(03) 9020 2905PORTFOLIO POINT: Here’s seven of the deadly sins of running your own SMSF. Oh … okay, make it eight.
It’s an exciting proposition. Making the decision to sack the super platform/manager/provider who’s been running your super savings (often poorly, from a returns perspective) and taking on the responsibility for your retirement savings yourself in a self-managed super fund.
But, it’s not just about setting up a super fund and buying some shares. Becoming a SMSF member and trustee brings a bunch of responsibilities and a new world of, well, rules. No, you don’t need to be a complete expert. But you do need to know the basics. (And if you’re not going to keep on top of things perhaps you need to hire some professionals, such as accountants, financial advisers and SMSF legal experts).
Today, we’re going through some of the major mistakes that SMSF trustees (both new and old) make.
Not having a proper cash hub
One of the first mistakes that brand new SMSF trustees make concerns the decision on where they park their cash. After signing the document deeds, pretty much the next step is to get a bank account.
What do people normally do? They go to the local branch of the bank they’ve always used and say: “I’ve just opened a SMSF and I need a bank account.” Those people will generally walk out with a business bank account. That business bank account generally charges a monthly fee of between $4 and $20 and pays little or no interest. Plus you’ll be slugged with transaction fees for using the account too much.
There are plenty of options for base bank accounts for SMSFs. For a start, there are many cash management accounts that will fit the bill.
All super funds need a cash hub. They might not hold much cash in it, but it could, at various times, hold a lot of cash. Macquarie estimates that the average SMSF – and it has a huge portion of the market in its CMT and CMA products – holds between $50,000 and $80,000.
Your cash account certainly should NOT be a cost to your SMSF.
Here’s one comparison, based on having $50,000 in a business bank account. You could either pay fees of $120 a year ($10 a month) and earn no interest. Or you could have earn interest of 3.5% (which isn’t particularly competitive) and earn $1750 a year. The difference is nearly $1900 a year. That just about pays your accounting/audit fees.
Abusing the sole purpose test
SMSF have what’s known as the “sole purpose test”. That is, the sole purpose of a super fund is for the provision of retirement benefits for its members.
Some trustees just don’t get this. Or they come on hard times and get a small “loan” from the super fund. Or their business couldn’t get some much needed funding. Or they just wanted to help out a family member who needed some cash. Or they were a bit short for the school fees. Or they didn’t have cash and they needed to pay for a car/holiday.
Whatever it is, using the money in a way that provides a personal benefit is simply not on (unless you’ve satisfied a condition of release). The ATO hates it and could declare your fund non-compliant for doing so. Becoming non-compliant is, apart from being swindled by a thief, probably the worst thing that could happen to a super fund, as the ATO has wide-ranging powers to remove trustees, issue huge fines, or tax the super fund at the highest marginal tax rates.
Falling foul of the lending rules
The rules of lending for super funds changed dramatically in September 2007. SMSFs can now borrow to invest in almost anything that they could previously legally invest in without gearing. However, it’s not open slather – the rules that govern how a SMSF can borrow are actually still quite prescriptive in how the lending is to be done.
One of the most important rules is that the lender can only have recourse over the asset that the loan was used to buy (which should be held in a purpose-acquired bare trust inside the super fund). That is, if a loan was for the purpose of buying a property, the lender can only lay claim to the property, not other assets of the super fund. If $300,000 was loan to buy a $400,000 property, but the lender calls the loan in and, at the time, the house is only worth $200,000, then the lender has to wear that $100,000 loss. They can’t request the super fund top up the remainder of the loan from its other assets. (This is why lenders will usually only allow lower LVRs and, usually, higher interest rates.)
And you need to be very careful about lending money to your own super fund. You can loan money to your super fund, but the loan needs to conform to the lending rules. Doing it incorrectly could see the ATO deem it to actually be a contribution. If the loan is deemed to be a contribution and that contribution puts you over your annual limits, then the fund could be slugged with a much higher tax rate.
Not having commercial agreements in place
A super fund can own commercial investment property, even ones in which one of the member’s business operates from. In fact, that’s a favourite reason for starting a SMSF.
But you need to be very careful that the arrangements that are entered into between the SMSF and tenants or lenders (particularly if the lender is you) are made on commercial terms.
Why? Well, if your super fund owns the commercial property from which your business operates and you agree on an artificially high rent is paid (say $120,000 annual rent when the commercial rate would be around $80,000), the extra $40,000 could be seen as trying to get around the contribution rules. And if you were over 50 and had already contributed to your $50,000 concessional or $150,000 non-concessional limit, the ATO would take a dim view of the higher rent.
At the opposite end of the scale, charging a rent that’s too low could be seen as a breach of the sole purpose test, because you, or your business, could be seen to be gaining a benefit from your super fund.
The same sorts of ATO frowns would come from interest rates charged on loans made by members to a SMSF. Too high and you’re gaining a benefit from the SMSF. Too low and it could be considered to be contributions.
If you or your entites enter into commercial agreements with your SMSF, make sure the terms are commercial. And make sure it’s in writing. And that it conforms to the 2007 super lending rules.
Being poor with the paperwork
If you’re a generally poor record keeper, you’ve got two choices. First, don’t even start with a SMSF. Second, pay someone else to do the paperwork for you.
The majority of SMSF trustees are probably reasonable with making sure they file their contract notes, the banking statements and their quarterly platform performance statements. However, it’s the other paperwork that will often trip up trustees. For instance, have you made minutes for each of your investment decisions?
I don’t need an investment strategy. I am the investment strategy!
Sure you are. But if you don’t have one written down, that doesn’t look too formulaic, you’d be inviting trouble from the ATO in the event that you’re selected for an audit from the ATO. It’s one of the first documents they are going to ask for.
Your fund is required to have an investment strategy. Does it? Does the investment strategy reflect how the fund is currently invested (that is, are you invested within the ranges prescibed in your investment strategy? Does it match up with your super fund trust deed?
Breaching the trust deed
The laws surrounding super funds change. Far too regularly.
One of the biggest problems for trustees is they don’t follow the rules of their SMSF’s trust deed. Your trust deed – along with the law itself – sets the rules by which your SMSF can invest. You might be investing according to new laws, only to find that your super fund doesn’t allow it in any case.
And that means that trust deeds date. If you haven’t got an update on your super fund in the last two years, then there’s a good chance your super fund is not allowed to use the new borrowing laws introduced in September 2007.
Have you read your trust deed? Thoroughly? Are you doing anything other than pretty plain vanilla shares, cash and managed funds with your super? If you are doing outside those “basic” investments, then you’d best make sure that your trust deed allows it.
Messing up your insurance
Australians are appallingly underinsured in terms of life insurances. A SMSF can allow you to organise your insurances very flexibly, with (unlinked) retail insurance policies.
Sure, for older trustees who have enough total super and non-super wealth to cover those who depend on them, there might not be a great need for insurance. But for those who are starting their super funds, have young children, still have a mortgage, are highly geared, or have an expensive lifestyle that relies on high incomes, then proper insurance is seriously important, but often simply ignored.
There are loads of errors that are often made when it comes to insurance. But here’s two particularly common ones:
- Not taking into account the insurance you had (life, TPD and income protection) in your “from” fund – the one that you had before you transferred it to your SMSF.
- Putting the insurance in the wrong name. That is, putting the insurance in the name of the individuals (rather than the in the name of the individuals as trustee for the super fund), but having the super fund pay the premiums.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.