RISKS ASSOCIATED WITH AN SMSF
Setting up a self-managed super fund (‘SMSF’) allows you to invest your superannuation on your terms – but it also comes with responsibilities and is not the right option for everyone.
STAKE SUPER DOES NOT PROVIDE FINANCIAL ADVICE RELATING TO SMSFs
Stake SMSF Pty Ltd ('Stake Super') will assist in the establishment of an SMSF upon instruction under a ‘no advice model’. This means that Stake Super does not provide financial advice including whether an SMSF is suitable for your personal objectives, circumstances or financial needs. It’s recommended that prior to making a decision to establish an SMSF or purchasing or setting up any financial product via Stake you seek advice from a licensed financial adviser.
A licensed financial adviser can assist you with your decision making by reviewing your personal circumstances and financial needs and making recommendations based on your best interests. Engaging a financial adviser is not mandatory and it is your decision whether or not seek personalised advice.
More information on choosing a financial adviser can be found on the Australian Securities and Investment Commission’s ('ASIC') MoneySmart website here.
USEFUL SMSF RESOURCES
The following publications are useful resources for potential SMSF trustees and we recommend you review these to assist you with your decision to start an SMSF:
ATO – Thinking about self-managed super
ASIC Moneysmart – Self-managed super funds
SMSF Association – SMSF Connect for trustees
The information below outlines the key risks associated with an SMSF that need to be considered prior to establishing an SMSF. Please note that this list is not exclusive and there may be additional risks specific to your individual circumstances which should be considered.
TRUSTEE OBLIGATIONS, SKILL AND TIME REQUIRED TO MANAGE AN SMSF
Deciding to become a trustee of an SMSF is not a decision to be taken lightly. Being a trustee of an SMSF carries duties and responsibilities which are serious and wide ranging.
Acting as a trustee of an SMSF is more than just taking control of the investment decisions. There are a number of other responsibilities trustees have that will require time as well as a certain level of skill to manage.
Individuals looking to establish an SMSF need to determine whether they have the required skill to manage the investments of their fund. Although SMSF trustees can utilise the services of a financial adviser to assist with investment decisions, the trustees are still ultimately responsible for ensuring that the investments decisions will meet the needs of the members.
A financial adviser can help you prepare an investment strategy and advise you about the different types of investment and insurance products. The ASIC Moneysmart website has information about choosing a financial adviser.
After investment decisions, the other key responsibility is ensure the SMSF prepares and lodges its annual tax return with the ATO as well as appointing an independent auditor to audit the fund each financial year.
In addition to a financial adviser the following professionals can be engaged to assist in the management of an SMSF:
an accountant to help prepare the SMSF financial accounts and member statements;
a registered tax agent to complete and lodge the SMSF annual return, provide tax advice and assist in dealings with the ATO;
a fund administrator to help manage the day-to-day running of the SMSF and meet the reporting and administrative obligations; and
a lawyer to prepare and update the SMSF trust deed or rules.
It is important to note that regardless of professionals engaged to assist with the management, ultimate responsibility and liability for compliance with all relevant laws and regulations rests with the SMSF trustees.
The trustees have to spend the time to ensure all tasks are completed correctly. An SMSF should not be established or operated by individuals who do not have the necessary level of time and skill.
SUPERANNUATION BALANCE REQUIRED AND SMSF FEES
In late 2012, ASIC commissioned Rice Warner Actuaries to examine the fund balance at which an SMSF will be cost-effective compared with an Australian Prudential Regulation Authority (‘APRA’) -regulated fund.
The original 2012 Rice Warner report found that the cost-effectiveness of an SMSF is very much affected by the amount of work the trustee is prepared to do themselves in administering the fund. As such, there will be a range of fund balances at which an SMSF will be cost-effective compared with an APRA-regulated fund.
Rice Warner was subsequently re-engaged by the SMSF Association in 2020 to update the original report. The 2020 report found the following:
SMSFs with less than $100,000 are not cost effective in comparison to a large superfund unless the SMSF could grow within a reasonable time;
SMSFs with between $100,000 and $200,000 are competitive with APRA regulated funds provided the Trustees use a lower cost service providers (or undertake some of the administration themselves);
SMSFs with $200,000 or more are fee competitive with both industry and retail funds even when a full service SMSF administration provider is used;
SMSFs with $250,000 or more actually become the CHEAPEST ALTERNATIVE where either a low cost provider is used OR the trustees undertake some of the SMSF administration themselves; and
SMSFs with $500,000 or more are generally cheaper than BOTH industry and retail super funds regardless of whether a basic, low cost SMSF service is used or a higher cost provider.
