax event, Anderson says it might be possible to reduce the tax payable by claiming a tax deduction for the contribution if you're eligible, or using franking credits within the fund to offset your contributions tax.
Steer says the timing of such contributions can also be managed to minimise the tax impact.
He says periods such as now, when markets are depressed, can be a good time to transfer assets into super without taking a big tax hit and future growth will occur in the concessionally taxed super environment.
La Greca says benefits can also be paid in specie, so if you don't want to continue your super fund after retirement, you can transfer the remaining assets to members rather than having to sell them.
Anderson says a self-managed fund also gives you greater control over paying tax. With managed funds, the fund manager decides when to realise capital gains and the turnover of assets can be substantial. With your own fund, you choose when capital gains are to be realised. If you plan to receive a pension from the fund when you retire, she says it is even possible to avoid CGT entirely by deferring selling until you are in the pension phase. More about this later.
Steer says being in control of your super also allows you to look at your finances more holistically. ''Super isn't a separate investment,'' he says. ''It's just a structure. You can have assets in several places and, in terms of things like asset allocation, you can look at it across the board rather than looking at each structure or holding.
''We talk about having assets in three boxes. The first is super, which is by definition a long-term investment. Then there's a cash reserve to meet any short-term needs and investments that you may build up over the long term but they are not locked away and you have the ability to access them.''
DIRECT PROPERTY
A key attraction of self-managed funds for many is the ability to invest in direct property. Steer says properties can be bought outright by the fund, in partnership through a joint venture, or using limited recourse borrowing arrangements (which prevent the lender from claiming on the fund's other assets if the loan goes bad).
He says someone wanting to invest in a $500,000 residential investment unit, for example, could set up an arrangement where the super fund puts in $250,000 and the member acquires the other half personally, using money borrowed against another asset, commonly the family home.
While super funds are normally prohibited from acquiring assets from related parties, Steer says an exemption applies to listed securities (such as shares) bought at market value and business real property - property used for business purposes. This means business owners can free up cash by selling their business premises to the super fund and leasing them back on commercial terms.
Anderson says when you enter the pension phase, the property can be sold or leased to someone else to provide your retirement income.
Recent rules allowing self-managed funds to enter into limited recourse borrowing arrangements, Steer says, have made this much easier, as funds no longer need to have the full purchase price of the property. As long as the borrowings are structured correctly, the fund can borrow part of the purchase price and repay the loan over time.
However, La Greca says it is critical that the borrowing arrangement is structured and run according to the rules. He says it is disappointing the government still has not introduced licensing for advice in this area, because unlicensed operators such as property developers encourage people to set up self-managed funds to gear into property. ''It has the potential to turn into an unmitigated disaster if the government doesn't do something about it soon, '' he says. ''There's the risk of an explosion of people being put into something they shouldn't be in.''
He says a potential problem involves properties bought off the plan. ''When they make the initial payment, what are they actually getting?'' he says. ''Is it a payment on a deferred purchase or is it an option or right to purchase another asset at a set price? If it's the latter it's effectively a replacement asset and won't meet the borrowing regulations.''
RETIREMENT
Anderson says self-managed funds also have advantages as you move into retirement. She says most fund members are not aware that they pay capital gains tax on their investments when they start a pension through the majority of public super funds.
''When you start a pension you usually sell your units in the accumulation fund and switch to the pension fund,'' she says. ''CGT is reflected in the unit price but you wouldn't know it was there.''
With self-managed funds, however, there is no switching funds and therefore no CGT liability. Anderson says this means that if you have built up assets in your self-managed fund, they are, in effect, CGT-free once you move into the pension phase, because pension funds do not pay tax on their earnings.
La Greca says self-managed funds also have more flexibility in structuring multiple pensions (or transition to retirement strategies) because they can all be funded from the same investment pool rather than requiring a different investment pool for each account.
ESTATE PLANNING
Anderson says self-managed funds can also help with estate planning. Take the example of a mum and dad who hold their business premises through a self-managed fund. They need income in retirement but want the property to eventually go to their children.
Anderson says by bringing the children into the fund, the property could be slowly transferred to them via their contributions. ''It's like a never-ending trust,'' she says. ''A lot of people do it that way because when you pass on, your account with other super funds normally ends. But self-managed funds can continue on.''
La Greca says self-managed funds can also allow for more-flexible - and binding - nominations of how your benefits will be distributed if you die. Anderson says there are also 96 responsibilities required of trustees and it is critical to understand what you can and can't do and get good advice.
Warning: DIY not for everyone
While self-managed funds have benefits they are not for everyone, says Geoff Steer, a founding partner of Matthews Steer Chartered Accountants. ''There are a lot of people who have been pushed into them or convinced they're the only way to go and they're often not appropriate because the clients may not have the expertise,'' he says.
''I've also seen people who have set up funds and invested all the proceeds into managed funds, which to me doesn't make sense. It's just doubling up on costs.''
Steer says there are plenty of spruikers who will try to sell you the latest ''must haves'' for your fund.
''There is an army of service providers who profit from the appearance of complexity they create around self-managed funds,'' he says.
''Be cautious of those who promote theirs as the 'latest and greatest' trust deed that 'must be' updated every year; or the 'must have' estate planning for SMSFs; or the 'best' ways of getting property into your SMSF. These bells and whistles come at a significant cost and simply add to the complexity.''
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