Investment
Ashwin Ramdas Updated Dec 19, 2022
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This information has been reviewed by our SMSF Mates before it was published as part of our review process.
Much like a regular superannuation fund, an SMSF is an excellent way for you to save for your retirement. The key difference of an SMSF is that the members of the fund have much more flexibility with how they manage the investments in the fund. Running an SMSF includes things like managing the investments, preparation of financial statements, compliance of the fund and completing the annual audit requirements.
The members of the SMSF are also the trustees which mean they can run the fund for their own benefit; however, they are unable to access the funds until a condition of release has been met, most commonly reaching retirement age.
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Setting up an SMSF means you become a member and a trustee of the fund (which is similar to a director of a company that’s a trustee).
Being a trustee means you are either an individual or a company that is responsible for investing the fund’s assets to grow the fund for the member’s retirement. If the trustee of the SMSF is a company, it is commonly referred to as a corporate trustee, which means all members of the SMSF need to be directors of the company and vice versa. This structure allows for greater flexibility if one of the members of the fund passes away as a successor can replace the deceased member relatively quickly. This is in contrast to an individual trustee SMSF when administering a deceased members estate is burdensome, to say the least.
As you would expect, running an SMSF comes with specific responsibilities. A trustee of an SMSF must act according to the SMSF’s trust deed and the superannuation tax laws.
At the core of the superannuation laws is something called the sole purpose test which means the fund needs to be run for the sole purpose of providing retirement benefits to the members of the fund (or to their dependants if a member passes away before retirement).
If you are a trustee of an SMSF, you must maintain the fund so that it complies with the sole purpose test. This Includes when managing the investments and paying benefits to members upon retirement.
Here is a helpful list of bullet points that include other responsibilities of the trustee:
Contributions and payments made to members (or beneficiaries) must comply with the SMSF trust deed and super and taxation laws
Outsourcing functions required to run the SMSF is standard; however, the trustee is ultimately responsible for the operation of the SMSF with regards to superannuation and taxation laws.
If you are the trustee of a self-managed super fund, you must do the following:
Run the SMSF with the best interests of the fund member in mind
All trustees and directors are equally responsible for managing an SMSF and making decisions. People over the age of 18 can be a trustee of an SMSF as long as they are not legally disabled (such as mental incapacity) or a disqualified person by ASIC.
The trust deed is a legal document that outlines the rules for establishing and operating your super fund – things like the fund’s objectives, which can be a member and how benefits are paid. The trust deed and superannuation laws together form the fund’s ‘governing rules’.
An investment strategy will also need to be included as part of your trust documents. It is a formal plan identifying the SMSF’s financial goals (investment objectives) and the tolerance for risk and investment time horizon. As a trustee of the fund, you should regularly review the fund’s investment strategy to ensure it remains current.
It is essential that you understand:
Diversification allows you to minimise your investment risks by investing in a variety of asset classes. By arranging your portfolio in such a way that it holds various types of assets, if the assets do not move in symphony with each other, a diversified portfolio will be able to minimise losses. This will effectively reduce the risks within your portfolio.
The most common assets classes are as follows:
There are three main ways of diversifying:
By adopting a dollar-cost averaging strategy, you can spread out your investment entry points and potentially achieve a lower average cost of invested funds over a specific time frame. It is expected that for the same dollar amount, you will purchase more units when the share price is lower and fewer units when the share price is higher.
Investments within an SMSF must be made on an ‘arm’s length’ basis.
This means that the sale price of the asset should always reflect the actual market value. The income of the assets must show an accurate rate of the market return.
These include transactions with anyone who is related to the fund or the trustees.
A ‘related party’ of your fund includes:
As expected, there are many investment restrictions that apply to transactions involving ‘related parties’ of your fund.
You are unable to lend money or provide direct or indirect financial assistance from your superannuation funds to a member or a member’s relative even if there is interest paid. The fund’s assets must be kept solely for your retirement.
The SMSF is not permitted to purchase an asset from a related party unless it is received at market value and is:
An in-house asset is considered an investment in a related party’s fund.
It is any of the following:
Exceptions include:
Any ‘business real property’ within the SMSF which is leased to a related party of the fund;
Except for the above exemptions, the level of in-house assets that an SMSF can hold is limited to 5% of the SMSF’s overall asset value.
Some of the costs associated with SMSFs could include but are not limited to:
What are the annual costs?
What are the optional costs to consider?
What are the other important considerations?
Self-managed super funds do not receive the same government protections that are given to an APRA regulated superannuation fund.
When transferring an existing superannuation account balance from a superannuation fund regulated by the Australian Prudential Regulation Authority (APRA) to an SMSF, things to consider include the following:
It is generally more difficult and more expensive to obtain life insurance and TPD insurance within an SMSF when compared to an APRA-regulated super fund, which can often receive default levels of cover for life and TPD insurance without any kind of medical assessment. Unless the trustee of the SMSF specifically seeks out insurance cover for the fund, there may not be any in place.
Some of the dispute resolution mechanisms like the Superannuation Complaints Tribunal, might not be available to SMSFs.
It is costly to change structures, ownership of assets and trustees after the SMSF has been established.
See the ‘Structures’ section for more detail.