A ‘low cost service provider’ is defined by Rice Warner as having the following annual fees:
Financial statements / tax return / independent audit – $875
ATO SMSF Levy – $259
ASIC Annual Registration Fee – $56
Total Annual SMSF Fees – $1190
It’s also important to understand:
The ATO as regulator does not mandate a minimum amount of superannuation required to set up an SMSF;
The minimum figure relates to the combined amount of superannuation that all prospective members of the SMSF will transfer from their existing superannuation fund to the SMSF (up to four individuals);
Many SMSF related fees remain fixed / flat dollar amounts compared to APRA regulated super funds which generally have a percentage-based component of their fees; and
There are other costs that may be associated with moving from an APRA regulated super fund to an SMSF which may include brokerage fees, administration fees, withdrawal fees as well as capital gains tax (check with your current superannuation fund for further details).
Depending on the services utilised or the amount of work trustees are willing to undertake themselves, the minimum balance to make an SMSF cost comparable with other types of superannuation funds may be higher or lower.
For example, if the trustees are very ‘hands-on’ in regards to the investment decisions and administration of their SMSF, the required balance may be lower to make it comparable with an APRA regulated superannuation fund. Alternatively if the trustees outsource more activities to external professionals they will require a higher balance for the fees to be comparable.
There are a number of costs associated with the operation of an SMSF. Some costs are unavoidable, while others will vary depending on the decisions of the trustees. The following table outlines some of these costs.
| Type of costs | Explanation of costs |
Setting up an SMSF | + unavoidable: costs for a trust deed + optional: costs for establishing a corporate trustee, including the ASIC fee for establishing a corporate entity. |
Ongoing costs to operate an SMSF | + unavoidable: the annual SMSF supervisory levy (collected by the Australian Taxation Office), the annual independent audit fee, costs to produce an annual financial statement and tax return, and (when required) the fee for annual actuarial certification + optional: costs for amending the trust deed of the SMSF, professional investment advice fees, accounting and book-keeping fees, and investment management fees. |
Winding up an SMSF | Costs will include both compliance costs and costs related to realising assets. The nature of some of these costs will depend on the assets the SMSF invests in, but might include brokerage or agent fees. |
Opportunity cost for managing an SMSF | The time associated with managing an SMSF results in an ‘opportunity cost’ for the trustee. This cost is often overlooked as one of the costs associated with an SMSF structure. |
Insurance | An employer’s default superannuation fund must offer a minimum level of life insurance, and so most investors will have some insurance cover through their APRA-regulated superannuation fund. An SMSF’s investment strategy needs to consider whether the trustees of the fund should hold insurance cover for one or more members of the fund. The costs of obtaining such insurance through the SMSF may differ from the cost of holding similar insurance through an APRA-regulated superannuation fund. |
Investments | There will be costs associated with making investments through the SMSF. These costs will vary depending on the nature of the asset and also the frequency with which assets are bought and sold within the SMSF. The above list of costs are not exclusive. Other costs may include the cost to wind up (close down) and SMSF if the trustees deem it is no longer suitable for their situation. |
INVESTMENT RISK AND TRUSTEE INVESTMENT OBLIGATIONS
Under superannuation laws, trustees must develop an investment strategy before investing SMSF monies to ensure that the SMSF is likely to meet member retirement needs. In addition, SMSF trustees have a duty to exercise skill, care and diligence in managing the SMSF, and therefore need to possess a sufficient level of financial literacy to manage the fund and make investment decisions in line with the fund’s investment strategy.
SMSF trustees need to regularly review the investment strategy to ensure it remains current. It is important that trustees understand:
the benefits associated with asset diversification and investing across a number of asset classes (e.g. shares, real property and fixed interest products) in a long-term investment strategy, such as improving the risk and return profile of the SMSF;
there are some restrictions on SMSF investments and breaching these restrictions have severe consequences for the SMSF and the trustees; and
certain transactions are prohibited, such as lending the fund’s money, or providing financial assistance, to a member of the fund or their relatives.
The SMSF investment strategy must take into account the personal circumstances of all the fund members, including their age and risk tolerance. Specifically the following items need to considered:
diversification (investing in a range of assets and asset classes);
the liquidity of the fund’s assets (how easily they can be converted to cash to meet fund expenses);
the fund’s ability to pay benefits (when members retire) and other costs it incurs; and
the members’ needs and circumstances (for example, their age and retirement needs).
In addition the investment strategy must consider whether to hold insurance cover for each member of the SMSF.
CHOICE OF SMSF TRUSTEE STRUCTURE – INDIVIDUALS VERSUS CORPORATE TRUSTEES
Individuals looking to establish an SMSF have the option of having two or more individuals to act as the trustees of the SMSF, or a company (corporate structure) where the individuals act as directors.
