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Meg on SMSFs: my own reasons for early SMSF establishment

In a monthly column to assist trustees, specialist Meg Heffron explores major issues relating to managing your SMSF.

I really enjoyed reading this article explaining why the author, Shani Jayamanne, isn’t yet ready for an SMSF. She had lots of good reasons for her decision. So it prompted me to reflect back on some of the reasons I felt I was ready at a similar stage of life and with an even smaller balance. And back then, I did work within the superannuation industry but not SMSFs. I wasn’t an obvious advocate of the ‘do it yourself’ model.

It probably helped that I was married to an accountant who did all the work. That’s a great life hack if ever there was one.

I knew my super balance would increase 

But there were other reasons. Like many others in my age group, I’ve had compulsory super at an ever-increasing percentage of my salary for my whole working life. So even back then, it was clear that my super would become a substantial part of my savings someday.

So I did my research and decided that ‘one day’ I would want to manage my super myself. I didn’t profess to have any great stock picking skills or plan to invest in exotic artwork or gold. My logic was that if I was taking responsibility for my retirement in such a big way, I wanted more control. So the question for me was not ‘if’ I’d have an SMSF, it was ‘when’.

Friction points

I didn’t necessarily want to manage it at that point in time, but I did want to make sure the friction of moving later didn’t cost me too much. At the time I probably only really appreciated one friction point – capital gains tax.

I knew that if I waited too long to move to an SMSF, my super would grow in value and I would incur capital gains tax moving my money when the time came. Would the future benefit of avoiding the tax outweigh the costs of running my SMSF with such a small balance in the interim? Possibly not, but it was a risk I was willing to take. If it didn't work for me, I could wind up the SMSF.

A second important friction point that I didn’t think about at the time was insurance.

Obtaining insurance is cheaper and easier, with fewer medical checks and restrictions, when you’re young, fit and healthy. While the premiums will increase each year, you can keep the same policy in place for as long as you like if it’s set up in your SMSF to begin with.

I recently arranged some life insurance outside my SMSF and it was a shock to see the price compared with the premium I was paying in my SMSF. The cover specifically excluded death or disability linked to my epilepsy which was not diagnosed when I took out insurance in my SMSF, and therefore I was still covered by that original policy. I definitely wouldn’t want to be setting up my SMSF now and trying to find cover. When I needed it, I had much more insurance than I could easily get in a public fund. It convinced me that the earlier the better when it comes to life insurance.

Some people solve this by keeping a small balance in their original public super fund just to keep their insurance running, but that can compromise some great tax planning opportunities that work best if the insurance is in the SMSF.

And there’s one last big reason to get started with your SMSF as early as possible that didn’t even occur to me back in the day. I’ll call it ‘resilience’.

Flexibility to change

If one thing is certain, it’s that things will change. The best public super fund when I set up my SMSF certainly isn’t the best today. It might not even exist. The best investments today won’t necessarily be where we want to put our money in the future, but super is about planning for the long term.

This is where an SMSF works well. You can change absolutely everything about your SMSF, such as where it invests, who helps you look after it, who belongs as members, who provides the insurance, etc, but you can leave the SMSF itself intact. It can change with you. Changes which would be significant in a public super fund can be handled less intrusively in an SMSF.

I’ve had an SMSF since I was in my 20s, starting in the 1990s. In all that time, I’ve never invested in anything as exotic as artwork, gold or crypto. I’ve never borrowed to buy property through my super. But if I wanted to do those things, I couldn’t have used a public offer fund.

I’ve invested in managed funds recommended by my financial adviser. Although some are mainstream, they were not on the menus of many public funds at the time. At the time, new funds often took many years to be added to public funds. In my SMSF, I’ve taken advantage of Initial Public Offerings (IPOs) and investment opportunities such as share buy backs and rights issues. These are common in investing but often not available in a public fund.

Move to pension phase

My fund now pays a pension and that was created instantly without moving assets to a different fund or investment account. My fund is still one investment portfolio and my accountant keeps track of how much is in the pension versus accumulation. Because I’m still working and contributing, the minimum pension payments are financed by my own super contributions. I don’t need to isolate a special cash reserves to pay the pension. In fact, if there were other members of my fund making super contributions, we could even use the cash from their contributions to pay my pension without disadvantaging them.

There are also some investments that I’ve owned for what seems like forever and if I sell them now, part of the capital gains will be exempt from tax (thank you, pension).

All in all, if you think you’re likely to end up in an SMSF ‘one day’, then that day might be sooner than you think.

And then to top it all off for me, just like the Remington electric shaver advertisement of my youth:

“I liked it so much I bought [or in my case, started] the company.”

 

Meg Heffron is the Managing Director of Heffron SMSF Solutions, a sponsor of Firstlinks. This is general information only and it does not constitute any recommendation or advice. It does not consider any personal circumstances and is based on an understanding of relevant rules and legislation at the time of writing.

