Introduction to SMSF

The size of the market

Self-managed super funds make up over 30 per cent of the $1.4 trillion total super assets, according to the Australian Taxation Office.  The industry has grown by 33 per cent, or $109 billion, in the four years to June 2012, representing the strongest growing super sector.

According to the Australian Securities and Investments Commission’s (ASIC’s) recent publication, SMSFs: Improving the quality of advice given to investors, the SMSF sector is worth $439 billion. Nine per cent of those with an SMSF invest in property.

Andrea Slatery, CEO of the SMSF Professionals’ Association of Australia (SPAA), says the SMSF sector started in the 1940s and compulsory super was introduced in the early 1990s.

“About 32 per cent of the super market is SMSFs, and there are about 940,000 people who are trustees and close to half a million owners,” she says. “Of the people who have SMSFs, less than one per cent are taking out SMSF loans.”

According to Adam Goldstien, SPAA NSW state chapter chair, the recently released ASIC Report 337 states that 35 per cent of cases reviewed included advice to commence an SMSF and borrow to invest in real estate.

“Currently, domestic property investmentwithin SMSFs is approximately $66.4 billion,” he says. “This figure has grown from $33 billion in 2007; over the same period overseas property has grown from less than $100 million to more than $200 million.”

The main reason cited for the growth in people choosing to establish an SMSF was to achieve greater control over their investments, says Mr Goldstien.

However, “the decision to commence an SMSF is significantly greater than the decision on what shares or property to purchase. Most people going into an SMSF don’t really understand their responsibilities or obligations,” he says.

Mr Goldstien adds that if managed properly, a ‘second wave’ of SMSFs will become more significant than the first. His emphasis lies in addressing three important issues: appropriateness, risk management and compliance.

How they came about

While SMSFs have existed since the 1940s, it has only been in the past decade – in light of the introduction of the Superannuation Industry Supervision Act (‘SIS’) in the 1990s – that we have really seen the sector grow exponentially, says Mr Goldstien.

“According to Australian Prudential Regulation Authority (APRA) figures, SMSFs now account for one third of total superannuation assets in Australia, with approximately $439 billion dollars in funds under management,” he says. “As at June 2012 there were 478,000 SMSFs, with approximately 913,550 members.

“[With] the introduction of SIS, Section 67 prohibited SMSFs from borrowing; further, SIS Regulation 13.14 prohibits a trustee giving a charge over assets of the fund. To circumvent these rules, borrowings were undertaken through related entities like unit trusts in which the SMSF owned 100 per cent of the units,” Mr Goldstien explains.

“The introduction of Section 71A in August 1999 prevented new investments in related trusts and thus any future ability to borrow.”

However, in 2007, SMSF borrowing was re-introduced through the use of an installment warrant. It is believed this change was in part due to the significant holding of installment warrant investments in Telstra by SMSFs.

“The legislation was subsequently updated in 2010 to provide clarity and certainty around the use of installment warrants and, in particular, installment warrants and property investment,” he says.

According to Vince Scully of SMSF Finance Specialists, when SMSFs were first introduced, they were largely a tool for small business people, many of whom owned business premises bought in a trust.

“That was [a] standard small business structure going back to the 1980s,” he says, explaining that the practice was restricted in the sense that these trusts couldn’t borrow.

“That all changed in 2007, when the law was changed to permit certain forms of borrowing. The general prohibition is there but there’s an exception saying that if you’re borrowing with all these rules, it’s not prohibited borrowing.”

The new arrangement was called the Limited Recourse Borrowing Arrangement (LRBA) and comprised several conditions. The major condition concerns the limited recourse aspect, Mr Scully says.

“This means a super fund could only lose what was invested in the property. If the property fell below the value of the loan, that was the lender’s problem, not the fund’s problem,” he says.

“Essentially, it called for a limited recourse loan and the property or asset you are buying has to be in a special trust, generally referred to as a custodian trust, which adds paperwork and complexity.

“Then your conditions were that you had to be borrowing money to buy the asset, you had to be a limited recourse loan and the asset had to be held in a trust.

“It sounds simple when you say it, but actually it leads to a heap of complexities around stamp duty and capital gains tax, which took a while to calm down. The tax office has now been reasonably clear in its position.”

A need for decisions

Investing in property through an SMSF loan plays to the very reason many people start an SMSF, Mr Scully says – which is control.

“A major motivation is around control, which goes hand in hand with a natural predisposition to real estate,” he says.

“That’s the kind of asset that people who want control would go for – it’s the natural instinct – and that’s why I think it’s got so much profile.”

According to Ms Slattery, SMSFs are growing at a rate of around 2,600 new funds per month. “That’s around about 3,000 to 3,500 new trustees per month,” she says. “You’ve got new monies coming into the system and you’ve got current SMSFs that are investing with contributions and so forth.”

SMSF loans represent a very good opportunity when specialised advice is provided and when the particular circumstances of the member are met, Ms Slattery says.

“They’re not for everybody but there is a market for them. You need to really understand a lot of things and be very constant in the advice that you’re providing to put a loan into an SMSF and have it actually meet the needs of the member in their retirement,” she says.

Ms Slattery points out that SMSF loans have always been about control and flexibility. “People make decisions about other things in their life and it’s no different to making decisions about your savings or what you would like to do in your retirement,” she says.

“Most people with SMSFs are self-employed, small business owners, or professionals who are used to making decisions in various aspects of their lives, or executives or managers.

“All of these people, most of their life is around making decisions and controlling aspects of what they’re doing and getting information from professionals to help them make a decision. This is no different.”

A need for advice

According to Mr Goldstien, establishing and maintaining an SMSF is more akin to running a business than undertaking an investment. As trustee of an SMSF you are responsible for compliance with 2,500 pages of direct and associated legislation and regulations, ATO rulings, interpretive decisions, APRA and ASIC guidelines – SMSFs are anything but ‘self-managed’.

“My only piece of advice is to seek advice, preferably from an SMSF specialist adviser or at the very least, an appropriately qualified and licensed accountant or financial planner,” he says.

“Here’s the nub: although property is not deemed to be a financial product and thus does not require a Financial Services Licence (AFSL) to be recommended, the minute that property is to be acquired by or through an SMSF, an AFSL is required.”

But anyone planning to purchase an investment property through an SMSF needs not only to sign up a financial planner and an accountant; they are also almost certainly going to need a broker on their team. This is the opportunity that many brokers will want to seize with both hands.

By seeking advice, trustees will come armed with the various options available for achieving their desired goals.

“If an investment in property via an SMSF is an appropriate strategy and structure and investment, then by all means continue,” says Mr Goldstien.