Setting up your own self-managed super fund can be a liberating experience. It puts you in the driver’s seat to steer your savings towards the best personal retirement outcome. But that does not mean you have open slather.
There are strict rules governing how much money you can put into your super fund at concessional tax rates, what investments are allowed and how they are funded.
The reason for this is the ‘sole purpose test’. That is, the sole purpose of a SMSF – or any super fund for that matter - is to provide retirement benefits to its members. More on this later.
Before the fun of investing can begin, it is important to get your head around the annual super contribution limits because mistakes can be detrimental to your wealth. Unfortunately, the contribution rules keep changing.
Under current legislation, the maximum amount you can contribute into super each year at the concessional (pre-tax) super rate of 15 per cent is capped at $25,000. Concessional contributions include employer contributions, salary sacrifice and personal contributions claimed as a tax deduction by the self-employed.
If you exceed the cap you pay additional tax of 31.5 per cent on the excess amount, on top of the normal 15 per cent.
Under changes proposed by the Gillard Government, from July 1, 2013 individuals over the age of 60 will be able to inject up to $35,000 each year into super at the 15 per cent concessional rate. This higher cap will be extended to individuals over 50 from July 1, 2014.
The government is also proposing that any excess contributions will need to be withdrawn; they will then be taxed at the member’s marginal rate plus an interest charge.
After-tax contributions where no tax deduction is claimed are capped at $150,000 a year. If you are under 65 you can bring forward these contributions as long as they do not exceed $450,000 in any three-year period.
If you are over 65 (but under 75), you are only allowed to make a maximum contribution of $150,000, and only then if you worked at least 40 hours over 30 consecutive days in the year the contribution is made. Once you turn 75 you are unable to put any more money into super.
Excess contributions are taxed at the highest marginal rate of 46.5 per cent. This applies on top of tax already paid on the contributions which means some people could pay 93 per cent on amounts above the limits.
Sole purpose test
A surprising number of SMSF trustees struggle with the concept of the sole purpose test, especially when it comes to so-called related-party transactions. Related parties include other fund members, relatives of members, employers who make contributions to the fund, business associates and their relatives.
Trustees have been known to dip into their fund to arrange a “loan” for their business or a family member. Or they buy an investment property for their fund and rent it out to their adult children or other family members.
None of these practices is allowed, even if interest or rent is charged on a commercial basis. That’s because they are deemed to deliver a pre-retirement benefit to a related party when your SMSF is meant to be working for your retirement benefit alone.
As trustee of your own SMSF, fund investments must be managed separately from personal or business assets and any sales or purchases must be made on commercial terms at full market value. You are also precluded from buying assets or lending money to fund members or other related parties.
Failure to comply with the rules can result in an audit by the Australian Taxation Office (ATO), costly penalties or worse.
As the regulator of the SMSF sector, the ATO has the power to issue fines to non-complying funds. It can also order trustees to reverse transactions, remove trustees or tax your fund at the highest marginal rates.
An extensive investment menu
Once you understand the ground rules, running your own SMSF opens up a far wider range of possible investments and investment strategies than other types of super funds. Investments may include:
- Term deposits and cash management accounts
- Managed funds, listed shares, exchange-traded funds and listed investment companies
- Residential, commercial and industrial property
- Property purchased with borrowed funds (Chapter 8 will discuss limited recourse borrowing at greater length)
- Shares in private companies with non-related parties
- Derivatives including options, warrants and CFDs (contracts for difference)
- Art and collectibles
The rules covering art, collectibles and personal use assets such as wine, antiques, boats, coins, stamps and jewellery have been tightened in recent years. If you intend holding any of these assets, you need to be clear about the ground rules.
Assets that fall into this category must be fully insured and placed in special storage away from the member’s home or office. This is to ensure they meet the sole purpose test and not used for immediate personal pleasure. If art or other collectibles are publicly displayed - on loan to an art gallery for instance - they must earn a market return.
All new investments in art and collectibles made since July 1, 2011 must comply with these rules. SMSFs with pre-existing investments have until July 1, 2016 to comply or sell.
SMSFs offer greater control and flexibility than any other type of super fund, but there are limits. The ATO has stated publicly that it is keeping a close watch on related-party transactions and excess contributions using data-matching. As trustee of your own fund, the buck stops with you.