To view Heffron's latest SMSF Trustee webinar, 'Super contributions unpacked', click here (requires name and email address to view). For more articles and papers from Heffron, please click here.

 

20 Comments
Ramani
September 17, 2022

I have found it impossible to identify suitable APRA funds which would accept 'in specie' transfer of ASX-listed shares from a SMSF during a roll-over, meaning that the shares should be sold in the SMSF and cash remitted to the Public Offer super fund. This raises two issues:
(1) how does one identify APRA funds that will accept shares?
(2) given the ravages of longevity and SMSF members losing their marbles and mental agility, isn't there a policy argument for rollover relief from the CGT liability in the remitting SMSF?

Ramani
September 14, 2022

Meg has been a 'super' muse for many, and her views about starting SMSFs early will resonate with most. An actuary wedded to an accountant apparently works (as is also my case).
Much is written on the pros and cons of SMSFs, the right size, the right attitude, willingness and ability. Sadly not much on when to quit SMSFs, as the ravages of age, relationship and enjoying twilight time without worrying about the ATO and its curious ECPI (sorry about the acronym) rules. Recent publicity on fund rollover rules has thrown some light on the need for ESA and SuperStream (more acronyms).
Members must move when they are no longer able. ATO and others must alert SMSFs to this need. When you can no longer find your spectacles or dentures, imagine the 'pleasures' of responding to TBAR reporting.
It is not a victimless breach when SMSFs default in their obligations, given the huge tax concessions relative to marginal personal rates. Jill Taxpayer is the unrequited victim.
A discussion we really need. I broached it in a joint paper 'SMSFs: the elephnat in the mouse's guise' at the UNSW Reaserach Colloquium (2013), but it went nowhere. Could the marriage to an accountant be the proximate cause???

Meg Heffron
September 14, 2022

What a great idea for a future article - I'll write one soon called "when I will end my SMSF". You're completely right Ramani - we ran a technical session for accountants and advisers a few years ago called "when to hold and when to fold" that was looking at exactly this issue and I'd love to revisit. Nothing lasts forever after all!

Trevor
September 14, 2022

Ramani ! I love it ! Your comments I mean , on the technicalities and acronyms and other "red tape" entanglements ! I have a most enjoyable mental picture of just what an "elephnat ' is [ a combination of a gnat and an elephant !??? ] especially in the "mouse's guise "....that really taxes the imagination ! I guess that "one" would really need to design a much "better mousetrap" to snare an "elephnat" in mouse's guise !???

Ramani
September 15, 2022

Trevor
Lacking your imagination to coin 'elephnat' (like tigon or liger...) with English being my third language, I confess it was a mere typo on my part. Sweet are the thrills of misspelling!
Ramani

John Flynne
September 14, 2022

I started mine in 1969 and have seen some incredible changes firstly a limit on the sum to be put into it and a tax rate of 50% on all earnings above 5% as well as prescribed investments (30%)so I have seen a huge amount of change some of which were good but I would not mind a reinstatement of prescribed investments say 20% which would see Governments have funds to support housing and even social housing and other infrastructure activities all supported by Government guarantee.

Meg Heffron
September 14, 2022

I remember those days John! There was a baseline requirement for all super funds, I think, to hold something like 30% in Govt Bonds (?) of which 20% had to be in Federal Govt bonds? I have often wondered whether modern Governments are aware that we've been there before. In theory we could also achieve greater funding for activities like these if we had tax breaks etc that made it attractive for private capital (including super fund wealth) to be invested there. But paradoxically, super funds (including SMSFs) would have to make sure they could justify any voluntary investment as being in line with the sole purpose test (the requirement that fundamentally all the investments decisions are being made to optimise retirement wealth, not to do good works).

John
September 17, 2022

I am not sure that the sole purpose test would deny my suggestion because the interest rate would be about 5-6 % which is a reasonable return. I realise that this would not be possible in the current market but if it had been implemented over time it would be a reasonable rate of return but what is wrong with looking at it over the long term. Also the question of social/cost benefit should be addressed

Anthony Asher
September 14, 2022

The public offer funds also benefit from IPOs and tax savings when shifting to retirement - and some will give small bonuses when you move to drawdown. Probably not as much as an SMSF though. A significant advantage of the APRA regulated funds is their protection against fraud. My view is that it is naive to think that small investors are going to outperform the large professional teams in the long run. I have never found an SMSF investor who is doing a careful comparison of their performance against a benchmark. If you are not measuring it ... It seems to me that the significant tax advantages come from being able to channel tax deductible rent from your business to the SMSF property, or to put shares in your start-up into a low tax environment. You might also enjoy investing in obscure products. If these do not apply, then it is not worth the effort.

