(03) 9020 2905PORTFOLIO POINT: At some point, investment options open right up, leaving you to wonder whether tomake an investment inside or outside your SMSF. Plus, the anti-SMSF Red Book commentary.
I don’t know when exactly it is, but it seems to be when a SMSF approaches the three-quarters of a million dollar mark, that options open up for SMSF investors.
It’s usually a confluence of events. That is, there’s enough money in super to be able to make individually large investments (such as residential investment properties), you’ve usually passed 50, the home mortgage is down to a level where it is no longer significant, or no longer exists. And the kids are gone (or could be … with the simple change of a lock).
On top of that, access to super is only a few years away (or has already arrived, it just hasn’t been taken advantage of), so the “locked away” nature of superannuation is no longer much of an issue.
Add to this law changes that allow super funds to gear and all of a sudden you’ve got a dilemma.
“I want to invest. I’m ready to go. I just don’t know whether to do it inside or outside super.”
Personally, I’m not there yet. For a few months longer, I still get change out of 40. As a result, my SMSF doesn’t bother the Richter scale. I’ve just gone and got myself a massive new mortgage. And if I changed the locks on my three- and two-year-old, government agencies would come knocking.
But I am watching a lot of people grapple with this dilemma at the moment. There’s no straightforward answer. Today’s column won’t provide anyone clear cut answers. I’m aiming to give you something to think about if you want to invest, but are undecided as to where.
(And I won’t ignore the arguments put forward by Ivor Ries in last Friday’s edition of Eureka Report, or the misleading comments from the National Institute of Accountants this week. I’ll come back to those.)
For a start, let’s assume that you’re looking to make a sizeable investment. Say, the purchase of a $500,000+ investment property. You’ve broadly met the criteria above, namely:
- You’ve got more than $600,000 in super
- Your home loan is 25% or less of the value of your home.
- You have the ability to invest outside of super also
- You are 50+. That is, access to super is either here or within reach.
Super versus non-super
When it comes down to it, what’s the real advantage to super anyway? The upside is a low-tax environment. The downside is restricted access.
However, those who are now, say, 51 to 53, have less than a handful of years until they can start to get hold of some of their super. Those born before June 30, 1960, can get access to 10% of their super each year from age 55.
Switching your fund to pension phase also (currently) makes your pension fund tax free, for both income and capital gains. The real advantage of buying property inside super is that, from any stage after you’ve hit your access age, you can sell a property capital gains tax free.
High incomes and negative gearing
More pertinent to the non-super side of the coin is negative gearing. Many of the advantages of buying property comes from borrowing the entire investment amount – up to 106% of the value of a property, if you include stamp duty – and being able to offset the negative cashflow against your own positive income.
Negative gearing works fine for high-income earners. It has considerable advantages for anyone earning in excess of $80,000, but particularly those earning more than $180,000, and therefore paying a marginal tax rate of 46.5%.
The advantages of negative gearing outside super in the short to medium term can be pretty strong. Depending on the purchase, property can be negatively geared for 5-10 years or longer. The trade off for big negative gearing tax savings is paying the tax on capital gains down the track (which, of course, can be passed to the next generation, if you decide not to sell).
For those on lower incomes, negative gearing has less appeal. If you are asset rich and income poor and doing the sums, investing inside super might have higher appeal. With super gearing rules, it may make more sense to build assets inside super, neutrally geared.
Does my super fund need a tax deduction?
Who can make the most of the negative gearing? Me or my super fund?
Negative gearing inside super does have advantages. It can be used to offset other taxes, including contributions tax and can be used to claw back more of the franking credits than would otherwise be available.
The difference is that you’re only able to claim back a maximum of 15%, whereas outside super it can be up to 46.5%.
What sort of income streams will I have post retirement?
What sort of income is your non-super asset base likely to produce once you retire? If you don’t have too many assets (outside of your non-income producing home) outside of super, then it might not hurt to have a few assets outside of super. Recent governments have confirmed that they intend to give retirees a reasonable effective tax free income.
What’s my investment timeframe?
When do you think you’ll need the money? Be wary of access issues. Not that it can be easy to foresee these things, but if you think you’re going to need a good chunk of the profits or the capital during a time period when you’re going to have limited access to your super (under 60, or under 65 and still working), then it might make more sense to keep the investment outside super.
What might cause this? Big school fees for those with younger children, capital required for business expansion, house upgrade. Anything where you might need to get out more than the 10% restrictions for super.
Legislative risk
What if they change the rules? There’s no doubt that they will. This government. The next government. And the government after that WILL change the rules. Every year. I guarantee it. Some will be positive changes. Some will be negative. The flow during this Government has been largely to reduce super’s attractiveness.
What is important is whether Ivor Ries was right in his piece last Friday – essentially he argued that Labor is imminently going to make massive changes to the taxation of SMSFs and super more generally in response to Treasury’s Red Book claims that super, but particularly SMSFs, are a massive source of taxation leakage.
I don’t think this Labor Government is about to come down on super like a pack of seagulls on an abandoned bag of hot chips. I believe Labor is going to have far more important things to focus on in this term of government than neutering super, and in particular SMSFs.
While Ivor forecast that Labor would wind back the clock and reintroduce the concept of “reasonable benefit limits”, I’d argue that they already have, with the massive reductions in concessional contribution limits. And, further, their promise to introduce the 50-50-500 rule (see column from May 19, 2010) suggests even Labor has been convinced that their knee-capping went too far.
That’s not to say they won’t crack down further. They might. But I think Ivor has underplayed how effective the concessional contributions cuts have been and will continue to be.
But, at the risk of contradicting myself … consider the National Institute of Accountants response to Treasury’s Red Book claims about SMSFs being a significant source of revenue leakage.
NIA claimed that the rules for SMSFs are no different to regular super funds. While technically true, that’s like saying that the local under-12 cricket team and the district firsts are on an equal footing.
The same rules, yes. The same opportunities, no. Not even close. Managed fund (non-SMSF) super members have no opportunities to invest in residential property. They can’t gear into residential or commercial property. They can’t choose from any property in Australia. They have less choice of the timing of their asset sales (ie, waiting until pension phase to sell assets) and the benefits of negative gearing.
Control is one of the main reasons that trustees get themselves a SMSF. And control of taxation is a significant part of that. You control your tax so that you can pay less of it. To claim otherwise is being silly.
Where does that leave those wanting to know whether to invest inside or outside super? Sadly, with even less certainty. Legislative risk with super, as I bang on about endlessly, is ongoing.
*****
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.