There are several important obligations that an SMSF trustee must comply with under superannuation and taxation laws. These include:
The trustees of an SMSF must develop, implement and regularly review the fund’s investment strategy. Trustees must understand the following:
Trustees may want to wind up their SMSF for a wide range of reasons. To make any exit as straightforward as possible, it is important that trustees consider and develop an exit strategy for their SMSF. Specific wind-up requirements should be included in the fund’s trust deed.
It is a legislative requirement that SMSF trustees consider the insurance needs of the SMSF members when drafting the fund’s investment strategy. The three main types of insurance which can be held within an SMSF include Term Life, Total and Permanent Disability and Income Protection (salary continuance).
Life insurance pays out in the event of the insured person’s death to a beneficiary. This payout is commonly used to cover living expenses of which the insured person would have contributed to such as education fees for children, debt repayments and other expenses.
You may also like to read our article covering the 7 biggest myths about life insurance.
Total and Permanent Disability (TPD) provides a payout in the event of total disability incurred by the insured person. Policyholders can only choose an ‘any occupation’ definition which means you must be unable to work in your regular occupation or other occupation for which you are reasonably suited as a result of your education, experience or training.
Income protection insurance will typically cover up to 75% of the insured person’s income and in most cases and provides a monthly benefit if the insured is unable to work as a result of an illness or accident (up to age 70).
The SMSF sits between the SMSF trustees and the insurance provider and pays for the premiums. Before receiving any insurance proceeds, you will need to meet a ‘condition of release’. A general condition is for the member to permanently retire or reach age 65. Conditions of release allowing insurance proceeds to be accessed are as follows:
Under these limited conditions, funds may not be payable unless the beneficiary/recipient has also met a requirement of release. For income protection claims, payments can be made as a non-commutable income stream.
• Premiums for Term life and TPD insurance held within an SMSF are tax-deductible to the fund; and
• Funds can be paid from superannuation savings rather than after-tax monies.
• Retirement savings will decrease to fund insurance premiums and may affect overall balance upon retirement unless additional contributions are made to offset the premium payments; and
• Life insurance proceeds paid as part of a lump sum death benefit to a spouse will be tax-free, while profits paid to a non-dependent adult child will generally be taxed.
Borrowing or gearing your super into the property must be done under strict borrowing conditions called a ‘limited recourse borrowing arrangement’ (LRBA).
An LRBA arrangement provides you with the right but not the obligation to buy an asset through the payment of instalments. The fund will receive any interest generated by the asset; however, it will not have legal ownership over the asset until the loan is repaid.
The following steps need to be completed in order to establish the limited borrowing arrangement:
1) Ensure your trust deed allows for the arrangement;
2) Identify the assets to be purchased;
3) Meet with a specialist SMSF advisers;
4) Establish a holding trust; and
5) Meet with a lending specialist and apply for a loan and purchase the asset.
A limited recourse borrowing agreement (LRBA) requires the trustee of an SMSF to borrow from a third party lender. The trustee would then use the borrowed funds to purchase an asset that is held in a separate trust. If for some reason, the loan defaults, then the lender’s rights are limited to the asset which is held in the trust and does not have recourse on any assets within the SMSF.
From September 2007, superannuation funds, including SMSF’s can borrow using an LRBA provide the following conditions and features are adhered to:
• The borrowed funds are used to acquire an asset;
• The asset is held on trust. The SMSF trustee has a beneficial interest and a right to acquire the legal ownership of the asset through the payment of instalments;
• The lenders recourse against the SMSF trustee in the event of default is limited to rights relating to the asset;
• The asset being acquired is one which the SMSF is permitted to acquire or hold directly. The investment subject to the loan cannot be an investment the fund already owns. Additionally, the superannuation law places restrictions on investments that can be acquired from related parties such as relatives of members or trustees, members or fund trustees; and
• Depending on the lender an interest cover ratio may be imposed, meaning in the event of default, the asset may need to be sold and debt repaid.
Any loan arrangement must be on a full arm’s length commercial basis and in keeping with the sole purpose test (investments must be for the provision of retirement benefits for the members of the fund). There is no legislated limitation on the total amount a fund can borrow. However, the lender’s security must be limited to the underlying asset subject to the borrowing. Similarly, there are no legislative restrictions on where the loan can be sourced.
With an LRBA, a trustee of an SMSF may incur expenses associated with borrowing to invest in property. Some of these costs may include:
• Loan establishment fees;
• Valuation fees;
• Stamp duty fees;
• Legal expenses; and/or
• Title search fees.
• It allows an SMSF to purchase an asset in situations where it does not have enough available capital to purchase the asset outright;
• It may help in diversifying the SMSF’s investments by providing funds to acquire other assets; and
• There may be tax benefits.
Disadvantages of setting up an LRBA
• It may not be a cost-effective option for small amounts of money;
• Trustee must understand responsibilities and investment restrictions; and
• Managing the paperwork and maintain records may be a time-consuming process.
An SMSF must always transact on an arm’s length basis, which means the purchase and sale of any assets within the fund must reflect the true market value of the asset. Any income generated from assets within the fund should also reflect the actual market rate of return. If the trustee of an SMSF were to sell an asset for a below-market rate intentionally, then they would be in breach of this rule.
Confused about any of the terms in this content? Check out our glossary page for explanations of many different superannuation and SMSF terms.
Related reading: How to set up / start a self managed super fund (SMSF)
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