Ramani
September 15, 2022

Anthony's reference to the 'small bonus' on intrafund transfer from accumulation to pension phase can mask a hideous inequity. Funds prudently reserve tax on unrealised gains allocated as a debit to members' balance. On moving intra-fund to pension phase this accounting provision is no longer required and in symmetry and equity should be credited back. Many do not, leveraging member disengagement and the 'black box' which fundwide earnings allocated to member level represents (Note: this is not audited).

Savvy members and their advisers should scrutinise this hidden detriment while moving within a fund.

I was able to query my wife's super on this and negotiated a hefty credit. Another conjugal benefit of the actuary - accountant couple: the money of those brought together by double-entry book-keeping and curtate expectancy of life shall not be denied them by a mere hybrid fund!

Graham Hand
September 14, 2022

To clarify my own understanding of Meg's position on capital gains in large public trusts, I asked the head of the technical department of a leading super fund how it works. He confirmed Meg's view as the unrealised capital gain liability is built into the unit price, so the unit price is lower when a person redeems from a master trust. In effect, the cost of the capital gain liability, although unrealised, is already in the unit price. Treatment may be different for wrap accounts.

H Fenton
September 14, 2022

According to my (bank based) fund, the above issue is the primary reason to favour direct share holdings rather than "units" in any fund. On retirement, the in-specie transfer of the shareholdings from "accumulation fund" to "pension fund" does not seem to trigger a CGT event - so the shares move into a tax-free environment without any CGT paid.

If you hold individual shares rather than an EFT you can do even better by choosing which $1.7M of your shares to move across to maximise the above benefit.

Meg Heffron
September 16, 2022

Yep - this works. As long as the accumulation and pension accounts are in the same legal entity (ie the same APRA fund). Once upon a time APRA funds that offered pensions sometimes did this in completely separate superannuation funds which was a disaster as you can imagine - moving from one to the other triggered tax which put them at a considerable disadvantage to SMSFs. It's a good example of how SMSFs have prompted great innovation in APRA funds (and that's good for everyone). It's not because SMSFs are inherently subject to different rules, it's just that the fact that they only have to care about 1 or 2 members means they can really focus on doing the absolute best thing for those 1 or 2 members. Often, great strategies (like.... let's move to pension phase without selling any assets and THEN sell once we're in pension phase so there's no CGT) start life in SMSFs. APRA funds initially struggle to copy them because they have to care about hundreds of thousands of members which forces compromise. But eventually they find a way to do it and everyone is better off.

Graeme
September 15, 2022

I know from personal experience that share holdings can be moved from a public super fund (direct share option) to an SMSF via an off-market transfer.

Ramani
September 16, 2022

Sadly though, not vice versa. A savvy PO Fund wishing to capture SMSF monies by way of rollovers can and should offer this facility (at market rates of course).

Meg Heffron
September 16, 2022

Graeme you're right - legally you can move shares between super funds. In my (admittedly limited) experience, APRA funds will happily accept shares when they are being transferred IN but often don't allow you to transfer OUT. Sounds like in your case, transferring them OUT to an SMSF was also possible - which is great. The key point I was making about my friction / costs of setting up was that even if you are able to transfer shares directly from your APRA fund to an SMSF, the impact of moving them from one legal entity to another is that capital gains tax applies. Now, some funds allow for this very explicitly - by (say) reducing the amount you transfer to reflect it. Others allow for it behind the scenes (say via a unit price as Graham mentioned). But somehow they have to allow for it, otherwise it's unfair to the members left behind. It's not APRA funds pully a swifty, it's genuinely the right thing to do but just not optimal for those of us leaving to set up an SMSF.

Graeme
September 17, 2022

Hi Meg,
I don't believe that this share transfer triggered CGT. The beneficial ownership and the investment environment (superannuation) was unchanged.

Meg Heffron
September 18, 2022

Sadly Graeme, a move of shares from one super fund to another definitely triggers CGT even though the money is remaining in the super system and even if it's still set aside for the same member. That's why it can be a driver to start your fund early.

John De Ravin
September 17, 2022

Graham, thank you for this point of clarification, I was also surprised by Meg’s specific wording around treatment of capital gains on departure from a public fund.

I think it is worth noting that even in an SMSF, from an economic perspective (and also I think from an accounting perspective) there is an accrued contingent capital gains tax liability. It’s true that the CGT may never be triggered if the asset is retained until transfer to pension phase. But I’m a little sceptical as to what proportion of assets held by a young investor who is sufficiently “active” as to want to establish their own SMSF with a modest balance, is likely to be held for the whole duration of the accumulation phase.

Meg Heffron
September 18, 2022

You're right John - it's unlikely that all the shares you buy with your super at 30 will still be in your fund at 60 (although I've definitely seen some SMSFs hold their bank shares for a very long time :)). But even if you expect you will have to bear CGT on them one day because you'll sell them before retirement, the fact that moving funds forces you to realise gains "right now" is still a downside in my view - it means you pay tax "now" rather than "later", reducing your investment pool immediately.

 

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