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Self Managed Super Fund (SMSF) Article
Bringing it all back home

By Tony Negline.

This article may be out of date.

20th October 2010

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A reader of this column asked me if Self Managed Super Funds had lost some of their attraction because of the halving of the contribution caps in July 2009.

This question actually raises two issues.  Firstly, at what point does it become cost effective to set up a Self Managed Super Fund and secondly what truly motivates someone to set up these funds.

According to research released by the Cooper Review, SMSFs overall are the third cheapest super product available (the cheapest is public sector or government employee super funds).

In 2008 SMSFs on average cost just under 1% of funds under management to run.  This is a total fee including administration, investment management and advice.  By way of comparison industry super funds cost 1.05% of funds under management.

Sixty two percent of SMSFs had administration costs less than the average.  More than 50 per cent of these funds had operating expenses under 0.25% per annum.

However this data masks some underlying facts.  SMSFs with up to $50,000 of assets have operating expenses of between 5 and 6 per cent per annum.  For what it's worth, six per cent of $50,000 is $3,000.

At the other end of the scale SMSFs with more than $2 million in assets had an average operating expense of under 0.47 per cent.  This means that a SMSF with $2 million of assets would be paying $9,400 in running costs.

Clearly smaller SMSFs are paying more in percentage terms but less in actual dollar terms.

According to the Cooper Review data, SMSFs seem to become cheaper than publicly available super options – such as industry funds – when fund assets are higher than $500,000.

With the halving of the contribution caps does this mean that less people will be interested in setting up a Self Managed Super Fund because it's no longer cost effective to run them?

Over 90% of SMSFs have two members.  Assume therefore that a couple have been working for a few years and they are both making maximum concessional contributions of $25,000 each.

Ignoring all other contributions it will take them about 8 years to get to the magic $500,000 threshold assuming a modest net of all charges earning rate of 5% per annum.  If we halve the level of contributions to $12,500 each (or $25,000 in total per annum), it will take them 12 years to get beyond $500,000 in combined super assets.

Anecdotally many people who have less than $500,000 in super assets are not put off from setting up an SMSF.  Many financial planners and accountants have told me that their clients in this situation know that a SMSF will cost more than other super fund options but they know their fund will become cheaper in the medium term as their asset base grows.

So what is actually motivating these people?

According to the Cooper research in 2008, 86% of new SMSF trustees told the Tax Office that they set up their SMSF because of the control over their investments.  Fifty three per cent believe that their SMSF can perform better than their previous super fund.  Only one third of respondents said that saving on fees and charges was a reason they set up their SMSF.

The fact is that industry super funds and retail super funds are often seen as big impersonal organisations that can’t be trusted.  This is a harsh judgement but a natural one for many to make because almost everyday we are bombarded with negative messages about large super funds either from news stories or competitor advertising.

Consequently retail and industry super funds, despite their large expenditures on image building and advertising can’t kill off Self Managed Super Funds.  As normal market movements affect fund manager performance figures, their reputations seem to take a battering.  Each time this occurs a new wave of disgruntled investors crosses over to small super funds.  Many of these new converts never go back to retail super funds.  Over time they often bring along their friends and relatives.

Many years ago people very influential in the industry super fund sector believed that Self Managed Super Funds would be a passing fad.  No doubt many people in the funds management industry had similar thoughts.  SMSFs are no longer swooping under their collective radars and have become a juggernaut that they don't seem able to get their heads around.

SMSFs have also attracted the ire of the Federal Treasury.  In its 2010 Red Book to the incoming Government it was claimed that SMSFs were the tax avoidance vehicle of choice.  Several accounting bodies have objected to this comment.

We shouldn't be surprised that such nonsense is written.  Similar sentiments were found in the Henry Tax Review's detailed notes when it stated that "currently it is possible for members of self-managed superannuation funds to arrange their affairs so they avoid capital gains tax on their assets. … This … is not available to members in larger funds as these members cannot control the timing of the disposal of assets."

Why are SMSF trustees said to be avoiding tax – a highly emotive term – when in most cases they're legitimately and legally managing the fund's tax liabilities to maximise the beneficiaries' assets?

Interestingly only one third of new SMSF trustees told the Tax Office that they set their fund up because of "better tax planning".

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