There are advantages and disadvantages of each trustee structure that individuals need to understand prior to setting up an SMSF. Likewise there are also specific requirements that may influence the choice of trustee.
Where an SMSF is to be established with a single individual member, they must either utilise a company as trustee (of which they will be the sole director) or appoint a second individual who will also act as trustee of the SMSF and make decisions with the other individual.
There are additional costs involved with utilising a corporate trustee. These costs relate to the initial establishment of the company as well as an ongoing registration fee levied by ASIC. These fees can be paid by the SMSF. Details of these fees can be found on the ASIC website. Please note that neither individual trustees nor individuals acting as directors of a company trustee can be paid for their duties.
SMSFs are required to hold all assets and accounts in the name of the trustee(s) and separate from that of the individual members of the fund of any business that they may operate. Having a separate company act as trustee reduces the risk of personal or business assets becoming intermingled with fund assets. In addition, companies have limited liability and this offers greater protection if the SMSF trustee is sued for damages.
If an SMSF has individual trustees and the membership of the SMSF changes for any reason, the legal title of all assets and investments need to be transferred into the name of the new trustees. This can be costly and time-consuming. State government authorities may charge a fee for title changes. On top of this cost, most financial institutions charge fees for amending the titles of the assets within the SMSF.
If superannuation laws are breached, administrative penalties are levied on each trustee. Where a corporate trustee is used, there is only one trustee (the company) so only one lot of penalties is levied.
For more information on the risks and benefits of each SMSF trustee choice please visit the ATO website.
LIFE AND DISABILITY INSURANCE RISK
Although optional, all potential SMSF trustees need to determine whether it is appropriate to hold insurance policies that will pay a benefit if the members die or become disabled and unable to work again. This is part of the SMSF investment strategy.
APRA-regulated superannuation funds may have access to competitive insurance premium rates, such as group insurance policies and discounts. SMSFs can also access group insurance policies however the costs and features of the specific policies will differ to those available via APRA-regulated superannuation funds.
Alternatively SMSFs may utilise retail insurance policies which mean that each SMSF member needs to be individually assessed for insurance purposes. This may lead to higher premiums, loadings, exclusions or refusals of insurance.
Before joining an SMSF, potential members should review the insurance cover attached to their existing superannuation account(s) and determine the level insurance they require. It is important that potential SMSF members note that any insurance cover they hold will be lost if they rollover (transfer) the entirety of their balance to an SMSF.
It is also possible for members of an SMSF to retain a portion of their APRA-regulated superannuation balance to retain the associated insurances, however this may increase costs. It is recommended that potential SMSF members obtain appropriate advice from a licensed financial adviser regarding insurance cover prior to transferring the entirety of their current superannuation balance to an SMSF.
RELATIONSHIP BREAKDOWN
SMSFs can have up to six members and this combination could include friends, unrelated couples, business partners and siblings or other family members.
Where there is a change or breakdown in a relationship for any reason, there are risks involved. SMSFs do not have access to formal dispute resolution systems. In addition, unbundling or separating SMSF investments may be difficult and have legal and taxation ramifications.
All SMSF trustees are equally responsible for operating the SMSF and ensuring it meets all its legal and reporting requirements. In addition, trustees are jointly liable for the fund, and complex relationships between the trustees can make meeting the trustee obligations challenging which could lead to fines and other compliance action being taken by the ATO as the regulator of SMSFs.
LACK OF GOVERNMENT COMPENSATION IN THE EVENT OF THEFT OR FRAUDULENT CONDUCT
Unlike members of other superannuation funds which are regulated by APRA, SMSF investors are not entitled to receive Government compensation under the Superannuation Insurance (Supervision) Act 1993 (Cth) (‘SIS Act’) in the event of theft or fraud. Part 23 of the SIS Act makes provision for financial assistance to superannuation funds regulated by APRA that suffer loss as a result of theft or fraud – however, this does not extend to SMSFs.
Trustees and members of an SMSF are responsible for protecting their own interests when it comes to acts of theft and fraud. The reason for this is that SMSF members generally have greater control and choice when it comes to their investments, whereas members of other superannuation funds have to rely on the decisions of a trustee that is licenced and regulated by APRA.
SMSFs do have other legal options where their fund suffers a financial loss due to fraudulent conduct or theft. The ATO has outlined the following options that are available to SMSF trustees:
Members may have legal options under Corporations Law but there is no guarantee that compensation will be awarded.
Disagreements can be resolved through alternative dispute resolution techniques or in court, at the members’ own expense. There is no government compensation scheme.
SMSF trustees may also approach the Australian Financial Complaints Authority ('AFCA') if the trustee’s adviser, or other service provider involved in the fraudulent conduct, is a member of AFCA.