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Self Managed Super Fund (SMSF) Article
Why do people set up Self Managed Super Funds?

By Tony Negline.

This article may be out of date.

5th September 2007

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During the 2006-07 financial year 40,000 new self-managed super funds were created. There are now about 360,000 small funds with almost 700,000 members.

This represents a 100 per cent increase in the number of funds created in the 2005-06 year.

It's a safe bet that most of this increase is due to the closing of the $1 million undeducted contribution opportunity on June 30 2007.

The SMSF sector has consolidated its position as one of the largest parts of the super industry for total assets under management.

Members of SMSFs also tend to have an account balance larger than the average balance of employer or public super schemes.

There is always much speculation as to why SMSFs are so popular: independence, cost savings, using the fund's money to own commercial property, estate planning, "all my mates have one", "my advisers recommended it" and dissatisfaction with commercially available super funds are common reasons. A recent parliamentary inquiry suggested the tax office should research this.

No one really knows the main motivators for people setting up a SMSF because the detailed research needed to find out has never been done.

In its recently released compliance plan for the 2007-08 income year, the tax office said that it intended to inquire into why SMSFs were popular so it could tailor its education, support and compliance activities.

It is to be hoped the tax office will release this information publicly.

What bearing would it have on your life to know why other people run SMSFs?

The answer is simple: recent research shows that the way financial services companies market their products to prospective clients misses the mark.

The biggest failing is that they don't seem to understand what really motivates those who run their own funds.

If they are getting this wrong, it is reasonable to assume they really don't know why SMSFs are being set up.

If the popularity of SMSFs is researched correctly it might uncover an extremely useful reason for SMSFs that not many people had thought about.

Yet, the more people who set up SMSFs, the greater the number of potential breaches of the law that can occur. Recently, tax commissioner Michael D'Ascenzo said only those prepared to invest the required time, cost and responsibility in being a trustee should consider running a SMSF.

He noted that all new trustees of SMSFs must sign a trustee declaration that they understood the duties and obligations of that role.

D'Ascenzo also noted that every year the ATO has to deal with super funds that acquire assets from members or their relatives, or entities that the members or relatives control or are deemed to control.

There are lessons that those that do run their own funds can learn from this.

For example, John Smith has $40,000 worth of shares in his ASX-listed employer. He has acquired these through an employee share scheme and has always had to pay the prevailing market price for each share purchased.

He doesn't really want to sell the shares but access to the cash locked away in them would come in handy.

A minor issue, for Smith, is that selling would generate some capital gains tax.

Smith has $500,000 in his employer's super scheme. His wife also has a small amount of super with a fund manager.

He prefers the independence of running his own super fund and also thinks he can match or better the investment gurus when it comes to returns.

When the fund is set up and has an ABN, he tells his employer that he wants all his employer contributions paid into his own SMSF.

He also sets about transferring his employer super fund account into the SMSF.

Once his employer super monies are in the SMSF, the trustees decide their investment strategy would allow them to buy the employer shares from him.

This transaction must happen at arm's length -- that is, the price the fund pays must be the market price on the day the transfer occurs.

Smith extracts some cash from his super assets and also effectively retains ownership of the assets via his own fund.

Upon selling the shares to the SMSF, Smith generates some capital gains tax, which must be considered.

There are many types of assets that funds can acquire and it is essential to know which ones funds can purchase and which they cannot.

Securities listed on stock exchanges are allowed. Property used wholly or exclusively in the running of a business are also permitted. Most other assets are problematic. The penalty for breaching this rule is, at a minimum, a year in jail or its monetary equivalent. So making sure you understand these rules is essential. If you want to use an asset that your fund owns, you also need to make sure you satisfy the in-house asset rules.

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